EFFECTS OF FOREIGN INVESTMENT INFLOWS ON MACROECONOMIC PERFORMANCE IN NIGERIA (1987-2012)

ABSTRACT

This study investigated the causal relationship between foreign investment inflows disaggregated into foreign direct investment and foreign portfolio investment inflows and macroeconomic performance in Nigeria. Most emerging economies around the world strive to attract foreign investment inflows because of the gap between the domestic savings and investment especially into the real sectors of theireconomies. This   ismost   probably   because,   foreign   investment   inflows   are   seen   as   an amalgamation of capital, technology, marketing and management of resources which are  useful  in  harnessing  host  country  resources.  Since  globalization,  the  flow of foreign investments into emerging economies has increased  and the debate on the effect of these foreign investment inflows on macro economic performance has also intensified. Nigeria is one of the largest beneficiaries  of foreign direct investment (FDI) and foreign portfolio investment (FPI) in sub-Saharan Africa. Yet their impact on  macroeconomic  performance  has  not  been  fully  ascertained.  It  is,  therefore, against the foregoing that this study sought to examine the effect of total foreign investment  inflows  on  gross  domestic  product,  exchange  rate,  inflation  rate  and interest rate in Nigeria. The study adopted the ex-post facto research design. Annual time series data for 26 years  for the period, 1987 – 2012 were sourced  from the Central Bank of Nigeria (CBN) statistical bulletin. Four hypotheses were formulated and  tested  using the  ordinary least  square  (OLS) regression  method.  The  results revealed that total foreign investment inflows had positive and significant effect on gross domestic product in Nigeria;foreign direct investment had negative impact on exchange rate while foreign portfolio investment had positive impact on exchange rate. Again, total foreign investment inflows have positive and insignificant impact on inflation whereas foreign direct investment had positive impact on interest rate and foreign portfolio investment had a negative impact on interest rate. The study recommends, among others, that incentives such as tax holidays should be used to direct foreign  investment  inflows towards  non-oil  real sectors of the economy in order  to  boost  export.  This  will  obviously  lead  to  strongerexchange  rate,  lower inflation, and encourage competitive interest rate which will encourage savings and sustainable economic growth.

CHAPTER ONE

INTRODUCTION

1.2      BACKGROUND TO THE STUDY

Globalization is the process through which economies, societies and cultures relate through trade, transportation and communication. Economic theory clearly points to the tremendous potential advantages of cross-border capital flows.Neoclassical economists support the view that capital flow is beneficial because they create new resources  for capital  accumulation  and stimulate growth in developing  economies with capital shortages. Various types of these flows are welcomed to bridge the gap between domestic saving and investment that accelerate growth. Capital flow play significant  role  in  economics.  Finance  is  the  life  blood  of  any  enterprise.  With sufficient finance, an entrepreneur can get other factors of production such as labor, machinery/technology, management as well as raw materials and be involved in any other  business  activity  (Okafor  and  Arowshegbe,  2011).  According  to  Fuch- Schtindekn and Herbert (2001), foreign investments usually have absolute impact on domestic investment, and the productivity of investment, technology overflow, and household financial development. Fitzgerald (1998) theoretically argues that higher capital inflows lower interest rates, which help increase investment  and economic growth.  On  the  empirical  side,  using  data  from  seventeen  emerging  economics, Bekaert and Harvey (1998) find a positive relationship between equity capital flows and key macroeconomic indicators, including growth and inflation. Evidence from Latin  America  and  far  Eastern  economies  shows  that  capital  inflows  tend  to appreciate real exchange rates, lower interest rates, and increase consumption, investment   and   economic   growth   (Antzolatus   1996;  Calvo  1994;  Carbo   and Hernandez 1994; Fernandez-Arias and Montiel 1995, Khan and Reinhart 1995).

In contrast, the financial crisis that came up in Asia, Russia and Latin America have created doubts about the benefits of capital inflows and emphasized the necessity of capital controls. Agosin (1994) argues that capital inflows are used to finance imports and domestic consumption. Rodrik (1998) contends that capital flows have no significant impact on economic performance once the impact of other variable, such as education level, the initial level of income, the quality of government institutions, and regional dummies, are controlled for.

