Project Topic:
THE EFFECT OF INFLATION ON THE PERFORMANCE OF MULTINATIONAL FIRMS IN NIGERIA
CHAPTER ONE
INTRODUCTION
1.1 Background of the Study
Inflation is a sustained rise in the general level of prices of goods and services in an economy over a period of time. When the price level rises, each unit of currency buys fewer goods and services; consequently, inflation is also erosion in the purchasing power of money a loss of real value in the internal medium of exchange and unit of account in the economy. One of the main measures of price inflation is the inflation rate, the annualized percentage change in a general price index (normally the Consumer Price Index) over time (Bateman et al, 2000).
Economists generally agree that high rates of inflation and hyperinflation are caused by an excessive growth of the money supply. Views on which factors determine low to moderate rates of inflation are more varied. Low or moderate inflation may be attributed to fluctuations in real demand for goods and services, or changes in available supplies such as during scarcities, as well as to growth in the money supply. However, the consensus view is that a long sustained period of inflation is caused by money supply growing faster than the rate of economic growth (Dwivedi, 2005).
Today, most mainstream economists favor a low steady rate of inflation. Low (as opposed to zero or negative) inflation may reduce the severity of economic recessions by enabling the labor market to adjust more quickly in a downturn, and reduce the risk that a liquidity trap prevents monetary policy from stabilizing the economy. The task of keeping the rate of inflation low and stable is usually given to monetary authorities.
Measuring inflation in an economy requires objective means of differentiating changes in nominal prices on a common set of goods and services, and distinguishing them from those price shifts resulting from changes in value such as volume, quality, or performance. To measure overall inflation, the price change of a large “basket” of representative goods and services is measured. This is the purpose of a price index, which is the combined price of a “basket” of many goods and services. The combined price is the sum of the weighted average prices of items in the “basket”. A weighted price is calculated by multiplying the unit price of an item to the number of those items the average consumer purchases (John & Bernanke, 2005).
Weighted pricing is a necessary means to measuring the impact of individual unit price changes on the economy’s overall inflation. The Consumer Price Index, for example, uses data collected by surveying households to determine what proportion of the typical consumer’s overall spending is spent on specific goods and services, and weights the average prices of those items accordingly. Those weighted average prices are combined to calculate the overall price. To better relate price changes over time, indexes typically choose a “base year” price and assign it a value of 100. Index prices in subsequent years are then expressed in relation to the base year price (Bateman et al, 2000).
Inflation measures are often modified over time, either for the relative weight of goods in the basket, or in the way in which goods and services from the present are compared with goods and services from the past. Over time adjustments are made to the type of goods and services selected in order to reflect changes in the types of goods and services purchased by ‘typical consumers’. New products may be introduced, older products disappear, the quality of existing products may change, and consumer preferences can shift. Both the types of goods and services which are included in the “basket” and the weighted price used in inflation measures will be changed over time in order to keep pace with the changing marketplace (Ncebere, 2003).
Inflation numbers are often seasonally adjusted in order to differentiate expected cyclical cost shifts. For example, home heating costs are expected to rise in colder months, and seasonal adjustments are often used when measuring for inflation to compensate for cyclical spikes in energy or fuel demand. Inflation numbers may be averaged or otherwise subjected to statistical techniques in order to remove statistical noise and volatility of individual prices. When looking at inflation economic institutions may focus only on certain kinds of prices, or special indices, such as the core inflation index which is used by central banks to formulate monetary policy (Grant, 2000).
An increase in the general level of prices implies a decrease in the purchasing power of the currency. That is, when the general level of prices rises, each monetary unit buys fewer goods and services. The effect of inflation is not distributed evenly, and as a consequence there are hidden costs to some and benefits to others from this decrease in purchasing power. For example, with inflation lenders or depositors who are paid a fixed rate of interest on loans or deposits will lose purchasing power from their interest earnings, while their borrowers benefit. Individuals or institutions with cash assets will experience a decline in the purchasing power of their holdings. Increases in payments to workers and pensioners often lag behind inflation, especially for those with fixed payments. Increases in the price level (inflation) erode the real value of money (the functional currency) and other items with an underlying monetary nature (e.g. loans and bonds). However, inflation has no effect on the real value of non-monetary items, (e.g. goods and commodities, gold, real estate). Moreover, inflation is also influenced by food prices, indicating a non-negligible role for agricultural supply constraints in inflation (Dwivedi, 2005).
According to the quantity theory of money, most exactly stated in Professor Fisher’s ” equation of exchange,” an increase in money and bank credit beyond the needs of trade at a given price level tends to raise that price level. Such is the common conception of inflation. It is quite impossible to determine the actual volume of goods that enter into trade during a certain period in a complex country like ours. The relative increase or decrease may, however, be approximated from certain indexes. The best barometers of trade, measured in physical units and not in dollars of value, are the production of the basic materials, such as coal, iron, petroleum, copper, silver, the production of agricultural commodities, the tonnage of the railroads, the tonnage of vessels entered and cleared at lake ports and seaports, the number of building permits, and the number of shares traded on the stock exchanges. The volume of money in circulation and that of bank deposit currency, as well as the velocity of both of these, can be statistically determined with a fair degree of exactness (John & Bernanke, 2005).
