IMPACT OF FOREIGN PORTFOLIO INVESTMENT ON THE NIGERIA CAPITAL MARKET
Abstract: Foreign portfolio investment is an investment model where investors seek returns in foreign countries without any control over the firms. The study made use of Ordinary Least Square and Auto-Regressive Distributed Lag (ARDL) model which uses an abound test approach based on unrestricted error correction model (UECM) to measure the impact of Foreign Portfolio Investment on Capital Market Returns in Nigeria. The data was from the Central Bank of Nigeria Statistical Bulletin, for the period 986 to 2017. The variables used in the analysis are capital market capitalization used for capital market returns (dependent variable), while foreign portfolio investment, exchange rate, and interest rates were used as independent variables. The coefficients of the exchange rate and FPI are positive which implies that any change in the variables will change the capital market returns in Nigeria. The interest rate has negative and as well no significant influence on the stock market return. The results show that there is no long-run relationship between foreign portfolio investment and stock market returns in Nigeria. It was recommended that government and private individuals should provide an enabling business environment that will encourage foreign portfolio investors’ savings to enhance the capital market development.
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CHAPTER ONE
INTRODUCTION
1.1 Background to the Study
The capital market is the engine room for growth and after-all development in a modern capitalist economy. This is because it is responsible for the structure that channels long-term funds from surplus units to deficit units in the economy. Perhaps, this was the reason behind the rapid evolution of capital markets and a remarkable quantity of foreign capital inflows arising from the capital market liberalization in Nigeria that swept major emerging economies as well since the 1990s. Between 1989 and 1995, yearly average capital flows to Nigeria and other developing countries shot up to $107.6 billion in sharp contrast to $15.1 billion throughout the period of 1983 to 1988 (Singh and Weisse, 1998). Such increases in foreign portfolio investment (FPI) inflows were backed by rationalization about its relevance. From the perspective of the foreign investors, cross border investment can expand portfolio selection, particularly investment in emerging markets; where minimal correlation with developed countries aids foreign investors to spread their portfolios. For host countries, international capital can augment capital structure, advance capital market competence and efficiency and enhance corporate governance transparency.
Economic reforms and macro-economic liberalization have encouraged the proliferation of capital markets in Nigeria and in Africa which are now seen as vehicles for private capital. In spite of their marginalization by the international community foreign investors due to their perceived high risk, low liquidity and poor governance practices, capital markets in recent years have become the toast of high return-seeking investors (Osaze, 2007).
However, integration is driven by a number of factors, such as macroeconomic, political and religious factors. Through liberalization, foreign portfolio flows have been encouraged with the main aim of improving market activity and access to foreign finance. For foreign investors, the drive has been to diversify and spread investments, risk hedging and superior returns in emerging markets given the little correlation of emerging markets with developed markets (Conover, Gerald, & Robert, 2002; Allen, Isaac, & Lemma 2011).
Portfolio investment is considered to be important especially to emerging economies, as it brings with it technology, supplements foreign exchange and domestic savings for economic growth (Obstfeld, 2009; Karimo & Tobi, 2013). Hence, developing countries across the globe have been making conscious efforts to attract more portfolio investment which is believed to be a stimulus for economic growth. While foreign portfolio investment (FPI) may contribute to the well-being of the recipient country, it also exposes the vulnerability of the recipient country to global financial crises (Obadan, 2004; Pal, 2006; Rothenberg &Warnock, 2006; Kirabaeva & Razin, 2011; Osamwonyi & Ikponmwosa, 2018).In the presence of weak institutions, particularly in the financial sector, international financial integration may dampen the performance of financial markets (Edison, Levine, Ricci, & Slok,2002). Indeed, Kirabaeva and Razin(2011) observed that increasing openness to foreign portfolio investment (FPI) poses economic management challenges to countries that heavily rely on short-term foreign portfolio investment (FPI) flows due to its volatility compared to foreign direct investment (FDI). Given the merits and the demerits associated with portfolio investment, it is important to investigate the factors that drive foreign portfolio investment (FPI) and its effect on the capital market performance and its impact on the economic growth of the host economy.
Portfolio flows to emerging economies as a whole have gone through a number of stages since the implementation of financial liberalization initiatives in the 1980s. The African continent experience has not been different from this. The period from the mid-1990s to the early 2000s, the region recorded a steady increase in foreign portfolio investment (FPI) until the emergence of the Asian crisis in late 2001. Nigeria and indeed Africa has recorded the highest percentage decline in foreign portfolio investment (FPI) during the Asian crises. (Klugman, 2011).
