CAPITAL INFLOW, FINANCIAL DEVELOPMENT AND ECONOMIC

GROWTH IN NIGERIA (1981 - 2018)

Abstract

This study is as a result of diverse contention among researchers with respect to the
relationship that exist between capital inflows and economic growth on data spanning
from 1981 to 2018 using ARDL co-integration approach. The findings from the study
indicates the existence of long run relationship between foreign capital inflows and
economics growth in Nigeria. Furthermore, the ARDL regression estimate results
show that FDI, AIDS, Financial development have positive and significant impact on
economic growth while contrarily, remittances exerted a negative and insignificant
relationship with economic growth.. Also, inflation and exchange rate was found to
showcase a negative impact on economic growth. Based on the findings of this study,
we conclude that capital inflows (Foreign direct investment and Foreign Aids)
positively impacts on the Nigerian economy both in the short and long run within the
study period after controlling for financial development appropriately. Thereby
concluding that capital inflows is a potential driver of economic growth in Nigeria.
Consequently, the study recommends that the central bank should employs a more
restrictive monetary policy to suppress the adverse effect that could emanate from
inflationary pressure which can distort proper channeling of capital inflows into the
country.
 CHAPTER ONE

INTRODUCTION

1.1 Background of the study

A potentially significant benefit of investment in developing economies including

Nigeria cannot be overemphasized. This is because the need to raise savings and

attract investments to accelerate economic growth is universally acknowledged in

both developed and developing countries. Nonetheless, most developing nations still

characterized by a low level of domestic savings, which has impeded the much-

needed investment for economic growth. To corroborate the above, Frank (2016)

point out that the lack of this investible fund has limited the ability of most Sub-

saharan Africa governments to undertake public expenditures in the infrastructure

needed to increase domestic demand, create employment, and to aid growth.

Therefore, the saving-investment gap remains a significant impediment to their

growth and stability. Consequently, in order to bridge the savings-investment gap,

developing countries need some foreign savings which come in the form of capital

flows to attain a desirable level of investment that would facilitate economic growth

(Chigbu 2015). Similarly, Chenery and Strout (1966), in their two-gap theory, also

noted the need for the inflow of foreign capital in ameliorating the savings and foreign
exchange constraints in developing nations. Given the foregoing, it is not surprising

that efforts are being made by developing countries authorities to attract more foreign

capital.

This is as a result of the vital role foreign capital inflows can play in any economy via

reducing the difference between the desired gross domestic investment and domestic

savings (Vijayakumar et al. 2010). Notably, it is important to note that capital inflows

can be in various forms; foreign direct investment, foreign portfolio investment,

Remittance, foreign aid and so on. However, the focus of this study will be on three

types of capital inflows; Foreign direct investment, foreign aid and Remittance. The

study will carried out by Orji et al. (2014) documented that there are differences in the

growth impact of the various forms of foreign capital inflows in the west Africa

monetary zone. The outcome from their result indicated that more than one type of

capital inflow contributed positively to output growth in Nigeria. Foreign capital

flows take the form of foreign direct investment, foreign portfolio investments,

foreign aid, and Remittances.

Foreign Direct Investment (FDI) is the category of international investment in which

national of a country commit investible fund into the acquisition of sufficient stocks

in a new firm or an existing enterprise resident in another country to secure profit and

exercise significant management control over such firm (Akinmulegun 2011). The

literature on Foreign direct investment is vast in both developed and developing

countries. While many studies observe positive impacts of FDI on economic growth,

others also reported a negative relationship. Findings of Ekperiware & Adepoju

(2013) hold that foreign direct investment positively drives economic growth

significantly in Nigeria while results by Awe (2013) revealed a negative relationship

between economic growth and foreign direct investment in Nigeria which he

attributed to the size of the flow. Also, Akinlo (2017) noted that the flow of FDI in

Nigeria is low compared to the country's needs of external capital to support low

income and low domestic savings. Theoretically, FDI has been identified to influence

economic growth in several ways. The potential effects on the host economy include;

(1) access to new technologies, (2) augmentation of productivity, (3) increase in

employment, and (4) boost in export (Falki 2009).

Foreign portfolio investment (FPI) is an investment in which a foreigner invests in a

particular country by the purchase of stocks and bonds to obtain a return, profits, or

benefits on the funds invested. The composition of investments in a portfolio depends

on the number of factors such as investor's risk tolerance, investment horizon,

liquidity preference, and efficient portfolio selection among others as buttress by

(Nwokoma, 2003). The study also noted that a conducive business environment and a

reliable legal system had been identified as a significant attraction of foreign

investment, irrespective of how vibrant a capital market. Before 1986, Nigeria did not

record any figure on portfolio investment (outflow or inflow) in her Balance of

Payment (BOP) accounts (Adigun and ologunwa 2017).

Foreign portfolio investment benefits the investors with the acquisition of dividends,

capital gains, and interest, while interest rates, speculation, the expectation of profits,

economic conditions, political stability, and taxation policies are some of the factors

that can affect its movement (Nwokoma, 2003). While the recipient countries will

benefit as portfolio asset purchases from residents increase bank liquidity and

encourage a credit boom. In addition to the liquidity of the domestic capital market, it

favours the country's capital market development. It also leads to financial sector

development, thus strengthening the financial infrastructure and deepening the

process of financial intermediation. Dauda (2007) notes that foreign capital

investment, like portfolio investment, increases the gross domestic product (GDP) and

generates a stream of real incomes. It was observed that foreign portfolio investment

into a country will lead to more foreign exchange and could help to reduce pressure

on the exchange rate (Nwosa and Amassoma, 2014). It has been observed that the

essential characteristic of instruments classified as portfolio instruments is that they

are traded or tradable. Empirical evidence has been in diverse form, for instance,

researchers like (Acha and Essien 2018, Baghebo and Apere, 2014) reported a

positive and significant relationship between Foreign Portfolio Investment (FPI) and

Real Gross Domestic Product (RGDP).