Foreign  investment  comes  in  two  forms:  Foreign  Direct  Investment  (FDI)  and Foreign Portfolio Investment (FPI). The former entails a controlling authority over the concerned  enterprise;  at  times  it means  setting up  of new projects.  Portfolio investment  by contrast  is essentially  a financial  transaction  – purchase  of stocks, bonds and  currencies  as assets. Many developing  economies  have over the years depended heavily on the attraction of financial resources from outside in different ways.  Official  and  private  capital  flows  including  FDI  and  FPI  as  a  way  of accelerating  their  economic  growth  (Odozi,  1988;  Ekpo, 1997;  Uremadu,  2008). Some  nations  exhibited  a choice  for  FDI since  they regard  it  as  an  avenue  for overcoming the slow trend in official and private portfolio capital flow (Uremadu,

2008). The need to draw foreign capital in non-debt constituting way is one of the reasons, why emerging  economies  wish to encourage  private capital  flows. Thus, there has been a dramatic increase in the magnitude of capital flows from countries in the North to emerging economies across the South where the need is high. According to Siamwalla (1999) the relative low yields in industrial countries together with impressive economic growth and attractive returns in developing, countries motivated investors to relocate their funds to direct investments. He assumes that the growth in international foreign investment inflow is an aftermath of good mixture of macroeconomic   variables   as   well   as   the   drift   towards   trade   globalization, international  financial  linkages  and  expansion  of  production  bases  overseas.  He further  states  that  macroeconomic   variables   are  indicators  or  main   signposts indicating the current trends in the economy. Some main macroeconomic variables identified by Keynes (1930), that study foreign inflows into an economy are gross domestic  product  (GDP),  exchange  rate,  interest  rate,  inflation  rate  and  money supply.

Nigeria as an import dependent economy needs foreign investment to enhance her investment needs. That is why since the emergence of democratic governance in May

1999, she has embarked on some concrete means to encourage cross-border investors into her domestic economy. Some of these means are: the repeal of laws that are adverse   to   foreign   investment   increase,   promulgation   of   investment   laws, introduction of policies with favorable atmosphere like ease of businesses, fast export and  import  processing  methods,  fight  against  advanced   fee  frauds,  instituting

economic and financial crimes commission. These definite measures seem to have been making positive impact on Nigeria’s foreign capital inflows (Uremadu, 2011).

Nigeria has also been a mono-cultural economy and relies heavily on crude oil as the major  means  of  foreign  exchange.  Oil  is  vulnerable  to  the  inconsistencies  of production and prices at the international market. So returns from it may be subject to serious  inconsistencies.  This  usually  results  in  mono-cultural  economies  being deficient  in  investment  capital.Poor  economic  management  is  another  feature  in Nigeria economy and which often leads to trade imbalances, persistent fiscal deficit, insufficient  domestic  savings,  low  high  inflationary  pressure,  poor infrastructural facilities,  unemployment,  low output  and  excess  dependence  on  imports (Okafor,

2012).

A close survey of the Nigeria economy indicates  that Nigeria has recorded  trade imbalances in most fiscal years, indicating that total payments surpassed total receipts in  relation  to  total  imports  and  total  exports  (Amadi,  2002).  Overall  balance  of payments became worse in 1999, 2002 and 2008 mostly because of increased outflow from capital accounts (CBN, 2009). Most of the capital outflow must be attributed to increased  importation, declining  exports mainly non-oil  subsector  and particularly due to external debt servicing required in meeting up with resource gaps. Essien and Onvioduokit (1999) and Ariyo (1999) described debt servicing and reserve creation as  fluctuating  variables  that  create  dependence  on  foreign  capital  in Nigeria.Therefore,  increase in foreign investment  has stimulated  debates  about its influence on the macroeconomic performance of an emerging market like Nigeria.

