FDI and Portfolio Investment in Nigeria
By Herbert Orji
Foreign capital has long been accepted as an inevitable input in the development process. Given the fact that nv country is an "island" with self sufficiency on her own in terms of needed resources, recourse must from time to time be made to seek external finance to stimulate economic growth and development. The experience of some countries in Asia notably, South Korca, 'l'aiwan and Hong Kong in partfinancing economic development with foreign capital underscores this importance. Recent developments in Central and Eastern Europe have re-cmphasized the role of foreign capital in economic development.
The nced f'or external capitai inflow arises when desired investments exceed actual savings. They are unecessary also owing to investments with long gestation periods that generate non-monetary returns; growing government expenditure that are not tax financed; and when actuai savings are lower than potential saYings owing to repressed financial markets; and even capital flight.
Several variables, which create dependence on foreign capital, have been identified. They could be classified into Buctuating variables such as exports, imports and invisibles; offsetting variables like debt service and reserve creation; and rigid variables, including minimum level of imports, stage ol economic development and exportable surplus.
External capital flows could be non-debt creating flows (as in official transfers - grants and direct investment flows); debt creating ffows (as in official development finance); commersial bank loans and international bond offering; or could be a hybrid e.g. foreign portfolio investments and international equity ofFerings.
Historical antecedents indicate that until the 1st World War, capital to developing countries directly came mainly from Great Britain, France, Spain, Portugal etc, to their former colorues. By the 1950's, the United States (US), other industrialized nations and multinational agencies started official assistance to less developed countries (LDC's). Shortly alter the 2nd World War and up to the period of the oil shocks starting from the late 1970's, there was a surge in bank lending to LDC's, particularly to Latin America under sovereign guarantees. Bank lending dwindled thereaner in the wake of the debt crisis of 1982. Consequently, official assistance and capital flows were re-directed towards developed nations and the securitization of international finance started in developing countries. The upsurge of emerging market cconomies at the beginning ot the l990's witnessed a revival of private finance in the form of foreign direct investment (FDI) and foreign pnvate invesdnent (FPI) flows.
The number of claimants to foreign assistance has increased as the World Development Report (WDR' 1990) observed, "... a substantial increase in the resources for fighting povcrty in the poorest countries appears affordable. It is a matter of political commitment and the reassessment of donor priorities". Inspite of the above assertion, foreign asststance has over the years generated various perceptions. lirst, projects are tormulated without consideration for the long runs implications on the economy. Secondly, thc conditionalities attached to such asistance often cut budgets in the social sectors. thus accentuating poverty. Thirdly, it often leads to exchange rate crisis, massive devaluation and terms of hade deterioration. Fourthly, priorities in recipient countries are formulated and implemented without consideration for the recipient population. Lastly, fund earmarked for project lending are funneled back to donor countries in form of highly overrated consulting fees.
In all, foreign assistancc as the perception goes. is ol'tcn motivated by donor's self-interest - political, strategic. or economic - and seldom has ethical consideration of assisting in poverty reduction and economic growth. Recipient countries also have themselves to blamc for being in such a position as they often formulate and implement policies in very nondemocratic ways, resulting in low rate of return on their investments.
Internationai capital Hows had recently been marked by a sharp expansion in net and gross capital flows and a substantial increase in the participation of foreign investors and foreign financial institutions in the financial markets of developing, 'countries (World Bank, 1997). While this view has been found to be true for Asian and Latin American countries the same cannot bc said tor African countries cspecially sub-Saharan African countries (Taylor and Sarno, 1997). Even the liberalization of iinancial markets in sub-Saharan African countries since the late 1980's has not increased the rate of international capital mobility in these countries.
This emerging picture about capital flow to developing countries, including Nigeria, is worrisome as these couniries try to come out from one economic crisis or the other, attributed largely to past economic mismanagement. This paper, theref'ore, examines issues and determinants of non-debt capital flows (FDI), and foreign portfolio investment in equities (FPI). The major advantages of FDI and FPI, whether full or partial, are that they bring technology, ideas and access to industrial countrics' markets as well as hard currcncics, reduces borrower's exposure to changes in foreign interest rates and encourages growth-oriented economic iiberalization. Specifically, this paper seeks to address the questions: What are the macro-economic conditions for attracting foreign capital to Nigeria' What are the factors that motivate these flows and their effects on the economic performance of the country? Are these flows sustainable?