According to Lancaster (2006), foreign aid means voluntary transfer of public

resources from one country's government to another country, NGO, or an

international organization to improve the human well-being in the country receiving

the aid. It can involve providing financial grants, training, technical advice, equipment

and commodities, such as food, health care. Foreign aid refers to different

terminologies like Official Development Assistance (ODA), grant, loan, technical and

economic assistance. Doucouliagos and Paldam (2005) as noted by Fashina et al.

(2018) pinpoint three main channels through which aid influence economic growth,

these channels are Growth-direct model, Accumulation model and Conditional

theoretical models. The Growth direct model framework used the reduced model of

the effect of aid on growth. It showed that the estimates of the direct effect of aid on

growth scattered considerably, and also added up to positive, but not statistically

significant effect on growth. Accumulation model estimated that the impacts of aid

are on either savings or investment, and showed that aid has an unclear effect on

accumulation. Conditional model estimates showed that the effect of aid on growth

depends upon a third factor, if it is favourable, it will result in positive growth and
vice versa. All the same, the aid-growth literature result remains inconclusive.

Outcome from studies like Fasanya & Onakoya (2012) and Nkoro & Furo (2012) find

a positive relationship between aid and growth in Nigeria while studies like (Mbah

and Amassoma, 2014; Bakare, 2011) lend credence to conditional model by

establishing a negative and non-significant relationship between foreign aid to Nigeria

and GDP which can be attributable to unfavourable third factors as pointed out by

Bashir (2013).

Also, International remittance, as a form of foreign capital, has contributed to the

economic growth in developing countries. International remittance is a concept

dealing with the transfer of migrant earning from one country to the other. Its

significant impact on domestic investment, domestic credit constraints, the balance of

payment, exports, levels of employment and wages, diversification of economic

activities, competitive business environment, and the provision of new technologies,

products, management skills, overtime has been a strong impetus for economic

growth. Kumar et al., (2018) identified four views concerning the relationship

between remittances and economic growth and these include the growth-led

remittances, remittances-led growth, neutrality view and the feedback view. Growth-

led remittances view says that economic growth attracts more remittances into the

country while the Remittance-led growth mentions that remittances inspire economic

growth. The feedback view suggests that both remittances and economic growth

promote each other while neutrality hypothesis stipulates that there exists no

relationship at all between remittances and economic growth. Researchers like Akano

(2013) studies lend credence to growth-led remittance view in Nigeria by noting a

uni-directional causality running from GDP to remittance inflows into Nigeria's

economy.
Even though remittance is considered to be second-largest source of foreign capital

for developing countries (Aggarwal, Demirgüc-Kunt, & Martinez Peria, 2011;

Migration and Remittances, 2016; World Bank, 2017) not only that but also a stable

means compare to other form of capital inflows (Kapur, 2006; Ratha, 2013) yet the

impact of remittances on economic growth is still ambiguous as noted by (Adigun and

ologunwa 2017; Kumar et al., 2018). The outcome of a study carried out by Anetor

(2019) in Nigeria noted that remittances exert a negative relationship with economic

growth while other literature emphasized a positive influence on economic growth

(Kumar et al., 2018; Meyer and Shera, 2017; Nyamongo et al., 2012).

Interestingly, there is the argument that it is only countries with worth-developed

financial systems that benefit significantly from capital inflows (Agbloyor et al. 2014,

Hermes and Lensink 2003, Durham 2004, Alfaro et al. 2004). Furthermore, Tyson

and Beck (2018), in their study, also noted some reasons why the government need to

focus on financial development. They point out that it will help surmount dependence

on international private capital in financing growth-related plans and the problems

that can be associated with it, such as foreign exchange risk and pro-cyclical

investment flows. Consistent with this view, the results of the study by Akinlo (2017)

shows that the main determinants of capital inflow (FDI) in Nigeria are financial

development, exchange rate, inflation, discount rate, GDP growth and macro

instability. According to Okpara et al. (2018), there exists a long-run relationship

between financial development and economic growth in Nigeria. In the same vein,

Waliu (2017) reports similar results on the significant role of financial development

on the capital inflows (FDI) in Nigeria to actualize desired growth. He established that

the positive and significant effect of capital inflows (FDI) is subject to financial

development.
1.2 Statement of Problem

This study emanated as result of diverse contention among researchers with respect to

the relationship that exist between capital inflows and economic growth across the

globe. From theoretical perspective, it is expected that an increase in capital inflows

will lead to an increase in economic growth of the recipient country. Most developing

countries like Nigeria lack capital for development, and it will have to depend

partially on foreign capital to execute some of the growth plans. In a related study,

Igan et al. (2016) noted that foreign capital serves as a means of transporting scarce

capital to recipient countries and hence may loosen such financial constraints attached

to industries that are more dependent on external finance. Therefore, the role of

foreign capital inflow is quite germane in the development of economies. According

to Harrison et al. (2004), access to foreign funds can bring about augmentation of

investment resources, relaxation of credit constraints and accordingly the facilitation

of growth.

In an attempt to re-examine the potential impact of capital inflows on economic

growth in Nigeria, thorough literature review relating to the topic of interest shows

that there is exclusively usage of one component to proxy for capital inflow that is

FDI by most researchers ( Waliu (2017), Nwosa and Emma-ebere (2017), Olusanya

(2013), Obiechina and Ukeje (2013), Ademola, (2013)) to mention but a few in the

study country of interest with less emphasis on the types of capital inflows which can

also influence the economic growth as noted by Orji (2014).

The aforementioned may be attributable to the fact that FDI is considered to be most

stable categories of capital inflows even during the economic crisis as noted by (Sula

and Willett, (2006); Obiechina and Ukeje, (2013)). Also, the study of Tyson and Beck
(2018) noted there is a broad consensus on the positive relationship between FDI and

economy in the LICs country. They further noted that different type of capital inflows

have a different relationship with economic growth. This previous result corroborates

the assertion of Orji (2014). Also, Igan et al. (2016) in their paper also noted that

although foreign direct investment (FDI) served as the primary channel through which

foreign capital reached emerging economies, financial resources may reach through

different forms.

