THE IMPACT OF EXCHANGE RATE AND INFLATION ON FOREIGN DIRECT INVESTMENT IN NIGERIA AND THEIR RELATIONSHIP TO ECONOMIC GROWTH

CHAPTER ONE

INTRODUCTION

BACKGROUND OF THE STUDY: The lack of available cash for investment is a problem that plagues the economies of most emerging countries. As a result, many countries are struggling economically. In an effort to improve the situation, the governments of these countries have shifted their attention to investments, particularly direct foreign investment, which will not only ensure employment but will also have a good impact on economic growth and development (Krugman, 2022). Foreign direct investment (FDI) is required to narrow the gap that exists between the targeted level of gross domestic investment and the level of domestic savings. According to Lucas (2022), FDI is predicted to contribute to economic growth not just by bringing foreign capital but also by crowding in extra domestic investment. This is because FDI is expected to crowd in additional domestic investment. Through the development of both forward and backward links with the domestic economy, it is possible to indirectly generate additional employment opportunities and to encourage further economic activity.

According to McAleese (2022), foreign direct investment helps fill the gap in domestic revenue-generation in an economy that is developing. This is significant given that the governments of the majority of developing countries do not appear to be able to generate sufficient revenue to meet their expenditure needs. Additional advantages come in the form of externalities and the utilisation of foreign technology. Licensing, imitation, employee training, and the introduction of new procedures are all examples of the types of externalities that might be caused by foreign companies in this scenario (McAleese, 2022).

The term "foreign direct investment" refers to the use of resources from the outside, such as finance, managerial and marketing expertise, and technological know-how. The combined effect of all of these factors has a significant bearing on the productive capacities of the host nation. The ability of the government to control an adequate amount of foreign direct investment (FDI) consisting of managerial, capital, and technological resources to boast the economy's existing production capacity is a major factor in determining the success of policies aimed at stimulating the productive base of the economy. Even though the government of Nigeria has been working hard to create an environment that is friendly to foreign investment, there has not been a significant increase in the amount of money that has been invested in the country from outside sources. Given the resource base of the Nigerian economy, the country's strategy regarding foreign investment should be geared toward attracting and encouraging an increase in the flow of international money (McAleese, 2022). The underdeveloped condition of the economy of the country, which has, in essence, slowed down the rate of her economic development, is what gave rise to the requirement for the country to receive foreign direct investment (FDI). In general, the policy methods of the Nigerian government towards foreign investments are defined by two primary objectives, which are the desire for economic independence and the requirement for economic progress.

1.2    STATEMENT OF THE PROBLEM

An analysis of foreign flow into the country so far have revealed that only a limited number of multinationals or their subsidiaries have made Foreign Direct Investment in the country. Added to this problem of insufficient inflow of FDI is the inability to retain the Foreign Direct Investment which has already come into the country. Also what effect have foreign direct investment have on such variables as- Gross Domestic Product (GDP) and Balance of Payment (BOP).  Moreover, what effect does inflation and exchange rate have on Foreign Direct Investment. However the focus of this paper is on the effect of inflation and exchange rate and the bidirectional influences between FDI and economic growth in Nigeria. According to Ayanwale (2007). The relationship between FDI and economic growth in Nigeria is yet unclear, and that recent evidence shows that the relationship may be country and period specific. Therefore there is the need to carry out more study on their relationship. Developing countries economic difficulties do not originate in their isolation from advance countries. The most powerful obstacle to their development comes from the way they are joined to the international system. Also an economic policy that can provide a conducive economic environment that will help to attract FDI inflows into the country is desired. However the characteristics of monetary policy according to Kiat (2008) present the impossible trinity that is a dilemma problem where trade-offs must be done in order to maintain economic stability. Two of these anchors are inflation autonomy and exchange rate variability. These trade-offs can impact on the on FDI inflow (Lahreche-Revil and Benassy-Quere, 2002; Gelb, 2005; Umezaki, 2006) as cited by Kiat (2008). Foreign direct investment (FDI) is a major component of capital flow for developing countries, its contribution towards economic growth is widely argued, but most researchers concur that the benefits outweigh its cost on the economy. (Musila and Sigue, 2006). Me Aleese (2004) states that "FDI embodies a package of potential growth enhancing attributes such as technology and access to international market" but the host country must satisfy certain preconditions in order to absorb and retain these benefits and not all emerging markets possess such qualities. (Boransztain De Gregorio and Lee 1998, and Collier and Dollar, 2001).

