INTEREST RATE, EXCHANGE RATE AND FOREIGN DIRECT INVESTMENT PERFORMANCE ON THE NIGERIA ECONOMY

INTEREST RATE, EXCHANGE RATE, AND FOREIGN DIRECT INVESTMENT PERFORMANCE ON THE NIGERIA ECONOMY

The major purpose of the study is to empirically ascertain the relationship between interest rate, exchange rate, and foreign direct investment on the performance of Nigeria’s economy.

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CHAPTER ONE

INTRODUCTION

•   Overview of the Study

In a precise term, foreign direct investment has a financially viable spillover effect on an economy. It is considered as a measure of ownership of assets by a foreign investing country. Foreign direct investment is a vital ingredient in achieving sustained growth of any nation, including Nigeria. The foreign direct investment serves as a critical factor that helps to propel the economic growth of every nation Calin-Adrian, Elena, Valentina, and Daniel (2018). Undoubtedly, over the last three decades, foreign direct investment has emerged as one of the most important sources of globalization and an important catalyst for economic growth,  transferring technology and knowledge between participating countries.  Foreign direct investment offers advantages to both the investor and the foreign host country.  There are two types of foreign direct investment. They include horizontal and vertical foreign direct investment, the formal (horizontal) is the most common type of foreign direct investment in which a company merges with another company of another country to get stronger in the market and the products/services offered are homogeneous. It’s observed to have a piece of market share in the foreign market and next to reduce competition. These types of foreign direct investments replace exports from the home country to the host country. While the later (vertical) foreign direct investment occurs when a company of one country acquires or merges with another company of different countries just to add more value to their value chain, it would be called vertical foreign direct investment.

Note worth, foreign direct investment in a country with a high degree of exchange rate volatility will have a riskier 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 foreign direct investment to countries with more stable currencies. Foreign direct investment flows, record the value of cross-border transactions related to direct investment during a given period, usually a quarter or a year. Financial flows consist of equity transactions, reinvestment of earnings, and intercompany debt transactions. Outward flows represent transactions that increase the investment that investors in the reporting economy have in enterprises in a foreign economy, such as through purchases of equity or reinvestment of earnings, less any transactions that decrease the investment that investors in the reporting economy have in enterprises in a foreign economy, such as sales of equity or borrowing by the resident investor from the foreign enterprise. Inward flows represent transactions that increase the investment that foreign investors have in enterprises resident in the reporting economy fewer transactions that decrease the investment of foreign investors in resident enterprises.

Relatively, the interrelationships between interest rate, exchange rate,  foreign direct investment, and economic development in emerging economies are dynamic depending on the absorbing capacity of the country and her responsiveness to technology.  The role played by foreign direct investment in actualizing economic development in a  nation cannot be underestimated.  As such,  across the border transaction is celebrated mostly in the developing countries as it is seen as an avenue to promote and encourage inflows of technology,  skill,  materials and bridge the gap between savings,  exchange rate, and government spending  (Monogbe, 2016).

Arising from the foregoing,  foreign direct investment,  interest rate,  exchange rate, and inflation rate are all interrelated through the web of globalization in recent years for development purposes.  Some researchers have reported that abortive move in  Foreign  Direct Investment is caused by changes in exchange rate and interest rate volatilities while others see it the other way round. The effect of the instability of interest rate and the exchange rate is very significant to foreign direct investment inflow to a  developing nation like Nigeria experiencing transition and emerging markets.  A  rise in interest rate will cause an increase in the current real exchange rate.  Hence the variation between exchange rate and interest rate consistently correlates to foreign direct investment inflows and thus amplified economic development.

Foreign direct investment inflows are essential for an emerging resource-based economy like Nigeria Monogbe and John, (2017). Generally, the high-interest rate on loanable funds increases the cost of capital which invariably discourages investors from accumulating more capital, and consequently discourages Foreign  Investment. This, therefore, suggest that a reasonable level of economic development could be attained with a minimal level of interest rate which further encourages currency exchange and thus attracts foreign investors. The exchange rate is the measure of the worth of domestic currency in terms of foreign currency. The exchange rate can either be nominal or real. The exchange rate is imperative to attract  Foreign  Direct  Investment, so an over-valued exchange rate will discourage exportation and affect Foreign Direct Investment negatively. Exchange rate and interest rate volatility has grown overtime and such economic variations can result in significant depreciation in the value of assets invested by investors in the host country as well as the future profits created by the investment. Investments in a nation like Nigeria will have a more risky stream of profits due to the high degree of volatility of interest rate and exchange rate.

Another factor connecting the exchange rate and interest rate to foreign direct investment, and their associated relationship to economic development is via its impact on inflation. Since nominal interest rate depends on anticipated inflation, while the nominal exchange rate is determined by the relative rate of domestic and foreign inflation, an inflation shock will affect both nominal interest rate and exchange rate and thus has a spillover effect on economic development.