It is against the backdrop of the aforementioned problems that this study will be

carried out to empirically examine the relationship between economic growth in

Nigeria and capital inflows indicators decomposed into Foreign direct

investment(FDI), Foreign aid(FA), and Remittance(REM). Also, exact extant research

related to the study is cross-country studies with little country-specific studies.

However, cross-country analyses have been observed to be subjected to endogeneity,

omitted variable problems, implicit assumption of a common economic structure and

the issue of causality cannot be formally handled (Cuadros et al., (2001); Khan and

Senhadji, (2003)).

The study is, therefore, undertake to examining the role of foreign capital inflows and

financial development on the economic growth in Nigeria.

1.3 Research question

1. What is the impact of capital inflows on economic growth?

2. What is the effect of effect of capital inflows and financial development on

economic growth?
1.4 Objectives of the study

The main objective of this study is to examine the impacts of capital inflows and

financial development on economic growth in Nigeria. The specific objectives of the

study:

i. To examine the impact of capital inflows on economic growth.

ii. To ascertain effect of capital inflows and financial development on economic

growth.

1.5 Justification of the study

Several recent works of literature highlight the role of capital inflows and financial

development in shaping the economic growth of a nation. They argue back and forth

on the negative and other positive benefits of capital inflows. However, the report

usually shows a complex and mixed picture on the real effects of capital inflows-

growth nexus. Thus, the nexus in different countries remains a subject of debate

between researchers (Orji et al. (2014); Frank (2016)).

The study will be of importance to further establish and review previous studies

related to the subject matter in order to educate policymakers by revealing to them the

area of capital inflows that require further attention to achieve desired growth.

The results from this research are expected to contribute to knowledge on existing

literature about capital inflows, financial development and economic growth in

Nigeria in at least two significant dimensions. First, it identifies the relationship

between the various form of capital inflows and economic growth in Nigeria.

Furthermore, despite broad consensus on the positive benefits of capital inflows, the
evidence of abject poverty, high rate of unemployment, decaying infrastructure and

others despite the massive inflows in Nigeria shows there is the missing link for its

effectiveness (Nwosa et al. 2015). Accordingly, Waliu (2017) noted that positive and

significant effect of capital inflows (FDI) in Nigeria is subject to financial

development. In the same vein, Okpara et al. (2018) find that there is a long-run

relationship between financial development and economic growth in Nigeria.

Therefore, the study extended its analysis to examine whether the presence of a sound

financial system in the recipient country is necessary for capital inflows to have the

desired effect on economic growth. Second, the study fills the gap of little or no

country-specific study on the topic of interest.

1.6 Scope of the Study

The study focuses on capital inflows being one of the essential aspects that augment

investment which in turn facilitate economic growth. Again the study focuses on

financial development since it forms an essential aspect for the effectiveness of capital

inflows in the economy. The period covers 1981 to 2018, a period of 39 years that is

long enough to reduce any biases expected estimates in the model.

1.7 Organization of the Study

Chapter one covers the introductory section of the study, which is followed by

Chapter two, which presents the literature review. Chapter three discusses the

research methodology. Chapter four presents the results of the analysis and the

discussion of findings, while chapter five involves policy recommendations and

conclusion.
 CHAPTER TWO

LITERATURE REVIEW

2.0. Introduction

This chapter is consist of theoretical and empirical framework. The theoretical

review is where theories relating to the research work is review. Similarly, the

empirical framework entails empirical findings of other researchers on this study.

2.1 THEORETICAL FRAMEWORK

2.1.1 Auerbach-Kotlikoff (AK) Dynamic Life-Cycle Simulation Model

Pagano (1993) developed the Auerbach-Kotlikoff (AK) Dynamic Life-Cycle

Simulation Model. According to (Baillui, 2000), the AK Dynamic Life-Cycle

Simulation Model explain the possible effects of financial variables (i.e., financial

development and capital flows) on growth in a closed economy.

The new growth model focuses on the role of human capital accumulation, R&D and

externalities (Romer 1996). The capital flows - growth nexus can be look into using a

simple endogenous-growth framework called the AK model which is an endogenous-

growth model that stresses the likely effects of changes in financial variables (capital

flows and financial development) on steady-state growth through their influence on

capital formation. Van den Berg and Lewer (2007) point out that the AK model was

developed as a response to the outcome of the neoclassical theory which states that, in

the absence of technological development, economic growth would in the end be

deemed to be equal to zero. The new growth theories are different from the

neoclassical growth theories in the sense that they focused on the creation of

technological knowledge and its diffusion and innovation efforts that react to

economic incentives that are regarded as major engines of growth.

2.1.2 The Two-Gap Model

The two-gap model is an extension of the Harrod-Domar growth model in which

growth is driven by physical capital formation. In the Harrod-Domar Model, output

depends upon the investment rate and the productivity of investment. A savings gap

exists if domestic savings alone are insufficient to finance the investment required to

attain a target rate of growth. In addition to the savings gap, there is also a trade or

foreign exchange gap which is based on the assumption that not all investment goods

can be produced domestically. These two gaps are combined to form the two-gap
model. More closely related to the two-gap model is the recent concern over the third

“Fiscal” gap between government revenue and expenditures, as illustrated by the

three-gap models by Bacha (1990) and Taylor (1990).

2.1.3 Push- Factor and Pull- Factor Theories

The direction of international capital flows is explained by two classes of theories,

namely; push- factor and pull- factor theories (Calvo et al, 1993). Thus, push- factor

theories attribute direction of capital flows to what happens on the international front

such as falling international interest rates, business cycles in industrial countries and

the rising trend toward international diversification (Calvo et al, 1996; Calvo and

Reinhart, 1998). Pull- factor theories, on the other hand, trace the causes of capital

flows to such domestic factors as autonomous increases in the domestic money

demand function, increases in the domestic productivity of capital, and increasing

integration of domestic capital markets with global capital markets (Agenor and

Montiel, 1999).