Performance is how well a firm can use assets from its primary mode of business and generate revenues. This term is also used as a general measure of a firm’s overall financial health over a given period of time, and can be used to compare similar firms across the same industry or to compare industries or sectors in aggregation. There are many different ways to measure financial performance, but all measures should be taken in aggregation. Line items such as revenue from operations, operating income or cash flow from operations can be used, as well as total unit sales. Furthermore, the analyst or investor may wish to look deeper into financial statements and seek out margin growth rates or any declining debt (Koivu, 2002).
1.2 Statement of the Problem
Inflation can have positive and negative effects on an economy. Negative effects of inflation include loss in stability in the real value of money and other monetary items over time; uncertainty about future inflation may discourage investment and saving, and high inflation may lead to shortages of goods if consumers begin hoarding out of concern that prices will increase in the future. Positive effects include a mitigation of economic recessions, and debt relief by reducing the real level of debt. The effect of inflation on the Kenyan economy has been experienced by various sectors in the economy including the multinational companies. Huybens and Smith (1999) argue that an increase in the rate of inflation could have at first negative consequences on financial sector performance through credit market frictions before affecting economic growth. In fact, market frictions entail the rationing of credit, which reduce intermediary activity and capital formation. The reduction of capital investment impacts negatively both on long-term economic growth and equity market activity. However, Azariadis and Smith (1996) emphasize the importance of threshold level of inflation in the relationship between inflation and performance of multinational companies.
The impact of inflation on growth, output and productivity has been one of the main issues examined in macroeconomics. Theoretical models in the money and growth literature analyze the impact of inflation on growth focusing on the effects of inflation on the steady state equilibrium of capital per output. There are three possible results regarding the impact of inflation on output and growth: money is neutral and supernatural in an optimal control frame work considering real money balances (M/P) in the utility function. The assumption that money as substitute to capital, established the positive impact of inflation on growth; this result being known as the Tobin effect. The negative impact of inflation on growth, also known as the anti-Tobin effect, is associated mainly with cash in advance models which consider money as complementary to capital (Tobin 1999).An increase in the general level of prices implies a decrease in the purchasing power of the currency. That is, when the general level of prices rises, each monetary unit buys fewer goods and services. The effect of inflation is not distributed evenly in the economy, and as a consequence there are hidden costs to some and benefits to others from this decrease in the purchasing power of money.
The research therefore seeks to find out if inflationary tendencies in Nigeria affect the growth or otherwise among multinational companies.
1.3 Objective of the Study
The main objective of the study is to examine the impact of inflation on the performance of multinational companies in Port Harcourt.
The specific objective of this study is to:
1. Examine the trend of inflation in Nigeria over the years.
2. To investigate the impact of inflation on the profitability of multinational companies in Nigeria.
3. To explore the effect of inflation on the investment of multinational companies in Nigeria.
4. To suggest visible solutions to the problems of inflation in multinational companies in Nigeria.
1.4 Research Questions
1. What is the trend of inflation in Nigeria over the years?
2. What is the impact of inflation on the profitability of multinational companies in Nigeria?
3. What are the effects of inflation on the investment of multinational companies in Nigeria?
4. What are the solutions to the problems of inflation in multinational companies in Nigeria?
1.5 Statement of Hypothesis
The following are research hypothesis.
H01: There is no significant impact of inflation on the performance of multinational firms in Port Harcourt.
H02: The trend of inflation does not exist in Nigeria over the years.
H03: Inflation does not impact on profitability of multinational firms companies in Nigeria.
H04: There does not exist any solution to inflation of the multinational companies in Nigeria.
1.6 Significance of the Study
The importance of inflation on the performance of multinational companies in Nigeria cannot be over emphasized. This research is therefore of immense significance to the Government and investors. It will help to keep Nigeria Government informed on manage the market properly to avoid inflation. With regards to the general public, it is a welcomed study because if there is improvement in the economic sector, it will help create more favourable economic environment and a better standard of living. Finally, the academia can use this work as a reference material on this issue of inflation on the performance of multinational companies in Nigeria.
1.7 Scope of the Study
This study limit scope to the impact of inflation on the performance of multinational companies in Nigeria. However the empirical investigation of inflation rates and the gross domestic product at current price in Nigeria. Cost and expenditure in cured in course of gathering and analysis of data.
1.8 Limitation of the Study
The main constraint of the study is the limited time; the specified time for the study is not adequate for a thorough research. Also, the problem of finance for printing of materials and cost of internet access for data.
1.9 Definition of Terms
Inflation: This is seen as a continues rise in the general price level. It can also be seen as a persistent rise, increase in the general price level of broad spectrum of goods and service in a country over a long period of time
Monetary Policy: This involves the rise of monetary tools adopted to reduce the quantity of money in circulation.
Financial performance: This is a subjective measure of how well a firm can use assets from its primary mode of business and generate revenues.
Profitability: This is the state of yielding financial profit or gain. It is often measured by price to earnings ratio
Return on Asset: ROA is an indicator of how profitable a company is in relation to its total assets. ROA tells you what percentage of every dollar is returned to you as profit.
Return on Equity (ROE): This is the amount of net income returned as a percentage of shareholders equity. Return on equity measures a corporation’s profitability by revealing how much profit a company generates with the money shareholders have invested
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