Inflation equally has a role to play in the development of the nation. Three theoretical rationales explain the impact of inflation on FDI: Nnadi and Soobaroyen, (2015) observed that inflation is a measure of macro-economic instability and that higher inflation rate could chase away prospective and already existing foreign investors.

•  Statement of the Problem

One of the core essences of investors (countries) investing in foreign direct investment is to increase her scale of economic value in the of capital formation. Despite the increased flow of investment, especially, to developing countries, Sub-Saharan Africa (SSA) countries Nigeria inclusive, still lag behind others in attracting foreign direct investment. The uneven dispersion of foreign direct investment is a cause of concern since it is an important source of growth for developing countries. Not only can foreign direct investment add to investment resources and capital formation, but it also serves as an engine of technological development with much of the benefits arising from positive spillover effects. The formation of capital plays an important role in achieving sustainable economic development. Developing economies rely on foreign capital and construct policies to attract foreign direct investment Calin-Adrian, Elena, Valentina, and Daniel (2018).

Given these significant roles of foreign direct investment in developing economies, Tere is a need to determine the factors that influence foreign direct investment inflows into the economies. This high exchange rate instability in Nigeria, may among others, led to an unwarranted operating environment which can be attributed to the reason why Nigeria was not only unable to attract foreign investment to its fullest potentials. 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.

From the foregoing, it becomes relevant for a study like this to investigate and examine the relationship between interest rate, exchange rate in the Nigerian economy, the variables outlined are macroeconomic variables Odili, (2015).

Although several studies have been carried out in the past, less attention has been given to the area of examining the relationship between interest rate, exchange rate, and foreign direct investment. This has led to the creation of a knowledge gap, thereby making it look as though there is no relationship between interest rate, exchange rate, and foreign direct investment.

•  Purpose of the Study

The major purpose of the study is to empirically ascertain the relationship between interest rate, exchange rate, and foreign direct investment on the performance of Nigeria’s economy. While the specific purpose is as follows:

1. To examine the relationship between the interest rate and gross domestic product in Nigeria.
2. To examine the relationship that exists between the exchange rate and gross domestic product in Nigeria.
3. To examine the relationship between foreign direct investment and gross domestic product in Nigeria

•  Research Questions

This study is guided by some research questions formulated to achieve the objective of the study. They include the following:

1. What is the extent of the relationship between the interest rate and gross domestic product in Nigeria?
2. What is the extent of the relationship between the exchange rate and gross domestic product in Nigeria?
3. What is the extent of the relationship between foreign direct investment and gross domestic product in Nigeria?

•  Hypotheses

The following hypotheses were drawn in the course of this study.

H0₁: There is no significant relationship between the interest rate and gross domestic product.

H0₂: There is no significant relationship between the exchange rate and gross domestic product.

H0₃: There is no significant relationship between foreign direct investment and gross domestic product.

•  Significance of the Study

The following are the significance of the study.

A thorough investigation into the study will be the bases of help to other researchers in related fields as they will find the knowledge of this work useful. It will serve as a reference point adding to existing ones in the educational resource center. It is also believed that the outcome of the empirical findings from this study will benefit among others the government, policymaker, stakeholders, and investors, etc.

•  Operational Definition of Terms
  • Interest Rate: This is the cost associated with borrowing capital for a specified period.
  • Exchange Rate:  is the price of one currency in terms of another currency. It can be either fixed or floating.
  • Horizontal FDI: Arises when a firm duplicates it’s home country-based activities at the same value chain stage in a host country through foreign direct investment. Horizontal foreign direct investment refers to the establishment of homogenous plants in foreign locations as a means of supplying certain goods in a foreign country. This type of foreign direct investment replaces exports from the home country to the host country.
  • Vertical FDI: Takes place when a firm through foreign direct investment moves upstream or downstream in different value chains i.e. when firms perform value-adding activities stage by stage in a vertical fashion in a host country.
  • Inflation: This is referred to as the persistent increase in the general price of goods and services within an economic territory.
  • Foreign Direct Investment: This is an investment involving a  long term business interest and control by a  foreign investor in another country different from that of the investor.
•  Limitations of the Study

Like most studies, there are several limitations anticipated for this study. Herein, the major constraint is the complete reliance on secondary data. The validity and reliability of data are not known by the researcher. The foregoing, constitute limitations.

•  Organization of the Study

This study is divided into five (5) chapters. The chapter provides an introduction to the subject under investigation, statement of the problem, the purpose of the study, research questions, research hypotheses, and significance of the study, definition of terms, limitation as well as the organization of the study. Chapter two present a review of the literature by different authors. It is made up of the theoretical and conceptual framework of government capital expenditure and economic growth. Chapter three described the methodology that will be used in the investigation and justification of the variables utilized. Highlights of chapter three are research design, analysis, data, and technique among others. Chapter four contains the data presentation and analysis, result. Chapter five will present discussion, conclusions, and recommendations