2.1.4 Theories of International Financial Puzzle

Finally, five views regarding finance-growth nexus debate have been identified by

Levine(1997): firstly, the views attributable to Hamilton, Bagehot and Schumpeter,

which argues that finance ignites growth; a second view traceable to Adam Smith

opines that finance hurts growth ; a third view due to Robinson is that finance is

growth led; a fourth view credited to Lucas avers that growth is finance neutral ;and a

fifth view, mainly canvassed by World bank and IMF emphasize that finance matter

because there is financial crisis. Finally, we conclude by deducing that if finance

matters, then Foreign Capital Inflows (FCI) being a part of the financial flows, needed

to finance investments, equally matters.

2.2 EMPIRICAL REVIEW

The available empirical literature on the relationship between capital inflows,

financial development and economic growth provides contrastive reports not only

about the existence of a significant link but also the signs of such relationships.

Chigbu (2015) investigated the impact of capital inflows on the economic growth of

developing economies comprising of Nigeria, Ghana and India. The data used in this

study range from the period of 1986 to 2012. The Ordinary Least Square analysis

technique was utilized to determine the significance of different factors. Findings of

the study reveal that capital inflows have a significant impact on the economic growth

of the three countries. Results indicate a positive and significant impact of foreign

direct and portfolio investment as well as foreign borrowings on economic growth in

Nigeria and Ghana while Workers' remittances are positively and significantly related

to the economic growth of the three countries. By using the Seemingly Unrelated

Regression Estimation (SURE), in the same vein, Orji et al. (2014) examined the

impact of all the four different forms of Foreign capital inflows on the economic

growth of the West African Monetary Zone including Nigeria, Gambia, Ghana and

Sierra Leone over the period 1981-2010. The empirical result for Nigeria suggests

that ODA and FDI had significant and positive effects on the economic growth of

Nigeria during the period of their investigation. Similar results are obtained by Ikpesu

(2019) who employed the least square regression method to analyze the data spanning

from 1981 to 2016 and finds that capital inflows have a positive and significant effect

on the growth of the Nigeria economy. This position was corroborated in a similar
study by Osinubi et al. (2010). Their empirical result reveals not only long-run

relationship between Foreign Direct Investment and growth in Nigeria but also found

a strong positive impact of foreign direct investment on growth.

On the other hand, Ikechi (2015) using multiple regression techniques to estimate the

impact of foreign capital inflows on the economic growth of SSA finds no significant

long-run relationship between foreign capital inflows and the level of economic

growth in Nigeria and South Africa. He noted that variables that were significant in

the short run turned out to be insignificant in the long.

This results are in line with those obtained by the study of Anochie et al. (2015), who

using Ordinary Least Square method to estimate the impact of foreign direct

investment on economic growth in Nigeria for the period 1981 to 2009 found that

foreign direct investment had a positive but insignificant impact on economic growth

in Nigeria. Also, Edu et al. (2015) with an extended sample of data over the period of

1980 to 2013, find that foreign capital inflow has a positive but insignificant effect on

economic growth in Nigeria. Furthermore, researchers like Alhassan et al. (2018),

Onyinye et al. (2018), Otto and Ukpere (2014), Babalola et al. (2012), Ilomona

(2010), Jacques (2010), Ayanwale (2007), using various estimation techniques

ranging from Ordinary least square (OLS) method to Autoregressive Distributed Lags

(ARDL) found results that are much related with the aforementioned in their analysis

of relationship between capital inflows and economic growth in Nigeria.

However, the study carried out by Okoro & Atan (2013) found that FDI does not

enhance growth in Nigeria. They found a negative relationship which was statistically

significant between FDI and growth in Nigeria. In corroboration, the study of Osuji

(2015) investigated the relationship between foreign direct investment (FDI) and
economic growth in Nigeria for the period covering 1981- 2013. Using

Autoregressive Distributed Lags (ARDL) model and Bounds testing approach, they

found that the error correction model was negative and statistically significant. They

also showed that there is a long-run relationship between FDI and economic growth.

Awe, (2013) using the two-stage least squares (2SLS) method of simultaneous

equation model for the period covering 1976 - 2006 also found that FDI has a

negative relationship with economic growth in Nigeria. In support of this, Badeji and

Abayomi (2011), in their study, revealed a negative relationship between FDI inflow

and economic growth in Nigeria. Therefore, it can be deduced that though in

economic theory, it is considered that capital inflows positively impact growth,

empirical reports show that capital inflows could sometimes negatively impact

growth.

Despite the heavily skewed consensus towards the possible positive effects of capital

inflows on economic growth, some studies documented that the actualization of

benefits is dependent on some factors (absorptive capacity) present in the domestic

economy in terms of modern infrastructure, financial sector development, human

capital, advanced technology and macroeconomic environments (Akinlo, 2004, Oji-

Okoro & Huang, 2012, Agbloyor et al., 2014, Akinlo 2017).

Sghaier and Abida (2013) focused their study on more direct evidence of ways

through which capital inflows (FDI) can promote economic growth in the receiving

nation. They found that financial development is an essential prerequisite for FDI to

positively influence economic growth in the study countries of interest utilizing the

GeneralisedGeneralised Method of Moment (GMM) techniques for analysis of data.

Also, Korgaonkar (2012) in his submission on the impact of financial development on

FDI using data of 78 countries over the period of 1980 to 2009 suggested that weak

financial sector does not attract FDI and furthermore well functioning financial sector

is a precondition in maximizing the benefits of the presence of FDI.

Notably, Khan (2007), in his study, discovered that the interaction variable between

foreign direct investment and financial development is significant for growth. The

study explained that although foreign direct investment taken individually does not

have a significant effect on growth, the possible gains from FDI will only be felt in

the presence of well developed financial sector in the receiving country. This is in

tandem with the result of Waliu (2017).

Likewise, Adeniyi et al. (2015) lend credence to the position that the level of financial

development matters for the possible benefits that the Sub-Saharan Africa countries

(including Nigeria) will reap in terms of growth returns from presence foreign capital

flows. In their study, financial development was proxied by the total banking sector,

credit to the private sector and total liquid liabilities.

