Investigating the Effect of Capital Inflow on Domestic Investment in Nigeria: A Vector Error Correction Model (VECM) Approach

Abstract

The exact role of capital inflows enhancing domestic investment and promoting economic growth has been of great concern to policymakers and researchers taking into account the huge reliance on capital inflow in Nigeria. This study investigates the effect of capital inflow on domestic investment in Nigeria between the periods 1981 to 2016 using Vector Error Correction Model (VECM) approach. The variables used are the various components of capital inflow (foreign borrowing, foreign direct investment, portfolio investment, official development assistance and workers’ remittance) and domestic investment. The study revealed that a rise in the various components of capital inflows (foreign direct investment, portfolio investment, and official development assistance) would enhance domestic investment in the country while a rise in foreign borrowing and workers remittance would lead to decrease in domestic investment. Furthermore, the study revealed that capital inflows (portfolio investment and official development assistance) Granger cause domestic investment in the country. The study recommends that for government to close the savings and foreign exchange gap there is the need for appropriate policies to be design to determine the optimal level of capital inflow that will enhance domestic investment in the country. In addition, the government should provide adequate social amenities, infrastructural facilities, political stability and also conducive environment that is business friendly so as to attract foreign capital into the country for investment purpose.

Keywords: Capital Inflow, Economic Growth, Domestic Investment, Nigeria, VECM.

JEL CODE: F21, O55, P33