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The study examines the effect of exchange rate volatility on foreign investment in Nigeria for a period of 35 years (1981 to 2015). The data gathered for this study is a secondary time series data and a linear model was estimated using the OLS estimation technique. The study revealed that exchange rate volatility had a positive and significant effect on foreign direct investment in Nigeria. Based on the finding of this study, it is recommended that there is need to minimize exchange rate volatility and to keep exchange rates stable.
Given the central role of exchange rate in an economy generally, and its importance to international trade and investment in particular, the national government has increasingly felt the impact of this volatility on their own policies towards the achievement of macroeconomic objectives (Chukwudi and Madueme, 2010). It comes with no surprise why there has been an increasing research into the behavorial pattern of exchange in most economy of the world.In many emerging economies, foreign capital plays an important role in infrastructure development, technological advancement and productivity enhancement (Ullah, Haider and Azim, 2012).
Exchange rate volatility refers to the erratic fluctuation in exchange rate, occurring during periods of domestic currency appreciation or depreciation. Exchange volatility has acquired a special interest in the research works on international trade and investment. Exchange rate changes 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. Volatility of Dollar exchange rate may also affect developing countries through its effect on foreign investment inflows. According to Chukwudi and Madueme (2012) greater exchange rate volatility of the Dollar currency against Naira increases uncertainty over the return of a given investment in Nigeria.
There are several channels through which volatility of Dollar may affect developing countries. Some of the variables often mentioned as being influenced by this volatility are; trade flows, foreign investment, currency crises, debt servicing cost, portfolio composition and commodity prices.
The insufficient nature of domestic investment coupled with the high dependence on oil revenue, high poverty rate, poor capacity utilization and the need to attain economic growth (Udoka, Tapang and Roland, 2012) suggest that an enabling environment be created for foreign investment inflow to Nigeria. Foreign investment inflow could be in form of foreign direct investment (FDI), foreign portfolio investment (FPI), official inflows (OI) and commercial loans (CL) (Jeffrey and Spaulding, 2005). According to Ndem, Okoronkwo and Nwamuo (2014), the composition of foreign investment inflow to developing countries in general and Nigeria in particular has shifted from commercial loans to foreign direct investment (FDI) and portfolio investment. Between the periods of 1970s to 1980s, commercial loans were the primary form of capital flow to the Nigerian economy. This was due to the restrictions and capital controls placed by the country as part of the policy of import substitution industrialization strategy aimed at conserving foreign exchange and protecting domestic industries (Ndem, Okoronkwo and Nwamuo, 2014).
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 cited in Osinubi, 2009). Given these significant roles of Foreign Investment 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 volatility. The existing literature has been split on this issue, with some studies finding a positive effect of exchange rate volatility on FDI, and others finding a negative effect. A positive effect can be justified with the view that Foreign Investment is export substituting. Increases in exchange rate volatility 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). However, most studies of this nature focused more the effect of exchange volatility on foreign investment and not the other way round, as such this study intends to study the effect of foreign investment on exchange rate volatility in Nigeria.
Despite the increased flow of investment, especially, to developing countries, Sub-Saharan Africa (SSA) countries still lag behind other regions in attracting foreign investment. The uneven dispersion of FDI is a cause of concern since Foreign Investment is an important source of growth for developing countries. Not only can Foreign Investment 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 spillover effects. Such positive spillovers 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 volatility. The existing literature has been split on this issue, with some studies finding a positive effect of exchange rate volatility 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 volatility 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). A direct investment in a country (such as Nigeria) with a high degree of exchange rate volatility 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.
The Nigerian domestic market is large and potentially attractive to domestic and foreign investment, as attested to by port-folio investment inflow of over N23.56bn into Nigeria in 2003 and by 2011 this figure was seated at N2.69tn but however declined to N8.32bn in 2013 (CBN, 2014). According to (Osinubi and Amaghionyeodiwe, 2009) Investment income, however, has not been encouraging, which was a reflection of the sub-optimal operating environment largely resulting from inappropriate policy initiatives. The sub-optimal investment ratio in Nigeria could be traced to many factors including exchange rate instability, persistent inflationary pressure, low level of domestic savings, inadequate physical and social infrastructure, fiscal and monetary policy slippages, and low level of indigenous technology as well as political instability.
Exchange rate instability, especially after the discontinuation of the exchange rate control policy, has played a major role influencing investment income negatively in Nigeria. 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, N) 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 this figure depreciated further to 157.31 in 2013, 158.55 in 2014 and 193.28 in 2015 (2015). Consequently, the premium between the official and parallel market remained wide throughout the period. This high exchange rate volatility 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 and the decline in its foreign investment from the years following 2012. 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.
In addition, several studies have been conducted to investigate the effect of exchange rate volatility in Nigeria and none has asked the question of “how does exchange rate react with high inflow of foreign capital?” As a result of the above, it becomes relevant for a study like this to investigate the effect of Foreign Investment on exchange rate volatility in the Nigerian economy.
From the above stated research problem, the following research question arises;
The broad objective of this study is to investigate the relationship between foreign investment and exchange rate volatility in Nigeria, while the specific objectives are to;
The study hypotheses as stated in their null form are given as;
Every research work is expected to be of relevance to a set of people or group of persons. Thus for this work, it is expected to explain the relationship between foreign investment and exchange rate volatility in Nigeria thus will be very useful to the government since it will enable them to know how well or how bad their monetary policy (as it relates to foreign investment) induces changes on exchange rate of the nation.To students and researchers, it will stimulate further research and act as a research reference material.
The study covers the relationship between foreign investment and exchange rate volatility and how foreign investment affects exchange rate in Nigeria for a period of 35years (1981-2015)
1.8 Limitation of the Study
One limitation of this study is with the issue of time, as the researcher is also a student who needs to allocate time to other course work. And the issue of unavailability of finance to carry out a more comprehensive research and funds for travelling to necessary institutions to obtain relevant materials limited the researcher’s work.