The
study seeks to empirically analyse the impact of exchange rate depreciation on
foreign direct investment in Nigeria
from 1981 -2014. The data for the research study was extracted from CBN
statistically bulletin volume 25, 2014 edition. The methodology is ordinary
least square were foreign direct investment was regressed on Exchange Rate,
Real Gross Domestic Product and Openness of the economy. Some econometrics test
were conducted such as the unit Root, Contegration and Vector Autoregressive
Model. The unit root result shows that
none of the variables were stationary at level, but at first differencing they
all became stationary. The contegration result shows that there is no long run
relationship among the variables. The vector autoregressive model shows that
exchange rate had an impact on economic growth. It is on this note that the
researcher recommends amongst others that: policy makers should continue on the
part of floating exchange rate policy to enable our domestic currency assume
its proper level among the committee of world currencies, for purpose of
establishing appreciation in the exchange rate of the naira, to ensure
effective economic planning and sustainable growth and development.
TITLE
PAGE i
APPROVAL
PAGE ii
DEDICATION iii
ACKNOWLEDGEMENT iv
TABLE
OF CONTENTS v
LIST
OF TABLES vii
ABSTRACT viii
CHAPTER
ONE 1
INTRODUCTION 1
1.1 Background
of the Study 1
1.2 Statement
of the Problem 3
1.3 Research
Questions 5
1.4
Objectives of the Study 6
1.5 Hypotheses
of the Study 6
1.6 Significance
of the Study 6
1.7 Scope
and Limitation of the Study 7
CHAPTER
TWO 8
LITERATURE REVIEW 8
2.1 Theoretical
Literature 8
2.1.1 The
Optimal Currency Area (OCA) Theory 9
2.1.2 The
Elasticity Theory of Trade and Exchange 10
2.1.3 The
Two-Gap Theory 14
2.1.4 The
Flow Theory of Capital Movement 15
2.1.5 Dunning Eclectic Theory 16
2.2 Empirical
Literature 17
2.2.1 Exchange
Rate Levels 21
2.2.2 The
Behavioural Pattern of Foreign Direct Investment and Exchange Rate
in Nigeria 24
2.2.3 Analysis
of the Trends and Behavioural Pattern of the Naira Exchange Rate and
Foreign Direct Investment in Nigeria 24
2.2.4 Trends
under the Exchange Control Era 25
2.2.5 Trends
under the Flexible Exchange Rate 26
2.2.6 Trends
under the Deregulated, Fixed and Dual Exchange Rate Regimes 27
2.2.7 Exchange
Rate Movements and Foreign Direct Investments 29
CHAPTER
THREE 30
RESEARCH METHODOLOGY 30
3.1 Research
Design 30
3.2 Model
Specification 30
3.3 Estimation
Procedure 31
3.3.1 Unit
Root Test 31
3.3.2 Co-integration
test 32
3.3.3 Error
Correction Mechanisms (ECM) 33
3.3.4 Granger
Causality Test 33
3.4 Data
Discussion 34
3.5 Data
Sources 35
CHAPTER
FOUR 36
PRESENTATION AND ANALYSIS OF RESULTS 36
4.1. Unit
Root Test 36
4.2 Co-integration
Test
4.3 Vector
Auto Regression Model (VAR) 38
4.4 Implication
of the Study 40
CHAPTER
FIVE 41
SUMMARY OF FINDINGS, CONCLUSION AND RECOMMENDATION 41
5.1 Summary
of Findings 41
5.2 Conclusion 41
5.3 Policy
Recommendations 42
REFERENCES 44
APPENDIX 47
Table 4.1: Augmented Dickey Fuller Unit Root Test 36
Table 4.2: Johansen cointegration test for the series; FDI, EXC, RGDP & OPEN 37
The
developing countries of the world face a number of problems. The one of the
major problems is scarce financial resources, with the passage of time
investment needs to increase along with other things, these needs in the LDCs
are fulfilled by the capital inflow from the developed nations either in the
form of aid or foreign direct investment (Ellahi and Ahmad, 2011). FDI is
therefore, the key determinant of capital inflow that brings technological
spill over in the less developed countries (LDCs) by introducing better
production methods.
Exchange rates is defined as the domestic currency price
of a foreign currency, matter both in terms of their levels and their depreciation.
Exchange rates can influence both the total amount of foreign direct investment
that takes place and the allocation of this investment spending across a range
of countries.