1.3    RESEARCH OBJECTIVES

The general of objective of this study is to determine the exchange rate and inflation of on foreign direct investment and its relationship with Economic growth in Nigeria,

The specific objectives are:

i.        To examine the effect of exchange rate and inflation on Foreign Direct Investment

ii        To determine the extent to which foreign direct investment affect Gross Domestic product in Nigeria.

1.4    RESEARCH QUESTIONS

Based on the research problems and objectives mentioned above, the following research questions were formed.

i.        what is exchange rate and inflation?

ii.       What are the relationship between exchange rate and inflation?

iii.      How does exchange rate and inflation affect Foreign Direct Investment in Nigeria?

iv.      What is the impact of Foreign Direct investment on Gross Domestic Product in Nigeria?

1.5    RESEARCH HYPOTHESIS

The following were formulated to test the impact of exchange rate and inflation on Foreign Direct investment and its relationship with economic growth in Nigeria.

HYPOTHESIS ONE

Ho:   There is no significant effect of foreign exchange rate and inflation on FDI.

Hi:    There is significant effect of foreign exchange rate and inflation on FDI.

HYPOTHESIS TWO

Ho:   There is no significant relationship between GDP and FDI

Hi:    There is significant relationship between GDP and FDI

1.6    MODEL SPECIFICATION

This study is based on the assumption that the inflow of FDI affects economic growth in Nigeria (GDP).

And again, that inflation and exchange rate in turn affect the inflow of Foreign Direct Investment (FDI). Hence the model:

MODEL 1

FDI = f (INFL., EXR.) ……… (2)

Where:

FDI = inflow of Foreign Direct Investment

INFL = Inflation rate

EXR. = Exchange rate

FDI = βo +βI  INFL +β2 EXR +u ----- Equation 1

Where:

α0 = the intercept for equations (1)

β0 = the intercept for equation (2)

αI= the parameter estimate of FDI.

βI = the parameter estimate of INFL.

β2 = the parameter estimate of EXR.

u = the random variable or error term.

MODEL 2

GDP = f (FDI) ……….  (1)

GDP = bo+ bi FDI +U

Where:

Bo= constant, bi = coefficient of FDI and u = Error term.

1.7    SIGNIFICANCE OF STUDY

The significance of this study is to add to the general body of knowledge, enlighten the general public on the impact of exchange rate and inflation on Foreign Direct investment and its relationship to economic growth in Nigeria. It will also help the government to map out strategies that encourage foreign direct investment in Nigeria.

1.8     SCOPE OF STDUY AND LIMITATION

This study covering thirty year period 1990-2010 are used in this study for estimation of functions. Foreign Direct Investment inflow (FDI), Gross Domestic Product (GDP), Exchange rate (EXR) and inflation (INL) from Central Bank of Nigeria Statistic Bulletin and National Bureau Statistic.

Due to the financial constraint coupled with available, the research will make use of available materials in the Central Bank of Nigeria (CBN), National Bureau statistic and library where books relevant to the research topic will be consulted and the internet.

1.9    METHOD OF DATA COLLECTION

Annual time-series data on the variables under study covering thirty year period 1980-2010 are used in this study for estimation of functions.

Foreign Direct Investment inflow (FDI), inflation rate and exchange rate are the relevant explanatory variables. Equally, the Gross Domestic Product. The Gross Domestic Product is the quantitative variable that measures economic performance of a country. Data were collected from various editions of the various issues of Central Bank of Nigeria Economic and financial Review; and Central bank of Nigeria Statistical bulletin.

1.10 ORGANIZATION OF THE STUDY

This study is divided into five parts. Part one above is the introduction which is background of the study, research problem, objective of the study, research questions, research hypothesis, model specification, significance of the study, Scope and limitation of the study and organization of the study. Part two reviews the relevant literature, part three discusses the methodology employed in this study, and part four is data presentation and analysis while part five focus on summary, conclusion and recommendation.