Impact of Exchange Rate Instability on Foreign Direct Investment in Nigeria (1981-2014)
Chapter One
Research Objective
The objective of this research study was to establish the impact of the exchange rate volatility and Foreign Direct Investment in Nigeria.
CHAPTER TWO
LITERATURE REVIEW
Introduction
This chapter is divided into five sections; the sections will cover the theories in the study, the determinants of foreign direct investment, the empirical studies, the conceptual framework and the summary of the theoretical and empirical reviews respectively.
Theories on Exchange Rates Volatility
This section presents theories that are relevant in explaining the association existing between exchange rate fluctuations and foreign direct investment in Nigeria. Three theories have been reviewed, which are: The Eclectic Paradigm; The theory of exchange rates on imperfect capital markets and the Purchasing Power Parity Theory.
The Eclectic Paradigm
Professor Dunning (1995) came up with this theory which is in itself a mix of three different but correlated theories. These theories are Ownership, Location and Internalization (OLI) which are used to describe how the factors therein contribute to changes in foreign direct investments. Ownership related advantages are those provided by intangible assets. This asset must however be considered as exclusive possessions held and owned by the company and are transferable to other firms at prices that would lead to reduction of costs to the company, or would lead to the company registering high rates of return. In his arguments, Dunning (2005) argues that when all other factors are held constant, a company with a higher level of competitive advantages, in comparison with its competitors, has a higher chance in increasing its overall production and hence increasing its global presence.
Location benefits, as explained by Denisia (2010) are used to compare the different economies, as per their strengths and opportunity. The end results of this analysis is that the most suitable country is selected to be a host country for the activities of multinational firms. The correlation existing between location and ownership advantages is that when a multinational corporation is able to host itself in the most suitable economy, it is now able to engage in the exploitation of its ownership related abilities, and thus leading to the firm engaging in foreign direct investment.
The third theory, internalization, establishes a need for the firm to be able to have an established business in each of the economies that the company sells its products or services. The firm must derive ways through which it can benefit further through foreign production as compared to the meager fees that are earned in international trade activities such as exporting and franchising. Dunning (2005) states that a corporation is more likely to get higher returns if, it engages in foreign production as opposed to the extension of its production rights to other countries. The eclectic paradigm is therefore in support of the establishment of production markets by a corporation through exploitation of its competitive advantages and the selection of suitable locations. In doing this, the corporations are not only engaging in foreign direct invetments but also gaining much more than their competitors.
The Theory of Exchange Rates on Imperfect Capital Markets
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Cushman (1985) and Itigaki (1981) are some of the researchers whose studies can be related to this theory. Itigaki (1981) in his model, found out that the depreciation of the domestic currency led to higher demands for the adoption of a different design when coming up with the end products. Cushman (1985) observed that exchange rate uncertainties were a function of timing differences. Therefore, corporations engaging in international business required an incentive above their expected gains to compensate the uncertainties relating to changes in exchange rates.
Transnational firms will only have the incentive to invest in a particular country if such investments are profitable to them. This implies that their cost of capital needs to be more than the expected returns. Uncertainty related to macroeconomic variables such as exchange rates, inflation and economic stability of foreign countries will be very key in the computation of a corporation‟s cost of capital. It is to be expected that the cost of capital will be low if such variables are not so volatile as to make them substantially risky. When exchange rates are adjusted to reflect risks relating to uncertainties, the capital costs of the corporation decreases, thus leading to an increase in the level of investments directed to foreign economies (Cushman, 1985).
Theory of Purchasing Power Parity (PPP)
The purchasing power parity theory was first established by a Swedish economist, Cassel, in 1918. Cassel developed this theory when he was trying to investigate the currencies of different economies, and how they were correlated. The theory thus explains the prices of goods and services in different economies, and how this prices are affected by the translation rates of the different currencies. Therefore, if a unit of a currency in one economy is to have similar purchasing power with a different currency of a different economy, then the translation rates of these two currencies ought to be the same as the ratio of the price levels in the two economies. A similar amount of money that is able to buy a specific combination of services or goods in one economy should also be able to buy the same combination of services and goods in a different economy (Sarno & Taylor, 2002). When using this theory, one is able to compute the value of the currencies of different economy, and estimate the required adjustments that could be made to the translation rates of different currencies of the economies under investigation, so as to have the translation rates being equal to the purchasing power of the economies (Mishkin & Eakins, 2009). The theory borrows heavily from the law of one price and would hold when there is international goods arbitrage.
Purchasing power parity could be absolute or relative. When the purchasing power of the local currency is the same as that of the currency being used by another economy transalted using the prevailing market rates, then the form of PPP is absolute. However, for relative PPP, changes in exchange rates are compared to inflation changes. If the percentage change in the translation rates of two currencies counterpoises the change that occurred in the rate of inflation of the two economies in a specific period of time, this is relative purchasing power parity (Sarno & Taylor, 2002).