Exchange
rate depreciation refers to the erratic fluctuation in exchange rate, which
could during periods of domestic currency appreciation or depreciation.
Exchange rate depreciation may lead to a major decline in future output, if
they are unpredictable and erratic. The exchange rate is therefore, an
important relative price as it has influence on the external competitiveness of
the domestic economy. Depreciation of exchange rate is a sort of risk
challenged to international traders and investors engaged in FDI. So, we may
conclude that depreciation of exchange rate is a factor that curtails the trade
volume and reduces the investment. This depreciation when appears in developed
nations causes depreciation all over the world (Chege, 2009). It is a wide
recognized fact that exchange rate depreciation in LDCs is the key factor to
bring economic depreciation all over the world (Chege, 2009).
The 1980s witnessed increased flows of investment around
the world. Total world outflows of capital in that
decade grew at an average rate of almost 30%,
more than three times the rate of world exports
at the time, with further growth experienced in the 1990s (Kosteletou and Liargovas, 2000). Despite the increased flow
of investment, especially, to developing
countries, Sub-Saharan Africa (SSA) countries
still lag behind other regions in attracting foreign direct investment. The uneven dispersion of FDI is a cause
of concern since FDI is an important source of
growth for developing countries. Not only can
FDI add to investment resources and capital formation,
it can also serve as an engine of technological development
with much of the benefits arising from positive spill
over effects. Such positive spill overs include transfers of production technology, skills, innovative capacity, and
organizational and managerial practices.
Given these significant roles of FDI in developing
economies, there have been several studies that tried
to determine the factors that influence FDI
inflows into these economies. One of such factors
that recently have been a source of debate is exchange rate and its depreciation. The existing literature has been
split on this issue, with some studies finding
a positive effect of exchange rate depreciation on
FDI, and others finding a negative effect. A positive effect can be justified with the view that FDI is export substituting.
Increases in exchange rate depreciation
between the headquarters and the host country
induce a multinational to serve the host country via a local production facility rather than exports, thereby insulating
against currency risk (Foad 2005).
Justification for a negative impact of exchange rate depreciation on
FDI can be found in the irreversibility literature pioneered by
Dixit and Pindyck (1994). A direct investment in a
country with a high degree of exchange rate depreciation
will have a more risky stream of profits. As
long as this investment is partially irreversible, there is some positive value to holding off on this investment to acquire more
information. Given that there are a finite number of potential direct
investments, countries with a high degree of currency
risk will lose out on FDI to countries with
more stable currencies (Foad 2005). One of the
countries that fall into this category (countries with a high degree of currency risk) is Nigeria. With a
population of about 130 million people, vast
mineral resources, and favourable climatic and
vegetation features, Nigeria
has the largest domestic market in Sub-Saharan
Africa. The domestic market is large and potentially
attractive to domestic and foreign investment, as attested to, by portfolio investment inflow of over N1.0 trillion
into Nigeria through the Nigerian Stock
Exchange (NSE) in 2003 (Central Bank of
Nigeria, 2004). Investment income, however, has not been encouraging, which was a reflection of the sub-optimal
operating environment largely resulting from
inappropriate policy initiatives.
Except for some years prior to the introduction of the Structural
Adjustment Programme (SAP) in 1986, gross capital
formation as a proportion of the GDP was
dismally low on annual basis. It was observed
that aggregate investment expenditure as a share
of GDP grew from 16.9% in 1970 to a peak of 29.7% in 1976, before declining to an all-time low of 7.7% in 1985. Thereafter,
the highest was 11.8% of GDP in 1990, before
declining to 9.3% in 1994. Beginning from
1995, investment/GDP ratio declined significantly
to 5.8% and increased marginally to 7.0% in 1997 and remained there about, till 2004 when 7.1% was recorded. On
the average, about four-fifth of Nigeria’s
national output was consumed annually.
It is against this background that this study aims at investigating the impact
of exchange rate depreciation on foreign direct investment in Nigeria.
Since
the world has moved towards higher financial integration, a degree of openness
for foreign investments in many countries becomes higher. As both developed and
emerging economies continue to open their markets to attract foreign capital
flows and investors are becoming interested in diversifying their fund flows internationally, the role of foreign
investment is increasingly important.