1.2      STATEMENT OF THE PROBLEM

Nigeria is one of the largest  beneficiaries  of foreign  direct  investment  (FDI) and foreign  portfolio  investment  (FDI)  in  sub-Saharan  Africa  (Eboh,2013),  but  their impacts on macroeconomic performance have not been fully established.

Nigeria’s macroeconomic  performance  in the two decades preceding  reforms was generally negative (Ngozi and Philip, 2007). From 1992 to 2002, the annual GDP had an average  of about 2.25 percent  with a projected  population  growth of 2.80 per annum. This led to a reduction in per capita GDP over the years and which resulted in a decline of living standards of the citizenry. However, in recent years the real GDP

(at 1990 factor cost) is 7.0%, 8.0%, 7.4% and 6.3% in 2009, 2010, 2011 and 2012 respectively. The inflation level which is also an indicator of macroeconomic performance was averaging about 28.94 percent per annum over the same period, but has down gone to 10.8 percent in 2011 while slightly increasing to 12.2% in 2012. Capital inflows have been associated with a marked appreciation of the real exchange rate in most countries (Calvo, Ceiderman and Reinhart, 1993). In the case of United States net capital inflows have acted to reduce nominal interest rates (Willie, Belton and Cebula, 1995). Again for Borio and Filardo (2006) and Ercakar (2001) strong inflow  of capital  into  emerging  markets  could  still be  absorbed  by the domestic economy without increasing inflation.

Therefore, Fitz-Grald  (1998) theoretically  insists that higher capital inflows lower interest rates, which help increase investment and economic growth. Nigeria recorded over 20 percent of the total FDI to Africa and was rated first in 2011 with $8.92 billion as against $6.09 billion in 2010 according to World Investment Report (UNCTAD, 2012).   Also, according to CBN (2009) FPI appears to have taken the centre  stage  and  its  share  of  private  capital  flows  to  Nigeria  has  been  on  a phenomenal  increase that by 2007, FPI has surpassed  every other type of capital inflows into Nigeria with official flows and bank loans declining in real terms. So, as consecutive  governments make it their core objective  to keep the economy open, capital inflows through investments soared.

However  these  increases  in  foreign  investments  have  stimulated  intense  debates about their impact of an emerging economy like Nigeria. While some proponents stress its positive impacts on growth, critics express anxiety about its volatile nature whose flexibility could be unsustainable and adversely affect macroeconomic performance.

In Nigeria, however, the macroeconomic performance has generally been on the increase (Olutu and Kaine, 2011), foreign capital inflow, particularly in the area of foreign direct investment  and foreign portfolio  investment,  seem to coincide with increased macroeconomic performance. Particularly, since 1986 total value of shares traded (TVT) and real Gross Domestic Product (GDP) have been on the increase respectively  (CBN,  2010).  Could  foreign  investment  be  said  to  have  caused  the increase in macroeconomic performance? This is the crux of the matter. This study

departs  basically  from  existing  studies  for  Nigeria  because  previous  studies  like Olutu, et al (2011); Amadi (2002), Ayanwale (2007) examine either FDI or FPI and one specific effect, where as this study is examining FDI, FPI and a set of macroeconomic  variables (GDP, exchange rate, inflation  rate and interest  rate) to better assess the simultaneous  effects  of foreign  investment  inflows on macroeconomic performance in Nigeria.

1.3      OBJECTIVES OF THE STUDY

The main objective of this study is to examine the effect of total foreign investment inflows, disaggregated into foreign direct investment (FDI) and foreign portfolio investment  (FPI)  on  macroeconomic  performance  of the  Nigerian  economy.  The specific objectives to assess are –

1.        The impact of foreign direct investment and foreign portfolio investment on economic growth.

2.        The effect of foreign direct investment and foreign portfolio investment on exchange rate.

3.        The impact of foreign direct investment and foreign portfolio investment on inflation rate.

4.        The effect of foreign direct investment and foreign portfolio investment on interest rate.

1.4      RESEARCH QUESTIONS

The research questions that guided this research are:

1.        To what extent do foreign direct investment and foreign portfolio investment have positive and significant impact on economic growth?

2.        To what extent do foreign direct investment and foreign portfolio investment have positive and significant impact on exchange rate?