Nwosa (2011) using vector error correction model (VECM), investigated the causal

relationships among financial development, foreign direct investment and economic

growth in Nigeria employing data ranging from 1970 to 2009. The study used the

Augmented Dickey-Fuller (ADF) for unit root test and the variables though not in

level but in their first difference, were found to be stationary. The Johansen and

Juselius (JJ) co-integration technique indicated the presence of co-integration among

the variables. The trivariate vector error correction model (VECM) test for the causal

relationships showed the presence of causality among financial development, foreign

investment and economic growth. The study concluded that financial development

and foreign direct investment have a statistically significant causal influence on

economic growth. This was in line with the reports of Ugbaje and Ugbaje (2014),

utilizing same analysis technique (VECM) to ascertain the direction of causality

between financial sector development and economic growth in Nigeria finds that there

exist a strong positive relationship between the financial system and economic

growth. Furthermore, the results support the supply-leading hypothesis that is the

causality runs from financial sector development measured by market capitalization

and banking sector credits to economic growth.

Adebola and Dahalan (2011) also concluded a supply-leading hypothesis in Nigeria

when they examined the relationship between financial development and economic

growth in Nigeria for the period 1981 to 2009. The study showed a positive but

insignificant effect of the stock market and banking system on economic growth in

the short-run. They further noted that this relationship turns to significant with

banking system being more effectual in promoting economic growth in the long-run

using the Autoregressive Distributed Lag (ARDL) method and Granger causality test

for analysis of data.

Contrary to the above assertion, Nwosa and Emma-ebere (2017) in their study

observed a negative relationship between financial market development and foreign

direct investment in the long run while in the short run, a positive relationship in

Nigeria using the vector error correction model (VECM) technique. Employing the

same techniques, Adeniyi et al. (2012) investigated the causal linkage between

foreign direct investment (FDI), financial development and economic growth (1970-

2005). Their results show that there is no evidence of causal flow both in short-run

and long-run from FDI to economic growth with financial development

accompanying in Nigeria. Also, Saibu et al. (2011) applying the Autoregressive

Distributed Lag (ARDL) technique to examine the effects of financial development

and foreign direct investment on economic growth concluded that financial

development and foreign direct investment exert negative effects on economic growth

in Nigeria.

Nwosa (2015) employing error correction modelling techniques study the relationship

between capital inflows and stock market development in Nigeria (1986 to 2013).

This study considers three alternative measures of stock market development; value

traded ratio, market capitalization and turnover ratio. Capital inflow was proxied by

foreign direct investment and foreign portfolio investment. The findings of the study

show that none of the stock markets measures significantly influenced foreign direct

investment in the long run in Nigeria while only value traded ratio and market

capitalization had a significant influence on foreign portfolio investment.

Yilmaz and Marius (2018) analyzed the interactions between capital inflows (FDI)

and financial development in Central and Eastern European Union (1996 to 2015).

The result of findings showed that there exist no cointegrating relationship among

capital inflows (FDI), investments of the foreign portfolio, and financial sector

development, but there is a one-way causality from financial sector development to

capital inflows (FDI) over the short run.

As observed from the above literature review, there have been different views on the

relationship between capital inflows, financial development and economic growth.

While some support the positive effect, others argued that it exerts a negative effect

on economic growth. Furthermore, it is noteworthy that despite vast extant researches,

most studies in Nigeria focused on the impact of one type capital inflows on economic

growth, some centred on relationship between capital inflows and economic growth

without financial development while others were concerned on the impact of one type
of capital inflow and financial development on economic growth. Also, there is exist

paucity of knowledge on some types of capital inflows which can as well contribute to

growth. Finally, none to the best knowledge focused on the collective impact of the

types of capital inflows and financial development on economic growth. It is owing to

the aforementioned, that study attempt to fill the gap in the literature by carrying out a

country-specific study on the relative impact of capital inflows and financial

development on economic growth in Nigeria.

 CHAPTER THREE

RESEARCH METHOD

3.1 Introduction

This section contains the research methods that will be employed to achieve the

objectives of this study. Therefore, this chapter provides a detailed explanation on the

procedures to be used in carrying out the research analysis.

3.2 Theoretical Framework and Model Specification

The model specification will follow the model specified by Falki (2009) which is in

line with the equation of endogenous growth model, however with some

modifications. The modification include the expansion of what capital inflows entail

(FDI, REM, FA) and inclusion of a good macro environment indicators (INT, INF,

EXT) as suggested by literature. The reason for the expansion in capital inflows

component is due to the non-inclusion of other types of capital inflows which

according to the researcher’s best knowledge can hamper the extent to which

variables can impact the economic growth of the country. Thus, the endogenous

growth model is stated as follow:

Yt = ƒ(A, K, L)t

The expanded endogenous growth model is re-written as:

Yt = ƒ(A, Kdα, Kfλ, Lpβ)

Where Yt is output, Kd is the domestic capital and Kf represents foreign owned

capital, L is labour force, α is the output elasticity of domestic capital while λ

represents the output elasticity of foreign capital stock, β is the output elasticity of

labour force and A is total factor productivity that explains the output growth that is

not accounted for by the growth in factors of production specified.

Log-linearizing the endogenous growth model we have:

LnYt = ƒ(LnA, LnKd, LnKf, LnL)

From the above equation, the econometric model which is the model the researcher

intend to estimate can be specified as follow:

LnRGDP t =α 0 +α 1 LnFDI+α 2 LnFA +α 3 LnREM +α 4 LnFD+α 5 INF+α 6 EXR+α 7 INT +ε t

where α’s are parameters, lnRGDP, lnFDI, lnFA, lnREM, lnFD, INF, EXR and INT

were log of economic growth measured by real GDP, log of foreign direct investment,

log of Foreign Aid, log of remittance, financial development measured as ratio of

money supply to GDP, Inflation, exchange rate, Interest rate, and εt was white noise.

3.3 A priori expectation

In terms of a priori expectations, the literature suggests a positive relationship

between FDI, REM, FA, Exchange rate and real GDP while interest rate is expected

to have a negative effect on the economy.