Theorical and Most Country Macroeconomic Considerations
Capital flows are a result of savings/investment imbalances across countries, which result in transfer of real resources through trade or current account transactions. lhey respond to economic fimdamentals, ofEcial policies and financial markets imperfections. lt is, however, extremely difficult to assess the impact of these policies and distortions because they generatly overlap' creating both impediments and stimuli to capital flows.
Sevcral lactors dcter capital flaws to dcveloping countries. They include liquidity, size and concentration of markets, smal1 trading volume, weak capacity to enforce rules, country and regulatory risks and exchange controls. Taylor and Sarno (1997) recognized two scts ot tactors allecting capital movements. The first are country-specific-pull factors reflecting domestic opportunity and risk. As developing countries credit-worthiness is restored, capital (bond and equity) flows are likely to become increasingly prominent sources of external finance. For instance, according to them, equity-related capital flows could be very large and come in the form of either foreign direct investment (FDI) or portfolio investment in equities. FDl may be attracted by thc opportunity to use local raw materials or employ local labour iorce. Ratcs ot return, credit ratings, and secondary-market prices of sovereign debt, reflecting the opportunities and risks of investing in the country, have bcen recognized as other crucial determinants of capital flows.
The second set of determinants of capital fows to developing countries are global-push-factors such as interest rates, stable exchange rates and labour market conditions. Thus, as governments embark on macroeconomic and institutional refonns, international investors gain confidence and are morc willing to direct capital flows toward the new market (Parpaionu and Duke, 1993).
Identitying thc main dcterminants of capital flows to developing counties and the push and pull factors at play would help in designing effective policies. Also, if the causes of capital flows are largely exogenous to developing countries, compensatory policics are appropriate. However, if the causes are largely domestic, then direct policy design may be more appropriate and effective (Frnandez-Arias and Montiel - 1996).
The various macroeconomic considerations in host countries have been the impacts of monetary policies, real exchange rates and pressures for further liberalization of capilal accounts/trade and current accounts on capital flows. Serven and Solimano (1992) noted that monetary, fiscal, and exchange rate policies directed at correcting unsustainable macroeconomic imbalances also atffect private capital flows. They observed that, a standard macroeconomic package, orientcd towards improving thc balancc of payments includes restrictive fiscal and monetary policies supplanted by a real devaluation. The restrictive monetary and credit policics, which are usually part of most stabilization packages? impact on investmcnt through rise in the real cost of bank credit and by increasing the opportunity cost of retained earnings through an increasing intcrest rate. The combination of these impacts raises the user cost of capital, thereby reducing investment. However it was found out that in a repressed financial market (which is the hallmark of most developing economies, including Ghana, Egypt, Ivory Coast, Kenya and Nigeria), credit policy affects investments directly, since credits are allocated to firms with access to preferential interest rate mechanisms. But Van Wijubergen's (1993) results assert that interest rate also affect firms that borrow from the informal money market. Thus the institutional structure of financial markets in developing economies is important in explaintng the effect of monetary and credit policy on foreign private capital flows for investment, as well as, the transmission mechanism of such policy (Montiel, 1993).
With respect to fiscal policy, it is clcar from empirical findings that high fiscal deficits increase interest rates or reduce the availability of credit to the private sector, thus, crowding out private investment. It is, therefore, argued that the reduction in the public del'icit during macroeconomic stabilization/adjustment would allow private investment to expand.
The Enabling Environment
The principal laws regulating foreign investments in Nigeria are:
The Nigeria Investment and Promotion Commission Act No. 160fl995.
The foreign exchange (monitoring and miscellaneous provisions) Act No. 17 of 1995.
The investments Securities Act of 1999. This Act set up the Investment & Securities Tribunal (IST) as an appellate court and a court of first arena for the settlement of investment and securities disputes.
Effectively, the Nigerian Enterprises Promotion (Repeal) Act No. 7 of 1995 has abolished any restrictions, in respect of the limits ot' foreign holding in Nigcria registered/domiciled enterprises.
The only enterprises, which are still exempted trom free and unrestrained foreign participation, are those involved in:
Production of arms and ammunition;
Production of and dealing in narcotic drugs and psychotropic substances.