3.        How far do foreign direct investment and foreign portfolio investment have positive and significant impact on inflation rate?

4.         How far do foreign direct investment and foreign portfolio investment have

positive and significant impact on interest rate?

1.5      RESEARCH HYPOTHESES

The research hypotheses for this study are:

H01:    Foreign  direct  investment  and  foreign  portfolio  investment  do  not  have positive and significant impact on economic growth.

H02:    Foreign  direct  investment  and  foreign  portfolio  investment  do  not  have positive and significant impact on exchange rate.

H03:    Foreign  direct  investment  and  foreign  portfolio  investment  do  not  have positive and significant impact on inflation rate.

H04:    Foreign  direct  investment  and  foreign  portfolio  investment  do  not  have positive and significant impact on interest rate.

1.6      SCOPE OF THE RESEARCH

This research studies the impact of foreign direct investment and foreign portfolio investment on macroeconomic  performance  in Nigeria over a period of 25 years:

1987-2012.The liberalization of the Nigerian economy started in 1986 but the base year of 1987 was taken in order to capture a whole year values instead of part from

1986.  Liberalization  enhanced  globalization  and  reduced  barriers  to  cross  border capital  inflows  especially  investments.  Thus,  only  foreign  direct  investment  and foreign portfolio investment will be covered in the study.

Furthermore,  the  selected  macroeconomic  variables  included  in  this  study follow Keynes  (1930)  who  identified  major  macroeconomic  variables  as gross  domestic product (GDP), exchange rate, inflation rate and interest rate.

1.7.     SIGNIFICANCE OF THE STUDY

Macroeconomic variables act as indicators or signposts signaling the current trends in an economy and so this research will be significant to:

Policy makers/Regulators

The line between policy making and regulating is thin and uncertain, because both of them make policies. The difference is that policy makers define the fundamentals and parameters within which policy making is delegated to regulators. So it is regarded in terms of macro-policy making versus micro respectively. Thus, this study will give them an overview of the nature of the relationship between foreign direct investment,

foreign portfolio investments and macroeconomic variables. This will enable them in the  formulation  of  policies  that  will  help  achieve  the  growth  objectives  of  the economy with minimal conflicts. The predictions will assist them in determining the stance of monetary policy. They may borrow a leaf from this study and importantly keep themselves watchful of the changes in the macroeconomic fundamentals.

The Government

The government will be enabled to review past years economic conditions against its policies within the same period and also afford them the opportunity to introduce fiscal and monetary policy changes for the coming year.

The Academia

There is ongoing debate on the merits and demerits of foreign investment inflows and macroeconomic performance (Bekaert and Harvey, 2001; Calvo 1994). Many researchers have endeavored to determine the nature of this relationship but most are foreign. Empirical works along this line is still scarce in Nigeria and so, this study will serve as a resource material and equally as a base upon which further research can be made.

1.8.     OPERATIONAL DEFINITION OF TERMS

The following terms are defined as they relate to this study:

Liberalization

This refers to the relaxation of previous government restriction usually in areas of social and economic policies. Thus, when a country liberalizes trade it means it has taken away tariff, subsidies and other restrictions on the flow of goods and services between countries.

Globalization

This involves increasing interaction between national economic systems, more integrated financial markets, economics of trade, higher factor mobility, free flow of technology and speed of knowledge across the world.

Economic Growth

This is the increase in the amount of goods and services produced by an economy over  time.  It  is normally  measured  as  the  percent  rate  of increase  in  real  gross domestic product (GDP). Modern  growth theory rests on the view that economic growth is the result of capital accumulation which leads to investment.

Gross Domestic Product

This refers to the market value of all final goods and services produced in a country in a given period. As a measure of the annual improvement in the standard of living of the average citizen/residence in a country, it takes into account all the production inside a country not  minding  the ownership  of production  sites whether  local  or foreign. What is important is that the production takes place within the boundaries of the country.

Macroeconomic performance: This  refers  to  an  assessment  of  how  well  a  country  is  doing  in  reaching  key objectives of government policy.

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