3.4 Variable Measurement

Economic growth (RGDP) is the dependent variable and is measured by the average

annual real gross domestic product. Remittance (REM) is measured by current

transfers by migrant workers and wages and salaries earned by nonresident workers;

foreign direct investment (FDI) measured by the annual aggregate inflow of direct

investment in Nigeria; foreign aid (AID) measured by net overseas development

assistance and official aid received by the Nigerian economy; Exchange rate (EXR) is

measured by the official naira/dollars exchange rate; Interest rate (INTR) is measured

by the nominal interest rate less the inflation rate; financial development (FD) is

measured by the ratio of broad money supply to gross domestic investment; and

Inflation(INF) is measured by annual inflation rate.

3.5 Technique of Estimation

To achieve objective one the study will use descriptive statistics which is with the use

of tables to show the impact of monetary policy on macro-prudential on Nigeria

economy. To achieve other objectives the study will employ appropriate econometrics

techniques based on the unit root or stationary test of the variable. The following test

will be employed in the course of the study, in order to achieve the objective of the

study.

i. Stationarity Test

The Unit Root test, which measures the level of stationarity of the variables under

consideration, would be applied. This test is done using the Augmented Dickey Fuller

test (ADF) with the hypothesis which states as follows: If the absolute value of the

Augmented Dickey Fuller (ADF) test is greater than the critical value either at the

1%, 5%, or 10% level of significance, then the variables are stationary either at order

zero, one, or two.

ii. Granger Causality Test Procedure

Causality model on the Nexus between capital Inflows and Economic growth.

The first objective of this study was to determine the causality between capital

inflows and economic growth in Nigeria. To achieve this objective a Granger

Causality test was carried out. Granger Causality is a statistical hypothesis test for
determining whether one time series is useful in forecasting another (Granger, 1969).

That is, a time series X is said to Granger cause Y if it can be shown that X values

provide statistically significant information about future values of Y. If a time series is

stationary, then the test is performed using the level values of two (or more) variables.

Three results was expected. First, that foreign direct investment, remittance and

Foreign Aid granger cause economic growth or economic growth granger cause

foreign direct investment, remittance and Foreign Aid (a unidirectional relationship).

Secondly, foreign direct investment, remittance and Foreign Aid granger cause

economic growth and in turn economic growth granger cause foreign direct

investment, remittance and Foreign Aid (bi-directional relationship). Lastly, that

foreign direct investment, remittance and Foreign Aid does not granger cause

economic growth and economic growth does not granger cause foreign direct

investment, remittance and Foreign Aid.

iii. Auto Regressive Distributed Lag Model (ARDL)

An ARDL model is a parsimonious infinite lag distributed model. The term

“autoregressive” shows that the dependent variable is also explained by its own lag

value, along with it being explained by the independent variable(s). Irrespective of

whether the underlying variables are stationary at level-I(0) or at first difference-I(1)

or a combination of both, ARDL technique can be applied. This helps to avoid the

pretesting problems associated with standard co-integration analysis which requires

the classification of the variables into I(0) and I(1). This means that the bound co-

integration testing procedure does not require the pre-testing of the variables included

in the model for unit roots and is robust when there is a single long run relationship

between the underlying variables.

The second and third objectives of determining the effect of foreign direct investment,

remittance and Foreign Aid; and financial Development on economic growth were

achieved through Auto Regressive Distributed Lag Model (ARDL) estimation

technique. The Auto Regressive Distributed Lag Model (ARDL) estimation technique

included other determinants of economic growth. These variables were selected on the

basis that they have been identified in the literature as determinants of economic

growth. The variables included were Inflation (INF), Interest Rate (INT), Exchange

rate (EXR).

Thus the effects of foreign direct investment, remittance and Foreign Aid and

financial development on economic growth were captured by running an Auto

Regressive Distributed Lag Model (ARDL) estimation technique of the following

equation:

P P P P
LRGDP t =β 0 + ∑ RGDPt− j + ∑ β 1 j Δ FDI t− j + ∑ β 2 j ΔREM t− j + ∑ β 3 j ΔFA t− j +
j=1 j=0 j=0 j=0
P P P P
∑ β 4 j Δ FD t− j +∑ β 5 j Δ INF t− j + ∑ β 6 j Δ INT t− j + ∑ β 7 j Δ EXRt− j +α1 RGDPt−1
j=0 j=0 j=0 j=0

+α 2 FDI t−1 +α 3 REM t−1 +α 4 FA t−1 +α 5 FD t−1 +α 6 INF t−1 +α 7 INT t−1 +α 8 EXR t−1
3.6 Sources of data

The data employed in this analysis are secondary data. They are sourced from the

Central Bank of Nigeria statistical bulletin. The data were collected using the method

of extraction or transcription from the existing record which cover a period of 1981-

2018. The data collected are on economic growth, foreign direct investment,

remittance, Foreign Aid, Money supply, Credit to Private Sector, Inflation, Net

export, and Interest rate.

 CHAPTER FOUR

DATA PRESENTATION AND ANALYSIS

4.0 INTRODUCTION

This chapter covers data analysis, interpretation and discussion of the research

findings. In an attempt to investigate the relationship that exist between capital

inflows, financial development and economic growth, this section begins by

conducting some preliminary analysis (descriptive statistics, unit root and co-

integration test) on the variables employed in the study, sources of data utilized and

technique of evaluation among others.