The Nigcria investment and Promotion Commission Act No. 16, 1995 established the Nigerian Investment Promotion Commission (NlPC) as the successor to Industrial Development Co-ordination Committee (IDCC). Amongst the provisions relating to investment in the Act are the following:
A non-Nigerian may invest and participate in the operation of any enterprise in Nigeria.
An enterprise in which foreign participation is permitted, shall after it's incorporation or registration, be registered with the NIPC
A foreign enterprise may buy the shares of any Nigerian enterprise in any convertible currency.
A torcign investor in an approved enterprise is guarantecd unconditional transferability of funds through an authorized dealer in freely convertible currency of:
Dividends or profit (net of taxes) attributable to the investment.
Payments in respect of loan servicing where a foreign loan has been obtained.
The remittance ot procceds (net ot taxes) and other obligations in the event of sale or liquidation of the enterprise or any interest attributable to the investment.
Furthermore in a bid to assure foreign investment protection' the Act provides that:
No enterprise shall be nationalized or approprtated by any Government of the Federation.
No person who owns, whether wholly or in part, the capital of any enterprise shall be compelled by law to surrender his interest in the capital to any other persons.
There will be no acquisition oi an enterprise by the Federal Government unless the acquisition is in the national interest or tor a public purpose under a law which makes provision for payment of fair and adequate compensation and a right of access to the courts tor the determination of the investor's right of interest and the amount of compensation to which he is entitled.
In order to help improve the cnabling environment in emerging economies (including Nigeria), the Multilateral Investment Guarantee Agency (MIGA) was created in 1988 as a member of the World Bank Group to promote foreign direct investment into emerging cconomies by guarantceing non-commercial risks in order to boost industrialization, employment, capacity building and consequently improve pcople's lives and reduce poverty. MIGA has been in the forefront of addressing the minimal global FD1 flows to Africa. For instance, Africa accounted for less than 1% of global FDI flows in year 2000. A new effort, supported by MIGA is undcrway to address this issue. The nascent African Trade Insurance Agency (ATI) has been established to provide insurance against a host of non-commercial risks such as trade embargoes, war, expropriation and seizure of goods to facilitate trade and investmcnt into Africa and from African nations into other parts of the developing world. ATI is expected to be a strong pillar of support to the Cairo based African Export-Import Bank.
�Trends in Capltal Flows To Nigeria.
Several studies, including Montiel, (1993) have provided evidence of a huge and incrcasing degrce of international capital mobility among the major industrial countries, and among emerging markct economies which offer high rcturns, ensure macroeconomic stability and liberal trade regimes as well as case financial rcstriction and offer free access to listed stocks. For instance, while capital flows to developing countries have been on the increase f'rom 1986, averaging 30% between 1986 and 1994, a greater proportion of these flows have been to ernerging markets of Asia and Latin America. In 1986, 93.3% of capital to developing countries went to these emerging economies while 3.7% went to sub-Saharan Africa and only 1.6% to Nigeria. This trend has prevailed since that period and capital investmcut flows to emerging markets of Asia and Latin America have consistently averaged over 9()%' while flows to sub-Saharan Africa since 1987 have never been more than an annual average of 9.75%.
For Nigeria, there had been a steady decline from a level ot 7.3% in 1989 to 1.56% in 1994. Real foreign direct investment in Nigeria has been unstable over the years. In 1980 Nigeria recorded an FDI of US$357.3M, representing a 12.5% decrease from the 1979 levels of US$408.3M.
This declining trend was maintained through 1984. Betwcen 1985 and 1986, FDI fell by 65.8%, reflecting the decline in world oil prices which fell from over US$20.0 per barrel to about US$9.0 a barrel. Following the adoption of the Structural Adjustment programme (SAP) in 1986 and the subsequent liberalization of some aspects of the Nigerian economy, FDI in the country rose with the exception of 1990 when a decline of 69.5% was recorded. For instance, the FDI rose to US$1,374.72 million in l988, the second year of SAP operations in Nigeria, but declined by about 54.0% to USS634.87million in the succeeding year, 1989. Between 1990 and 1993, the FDI exhibited a rising trend, reaching their levels of US$666.14 million in 1991, US$678.14 million in 1992 and US$1909. 14 million in 1993.
Being excerpts of lecture on Foreign Direct and Portfolio Investment in Africa at the Nigeria Institute for Policy and Strategic Studies (NIPSS) presented by Dr. Herbert Orji, an economist, investment banker and chartered stockbroker.
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