The purchasing power parity theory, however, has inherent limitations due to the assumptions it is built around. It assumes that transportation costs are negligible, abstraction of taxes and tariffs, consumption baskets are identical, no arbitrage profits. It also assumes that the expenses of goods remain the same across borders that all traders have the same amount of information regarding prices and exchange rates across all the countries and that firms would price their goods the same way across all the markets. Perfect markets seldom exist in real world, and thus it would be hard for these assumptions to hold. However, significant these assumptions are, they are still not compelling enough to discard the theory (Froot & Stein, 1991).
CHAPTER THREE
RESEARCH METHODOLOGY
Introduction
This chapter presents information on the research design, the population, and sample that was selected for the study. In this section, we will also discuss the data collection methods, data analysis and presentation techniques that were used in this study.
Research Design
According to Kothari (2004), a research design is a frame of methods and procedures for the acquisition of information that is needed. It is the overall framework of the project that stipulates the information that is to be collected, from which source and by what procedures.
This study used a descriptive-explanatory research design to investigate the impact of exchange rates and foreign direct investment. A critical research seeks to explain the phenomena being studied; to determine the correlation between exchange rates and FDI while a descriptive research design is typically outlined with the aim of providing a general picture of a given situation as it unfolds naturally. It is usually used to make a justification of current practice and make an objective judgment and also help develop key theories (Kothari, 2004).
Population and Sampling
A population is an entire group of individuals, events or objects having the same observable characteristics (Mugenda&Mugenda2003). Each population has some unique features that differentiate it from the other. This study investigated the relationship between exchange rates volatility and FDI using secondary and time series data. Time series data was utilized for both exchange rate and FDI.
The study focused on aggregate data collected from the Nigerian economy from 1981 to 2014. This period was considered long enough to provide sufficient variables to assist in establishing the impact of exchange rates and foreign direct investments in Nigeria. This period was chosen in order to capture the most recent data and to give results that are conclusive and reflect the current trend.
CHAPTER FOUR
DATA ANALYSIS, FINDINGS, AND DISCUSSION
Introduction
This chapter focused on the analysis of the collected data from the central bank of Nigeria to establish the impact of exchange rate movement and foreign direct investment for the period between 1981-2014.The results were analyzed using descriptive statistics, tabulated and graphically presented as shown in the following sections.
CHAPTER FIVE
SUMMARY, FINDINGS, AND RECOMMENDATIONS
Introduction
This chapter tends to give the account of the results of this study, conclusions, and recommendations for practice and areas for further research.
Summary
The objective of this survey was to establish the impact of exchange rate movement and foreign direct investment for the period between 1981 and 2014. From the analysis of the finding, it was found that average foreign direct investment from different sectors of the economy remained steady between 1981 and 2005 with a significant increase in 2007 followed by a drastic decrease in 2008. The period between 2012 and 2014 showed a gradual increase in the foreign direct investment in the country. From the analysis of inflation rate between 1981 and 2014, the findings show that inflation rate recorded a sharp increase between 1991 and 1994 with the highest point being in 1994. This was followed by a drastic decrease in 1995. After 1995 an upward and downward trend is observed. The economic growth rate was highest in 1972. Some of the years show a positive growth rate while others show a negative one.
The findings also found that there exists a weak positive impact of exchange rate and foreign direct investment. The results showed that economic growth and inflation rate have an insignificant negative impact on foreign direct investment.
Conclusions
This study concludes that independent variables selected for this study economic growth rate, exchange rate, and inflation rate influence foreign direct investment but to a minimal extent. It is therefore sufficient to conclude that these variables influence foreign investor‟s decisions though not to a large extent. The overall multiple regression model is statistically significant, in that it is a suitable prediction model for explaining how the selected independent variables affect the foreign direct investment.
Recommendations
Nigeria is a developing country whose population goes up day by day. An increase FDI flows will go a long way towards promoting the domestic economy and creating job opportunities for the citizens. Although the impact exchange rates have on foreign investment is weak they could still be used as a tool to increase the country‟s foreign investment.
From the findings, there is a need for policy makers to minimize the exchange rate volatility by improvising suitable plans and properly regulating the foreign exchange market. The study further recommends an emphasis on price stability since this was also found to have an influence on foreign investment.
Limitations of the Study
The study used secondary data that was obtained from the publications of Nigeria Bureau of Statistics and Central Bank of Nigeria which could be prone to shortcomings. This study was based on a thirty three years study period starting from the year 1981 to 2014. This period of the survey experienced different exchange rate systems. This may have had an impact on the study.
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- Central Bank of Nigeria Act.Cap 491
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