4.1 Descriptive Statistics Result

Table 1: Descriptive Statistics of the Variables

  LRGDP LREM LFDI LAIDS M2/GDP INT INF EXT

Mean 10.27 6.63 10.99 19.83 14.20 12.95 19.91 88.66
Median 10.05 7.13 11.64 19.43 12.69 13.00 12.54 97.40
Maximum 11.15 9.96 14.12 23.20 21.31 26.00 72.81 306.08
Minimum 9.53 0.89 5.58 17.27 9.15 6.00 4.67 0.61
Standard Dev 0.561194 3.179133 2.879211 1.603747 3.931659 3.975124 17.77734 87.19287
Skewness 0.344411 -0.473082 -0.677286 0.139133 0.598480 0.763642 1.560525 0.799118
Kurtosis 1.630051 1.767033 2.089158 2.002240 1.828851 4.548305 4.227379 2.964231
Jarque-Bera 3.722789 3824438. 4.218789 1.698849 4.440146 7.488925 17.80840 4.046424
Probability 0.155456 0.147752 0.121311 0.427661 0.108801 0.023648 0.000136 0.132230
Observations 38 38 38 38 38 38 38 38
Source: Adopted from E-views 9
This study commenced its empirical analysis by checking for the time series

properties and the descriptive statistics of the variables in the model. The results of

the descriptive statistics as shown in Table 1 above revealed that, the average (mean)

of LRGDP is 10.27 with S.D of 0.5612. Similarly, the mean of LREM is 6.63 with

S.D of 3.1791. In the same vein, the mean of LFDI is 10.99 with the S.D of 2.8792

and LAIDS is 19.83 with S.D of 1.6038. Beyond the above, the value of the skewness

statistics revealed that other variables with the exception of foreign direct investment

and remittances are positively skewed. In addition, the Jarque-Bera statistic exhibited

that the residuals of RGDP, REM, FDI, FA, FD, and EXT respectively follows a

normal distribution while other variables does not follow.

4.2 Test of Stationarity

As a follow up of the outcome of the descriptive statistics of the variables, the

researcher considered it necessary to check for the time series properties of the

variables used. To check for these properties, the Augmented Dickey-Fuller (ADF)

and the Phillip Perron test were used and the result is presented in Table 2 below.

Table 2: Result of Unit Root Test

Varia
ble AT LEVEL AT FIRST DIFFERENCED
ADF-t PP - t CV at P- val Decision ADF-t PP - t stat CV at P- val Decision
stat stat 5% stat 5%
LAID -1.2257 -1.1958 -2.9458 0.6526 NS -5.6646 -5.1895 -2.9458 0.0000 S

LFDI -1.7574 -1.4204 -2.9434 0.3950 NS -8.8176 -8.5583 -2.9434 0.0000 S

LRE -0.7060 -0.6853 -2.9411 0.8332 NS -7.3672 -7.3482 -2.9434 0.0000 S

M
M2/G -1.0447 -1.0773 -2.9411 0.7272 NS -5.7295 -5.9199 -2.9434 0.0000 S
DP
EXR 1.8060 1.5903 -2.9411 0.9996 NS -4.2589 -4.2178 -2.9434 0.0018 S

LRG 0.5798 -0.0840 -2.9434 0.9872 NS -17.6870 -14.7266 -2.9434 0.0001 S

DP
INT -3.0758 -2.9789 -2.9411 0.0370 S - - - - -

INF -3.2097 -3.1352 -2.9411 0.0271 S - - - - -

Source: Adopted from E-views 9

The result of the unit root test indicated that the variables were of mixed level of

integration. The implication is that some of the variables (interest rate and inflation)

were stationary at level while the others (….) are difference stationery at 5% level of

significance.

Prior to the co-integration test, researcher deemed it necessary to also construct an

initial VAR model to determine the lag order/length to be utilized in the co-

integration test. Besides, because, it is a fundamental re-requisite to conduct a co-

integration test.

Table 3: Lag Order Selection

Lag LogL LR FPE AIC SC HQ

0 -631.4929 NA 1024340. 36.5424 36.8996 36.66517
1 -397.4991 347.6479 68.03107 26.82852 30.02810 27.93301
2 -294.9659 105.4628 144.00134 24.62662 30.67026 26.71289
3 -117.5773 101.3649* 0.192004* 18.14727* 27.03498* 21.21531*
Source: Adopted from E-views 9

The result of the estimation of the lag structure of a system of VAR in levels indicates

that all the five methods of selections (LR, FPE, AIC, SC, HQ) jointly identified lag 3

to be the most appropriate for the ARDL estimate as indicated by the astericks in

Table 3 above and consequently, the conduct the ARDL Bounds test as indicated from

the outcomes of the unit root test in table 2.

Table 4: ARDL Bound Cointegration test

Critical Value Bounds

Significance I(0) Bound I(1) Bound

10% 2.03 3.13
5% 2.32 3.5
2.5% 2.6 3.84
1% 2.96 4.26
Null Hypothesis: No long-run relationship exist
F = 5.862752 K=7
Source: Adopted from E-views 9

The result of the ARDL Bounds test as shown in Table 4 above revealed that there is

evidence of a long run linear relationship based on the value of the F-statistics which

appeared to be greater than both the lower and upper bound of the estimate at 1%, 5%

and even 10% significant level.

Table 5: Results of ARDL model

Dependent Variable: LRGDP

Selected Model: ARDL(1, 0, 1, 0, 1, 0, 0, 1)

Co-integrating Form
Variable Coefficient Std.Error t-Statistic Prob.*
D(LREM) -0.010133 0.006029 -1.680552 0.1053
D(LFDI) 0.004874 0.010489 0.464662 0.6462
D(LAIDS) 0.016944 0.008791 1.927474 0.0654
D(FD) 0.000302 0.003513 0.086000 0.9322
D(INT) 0.001058 0.001639 0.645697 0.5244
D(INF) -0.000940 0.000343 -2.744659 0.0111
D(EXT) -0.000596 0.000320 -1.863499 0.0742
CointEq(-1) -0.186870 0.056184 -3.326035 0.0027
Source: Adopted from E-views 9

Table 6: Results of co-integrating and Long run Form

Dependent Variable: D(LRGDP)

Method: ARDL
 Long Run Coefficients

Variable Coefficient Std.Error t-Statistic Prob.*

LREM -0.054224 0.041532 -1.305608 0.2036
LFDI 0.142686 0.0583348 2.445440 0.0219
LAIDS 0.090675 0.036256 2.500964 0.0193
FD 0.060649 0.014281 4.246773 0.0003
INT 0.005664 0.009021 0.627845 0.5358
INF -0.005032 0.002078 -2.421254 0.0231
EXT 0.000534 0.000809 0.659970 0..5153
C 6.618696 0.634714 10.427839 0.0000
Source: Adopted from E-views 9

As a digression, it is worthwhile to note that the co-integrating and short run outcome

as seen in panel b follows the rule of thumb peculiar to the short run where almost all

variables are insignificant. On the other hand, the results of the long run form estimate

of the ARDL revealed that remittances exerted a negative but insignificant

relationship with economic growth in Nigeria, Surprisingly, the outcome from the

above results corroborated the findings of Anetor (2019) who stipulated that there is a

negative relationship between remittance and economic growth. This means that when

the volume of remittance drops by one percent, it has the tendency to will slow down

the economic growth by 0.054 percent. The reason for the above, may not be far-

fetched from the fact that most of the inflows of capital are channeled towards

consumption (up to 80%) rather than investment (little as 10%) which would have

fostered economic growth in return as buttressed by Adigun and Ologunwa (2017).