The
exchange rate level effects on FDI through this channel relying on a number of
basic considerations. First, the exchange rate movement needs to be associated
with a change in the relative production costs across countries, and thus
should not be accompanied by an offsetting increase in the wages and production
costs in the destination market for investment capital. Second, the importance
of the “relative wage” channel may be diminished if the exchange rate movements
are anticipated. Anticipated exchange rate moves may be reflected in a higher
cost of financing the investment project, since interest rate parity conditions
equalize risk-adjusted expected rates of returns across countries. By this
argument, stronger FDI implications from exchange rate movements arise when
these are unanticipated and not otherwise reflected in the expected costs of
project finance for the FDI.
The sub-optimal investment ratio in Nigeria could be traced
to many factors including exchange rate depreciation,
persistent inflationary pressure, low level of
domestic savings, inadequate physical and
social infrastructure, fiscal and monetary policy slippages, low level of indigenous technology as well as
political instability. A major factor was
exchange rate depreciation, especially after
the discontinuation of the exchange rate control policy. The high lending rate, low and unstable exchange rate of the
domestic currency and the high rate of
inflation made returns on investment to be
negative in some cases and discouraged investment, especially when financed with loans. The
Naira (Nigerian currency) exchange rate witnessed a continuous slide in all the segments of the foreign
exchange market (that is, official, bureau de
change and parallel markets). In the official
market, the exchange rate depreciated progressively from N8.04 per US dollar in 1990 to N81.02 per dollar in 1995
and further to N129.22 in 2003 and N133.00 in
2004. Similarly, it depreciated from N9.62 and
N9.61 per dollar in 1990 to N141.36 and
N141.07 per dollar in 2003
in the bureau de change and parallel market, respectively.
Consequently, the premium between the official and parallel market remained wide throughout the
period. This high exchange rate depreciation
in Nigeria,
among others, led to a precarious operating
environment which can be attributed to the reason
why Nigeria
was not only unable to attract foreign investment
to its fullest potentials but also had a limited domestic investment. As such, despite the vast investment
opportunities in agriculture, industry, oil
and gas, commerce and infrastructure, very little
foreign investment capital was attracted relative to other developing countries and regions competing for global investment capital. As a result of the above, it becomes relevant for a study like this to investigate if
there exist any relationship between
FDI and exchange rate volatility or depreciation
in the Nigerian economy. It also investigates the
magnitude and direction of the effect of exchange rate and its depreciation on foreign direct investment.
Despite
all efforts, depreciation in exchange rate still persists. Could the
persistence of the problem due to inappropriate policies or gaps in the studies
already carried out? This is what this study seeks to address and in this
regards, provide evidence of the impact of exchange rate depreciation on
foreign direct investment in Nigeria.
This research work
will seek to answer the following questions;
Ø Is
there any significant impact of exchange rate depreciation on foreign direct
investment in Nigeria?
Ø Could
there be bi-directional relationship between exchange rate depreciation and
foreign direct investment in Nigeria?
Ø Does
long-run relationship exist between exchange rate depreciation and foreign
direct investment in Nigeria?
The objectives of this research work are stated as follows:
1.
To ascertain how the Nigerian exchange rate depreciation has
contributed in the optimization of output and stabilization in the Nigerian
economy.
2.
To evaluate the degree of
causality existing between exchange rate depreciation and foreign direct
investment in Nigeria.
3.
To ascertain the extent
to which long-run relationship exists between exchange rate depreciation and
foreign direct investment in Nigeria.
H0 There is no significant impact of
exchange rate depreciation on foreign direct investment in Nigeria
H0: There is no bi-directional relationship
between exchange rate depreciation and foreign direct investment in Nigeria.
H0: There is no long-run relationship existing
between exchange rate depreciation and foreign direct investment in Nigeria.
This
research work is multifaceted in purpose and significant in:
Helping
to document and analyse the current trend in the role of foreign direct
investment and exchange rate depreciation in the growth of the Nigerian economy
and evaluating the progress made from it during the past decade in attaining
long-term objectives of sustainable economic growth and improvement in the
quality of living future populations.
This research work
will be of great intellectual value to students of economics and other
discipline who would want to make further research on the impact of foreign
Direct Investment on the economic growth of Nigeria.
Lastly, it will
add to already existing body of knowledge on this topic as it will provides a
new window for further research.
The study would
cover the impact of exchange rate depreciation on foreign direct investment
(FDI) in Nigeria
within the period of 1981 - 2014. This period was chosen based on the available
data. The researcher encountered the following constraints in the course of
this work, financial constraint, data constraint, limited information due to
the type of research work and time constraint.
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