Foreign portfolio investment (FPI) is a phase of cross-border capital flow encompassing transfer and movement of financial assets (cash, stock or bonds) across international boundaries for-profit search. It ensues as investors acquire non-controlling interests in foreign companies or purchase foreign corporate bonds issued by the government, short-term type of securities or notes. Hence, trade flows are an outcome of individuals and countries looking for how to maximize their safety and wellbeing by utilizing their own comparative advantage, these are also capital flows as individuals and nations are in the quest of making themselves better off, moving build-up of assets to where those assets are expected to be most productive (Schneider, 2003). The revocation of the Exchange Control Act, of 1962 in Nigeria has approved that foreigners are allowed to participate in the activities of the Nigerian capital Market equally as operators and investors. The internationalization of the Nigerian capital market, which was a part of the financial liberalization policy in Nigeria in the mid-2000, has also triggered an increase in inflows of foreign portfolio investment into the Nigerian capital market (Central Bank of Nigeria, 2011).
Foreign portfolio investment raises the liquidity of domestic capital markets as well it enhances the efficiency of the market. An increase in market liquidity leads to a deeper and broader market, thus allowing for a wider range of investment financing. Innovative ventures, for example, have a better probability of receiving start-up financing. Investors have a better opportunity to invest with the guarantee that they have the ability to manage their portfolio or trade their securities quickly if they need access to their savings. In this manner, markets that are liquid can also make long-term investments more attractive (Evans, 2002).
1.2 Statement of the Problem
Nigeria and indeed African countries have continued to encounter a recurrent dearth of capital and finances to fund public and also private investments. Compared to the leading advanced economies of this world, capital markets in Nigeria are nascent, emerging (or developing) and relatively still small. These characteristics present certain unique and daunting disposition to the markets in terms of evolution, management, and overall performance. Inflows of resources, depth, and width of the markets are therefore critical to market existence, sustainability and efficiency. The capital markets suffer from the problem of low liquidity, which means that it is harder to support adequately domestic business demand (Yartey & Adjasi, 2007).
Apparently, the types of resources available in the markets tend to determine the direction of depth and width of the markets. Inflows of foreign portfolio investment (FPI) to emerging economies are often viewed as essential or outrightly critical for Nigerian market performance since it has a direct effect on the capital markets (IMF, 2016; Obadan & Adegboye, 2016). Among the benefits often alluded to such inflows are that foreign portfolio investment (FPI) is increasing access to foreign funds in the financial markets thereby enhancing capital allocation efficiency improving the productivity of the financial system (Ahmed & Zlate, 2014; WEF, 2016). Foreign financial resources inflows are necessary to complement domestic financial resources to reinforce and strengthen the domestic markets and infuse the much-needed liquidity into the domestic capital markets.
However, a number of recent studies argue against such and other positive benefits of foreign portfolio investment to the financial markets of Nigeria and other developing economies. For example, episodes of large foreign portfolio investment (FPI) increase the probability and impact of a sudden stop— which hurts both the capital markets and banking sector of an economy (Calvo & Reinhart, 2000; Gourinchas & Obstfeld, 2012; Osamwonyi & Ikponmwosa, 2018). In such situations, large inflows of foreign capital tend to affect both the resource base and prices in the capital market, thereby making the markets develop its own speculative dynamics, which may be guided by irrational behavior. Furthermore, Yartey and Adjasi (2007) and IMF (2016) have noted that these problems are further magnified in developing countries like Nigeria and sub-Saharan African economies where regulatory institutions are weaker and capital markets are more susceptible to greater market volatility. The higher degree of volatility on the capital markets in developing countries reduces the efficiency of the price signals in allocating investment resources.
While previous studies have focused on investigating the effects of foreign portfolio investment (FPI) on financial market growth, there is ample empirical evidence that the relationship between the two variables may also be bi-directional. Studies on other financial markets have emphasized this relationship, which has received little consideration for African markets. For instance, Shrikanth and Kishore (2012), found a cause and effect relationship between foreign portfolio investors and the Indian capital market. Also, Hsu (2013) found that market participants moved in the direction of capital market performance, thereby establishing a reverse effect of market performance on foreign capital in Taiwan. Moreover, previous studies have focused on FPI effects on the capital market performance, without considering how much inflows contribute to market instability, or how the quality of regulation helps to channel such effects in a country. Indeed, market efficiency requires a strong institutional system that improves regulatory coordination in the markets. since FPI is centered around macroeconomic elements, like interest rate differentials and exchange rate fluctuations (Dunning &Dilyard, 1999). Accordingly, it is obvious money seeks interest rates that are high including high profits, as major motives of any decision to invest.