In addition, the results also showed that, there is a positive and significant relationship

between FDI and AIDS on economic growth in Nigeria. The implication of the above

is that, if foreign direct investment and Aids increases by one percent, it will result to

or trigger economic growth by 0.143 and 0.091 percent respectively while holding
other variable constant. Interestingly, the findings from this study is in tandem with

the works of Orji et al (2014) who in their study finds that FDI and AIDS positively

influence economic growth in Nigeria. This when put together, showcase that capital

inflows exerts the expected impact on economic growth in Nigeria when

complimented with expected financial development transmissio0n channels. as

pinpointed by Waliu (2017). This is because, the outcome of financial development

variable was proven to exert a positive and significant with economic growth. Probing

further into the outcome of the results, the outcome of interest rate co-efficient

revealed a positive and significant on economic growth. The reason for this can be

attributable to the overtime noticeable hike in the monetary policy rate (MPR) in

some few years back till date. More so, the ARDL estimate reveals that inflation

exerts a negative and significant impact on economic growth both in short run and

long run which confirms it as a key determinant of economic growth in Nigeria as

also suggested by existing literature such as ….and ….. to mention a few. In similar

vein, exchange rate has a negative impact on economic growth. This implies that a

one percent increase in the naira - dollar exchange rate (i.e depreciate local currency)

reduces economic growth by 0.001%. Conventionally, this result is contrary to a-

priori expectation which ought to exert positive impact on economic growth.

Diagnostic Test result

In order to ascertain the appropriateness of the above results, the study conducted

some diagnosis test which include Serial Correllation LM Test, Normality test among

others. The outcome of the test is as presented below:

Table 6: Breusch - Godfrey Serial Correllation LM Test:

F-statistic 1.616962 Prob. F(4, 22) 0.2055

Obs*R-squared 8.406337 Prob.Chi-Square(4) 0.0778
Source: Adopted from E-views 9

Table 6 above shows the outcome of the LM test for Serial correlation check. From

the table, it was discovered that the probability of the observed R-square is 7.78%

which implies that we can not reject the Null hypothesis of no serial correlation

because the (P > 0.05). Hence, there is the absence of serial correlation in the model.

Table 7: Heteroskedasticity Test: Breusch - Pagan-Godfrey

F-statistic 1.198936 Prob. F(11, 25) 0.7622

Obs*R-squared 17.15241 Prob.Chi-Square(11) 0.6431
Scaled explained SS 20.64094 Prob.Chi-Square(11) 0.4185
Source: Adopted from E-views 9

The study went further to test for heteroskedascity as shown in Table 7 above. It was

discovered that the probability of the observed R-squared is 64.31% meaning that we

cannot reject the Null hypothesis of no Heteroskedacity hence the model is

Homoskedastic.

Figure 1: Normality test

8
Series: Residuals
7 Sample 1982 2018
Observations 37
6
Mean 3.37e-15
5 Median -0.001220
Maximum 0.058991
4 Minimum -0.048449
Std. Dev. 0.023304
3 Skewness 0.143991
Kurtosis 2.866253
2
Jarque-Bera 0.155433
1 Probability 0.925227

0
-0.04 -0.02 0.00 0.02 0.04 0.06

Source: Adopted from E-views 9

 In follow up of the heteroskedasticity test, the researchers went further to

ascertain if the variables in the model are normally distributed or not. To confirm this,

a normality test was conducted and the results revealed that all the variables were

normally distributed.

CHAPTER FIVE

SUMMARY, CONCLUSION AND RECOMMENDATION

5.1 Introduction

This chapter gives the summary, conclusion and policy recommendation based on

the findings of the research work.

5.2 Summary

This study investigated the relationship between capital inflows, financial

development and economic growth spanning from 1981 to 2018 in Nigeria. The

ARDL regression estimate result showed that remittances do not promote economic

growth both in the long-run and short-run, which might be owing to how the

remittances inflows has been channeled over years. Furthermore, the outcome of the

study established that FDI and Aids - growth linkage is both positive and significant

in the long run. More so, the study found that financial development has a positive

impact on economic growth both in the long-run and short-run but only statistically

significant in the long run. The rationale for this is that savings in the financial sector

are properly channeled to the real or productive sectors of the economy. In addition,

findings of the study also showed that interest and exchange rate is positive though,

this impact on economic growth is weak both in the long and short-run. Finally, the

study revealed that inflation has a significant adverse effect on economic growth both

in the long-run and short-run.

5.3 Conclusion

Based on the findings of this study, we conclude that capital inflows (Foreign direct

investment, Foreign Aids and Remittances) positively impacts on economic growth

both in the short and long run in Nigeria within the study period after controlling for

financial development appropriately. Interestingly, the outcome supports the findings

of Orji et al (2014) and Waliu (2017) and more recently research of Ikpesu (2019).

5.4 Recommendation
Based on the above conclusion, the study recommends that:

1. capital inflows as a result of remittances should be channeled to productive use

which will in turns promote economic growth.

2. capital inflows into the country should be used to support the government effort to

diversify the economy in order to foster economic growth.

3. the central bank employs a more restrictive monetary policy to suppress the adverse

effect that inflationary pressure can exert on an economy.