To best of our knowledge, there is a scarcity of cross country empirical evidence on foreign portfolio investment and capital market performance in African economies. Also, the actual effects of foreign portfolio investment on the Nigerian economy have not been known in the face of shocks to the market or instructional guidance. It is important to understand the patterns of FPI inflows into Nigeria in terms of stability, regularity, and intra-sectoral distributions. This is important in fully identifying the expected benefits of FPI in Nigeria and among African economies. This study, therefore, targets to fills these gaps in the investigation.
1.3 Aim and Objective of the Study
The broad objective of this study is to empirically investigate the impact of foreign portfolio investment on the Nigerian capital market. The specific objectives are to:
- Examine the relationship between equity portfolio and dividend in Nigeria Capital Market.
- Examine the effect of the bond portfolio on bond- yield in Nigeria Capital Market.
- Examine the contribution of equity-portfolio on capital-gain on stocks in the Nigeria Capital Market.
- Examine the effect of FPI on the volatility of the Nigeria Capital Market.
- Examine how FPI inflow affects market liquidity in Nigeria Capital Market.
1.4 Research Questions/ Hypotheses
1.4.1 Research Questions.
The identified gap, therefore, forms the following research questions which this study seeks to provide answers to.
- Is there any significant effect equity portfolio has on dividends in Nigeria Capital Market?
- Is there any significant effect bond portfolio has on bond- yield in Nigeria Capital Market?
- Is there any significant effect equity-portfolio flow have on capital- gain on stocks in the Nigeria Capital Market?
- Is there any significant effect FPI has on the volatility of the Nigeria Capital Markets?
- Is there any significant effect FPI has on the liquidity of the Nigeria Capital Market?
1.4.2 Hypotheses of the Study
The following hypotheses have been formulated as a guide to finding an answer to the research questions. The hypotheses are stated in the null form.
Ho1: There is no significant relationship between equity-portfolio and dividend in the Nigeria Capital Market.
Ho2: There is no significant relationship between bond- portfolio and bond-yield in the Nigeria Capital Market.
Ho3: There is no significant relationship between equity- portfolio and capital-gain in the Nigeria Capital Markets.
Ho4: There is no significant relationship between FPI and volatility in the Nigeria Capital Markets.
Ho5: There is no significant relationship between FPI and the liquidity of the Nigeria Capital Markets.
1.5 Significance of the Study
The outcome of this study would add up a new vista to the existing literature by attempting to explore the role of foreign portfolio investment in the Nigerian capital markets, not only to affirm its need but also to appreciate the need for protective measures to prevent possible corporate distress in the situation of foreign portfolio repatriation.
Investors, on the other hand, need to know how foreign portfolio affects the capital markets in order to be able to accurately measure the intrinsic value of securities, associated risk and therefore make buying into and or divestment decisions appropriately.
Further, the findings would also provide a platform for quality discussion and debates amongst academicians and mainly economists, policymakers, professionals and corporate leaders and also provide a basis for further research regarding foreign portfolio investment and Nigerian capital markets.
This research work will also serve as a reference for a subsequent write-up and stimulate further in-depth and insightful study in this area of study.
1.6 Scope of the Study/Delimitation.
Foreign portfolio investment and its impact on Nigeria’s capital market performance as an emerging economy is actually a very broad topic. This study will be limited to the Nigerian capital market. The choice of Nigeria is anchored on the fact that it is one of the most viable markets in the region of West African countries (IMF, 2018), and also on basis of data available on our variables chosen for this study. The study will cover a period of 29 years (1990 to 2018).
The study is limited to the Nigerian capital market. This study is also limited by the fact that regularity conditions that are not always satisfied and which can affect sample performance adversely, under such weak moment conditions. Moreover, due to the fact that findings are obtained based on historical data, the future determinants of portfolio inflows of the Nigerian capital market are not reflected. Models will be judged on historical financial data which might not be an accurate predictor of future values. However, time series analysis help researchers predict the one next period value base on the past and present value since the data is to over a wide range of periods. The result of our analysis may be strongly influenced by other factors not captured in our models responsible for its stochastic trending nature. The period covered by the study is characterized by unique events that may impact on the study results. We are limited to the data provided by the Nigeria Stock Exchange, (NSE), Central Bank of Nigeria (CBN) based on the variables of the study. The validity and reliability of the data can only be proved by CBN and NSE.
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