EXCHANGE RATE VOLATILITY AND FOREIGN DIRECT INVESTMENT; EVIDENCE FROM FIVE SELECTED COUNTRIES IN SUB-SAHARAN AFRICA

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ABSTRACT

This study investigated the empirical evidence on the effect of exchange rate volatility on foreign direct investment (FDI) in Nigeria, using secondary time series data from1970 to 2004. In doing this, the study utilized the error correction model as well as OLS method of estimation. The results suggest, among others, that exchange rate volatility need not be a source of worry by foreign investors. Also, the study further reveals a significant positive relationship between real inward FDI and exchange rate. This implies that, depreciation of the Naira increases real inward FDI. Also, the results indicate that the structural adjustment programme (introduced in Nigeria in 1986) had a negative impact on real inward FDI, which could be due to the deregulation that was accompanied by exchange rate volatility. As such, a major challenge before the Central Bank of Nigeria therefore, is to attain a stable and realistic exchange rate that will boost domestic production, increase real inward FDI and maintain internal and external balance.

CHAPTER ONE

INTRODUCTION

A Nation’s economy is basically pivoted by various economic structures and policies which aims to direct the operations of economic activities in the state in a system which leads to economic growth and  development.  The  fact  remains  that  to  ensure  consistency in  economic  growth  and development, policies geared towards expanding productive capacity is essential such as the exchange rate system. A volatile exchange rate system is seen to be epidermic to economic growth.

Volatility in the exchange rate indicates inceasant swings in the price of a nation’s currency as it relates to other foreign currencies at a particular period of time. A volatile exchange rate always occur when the country’s currency tries to achieve an equilibrium position at a rate that would enable investors to carry out foreign transactions in terms of trade or debt settlement.Volatility in exchange rate majorly occurs over time in financial markets and among currency trading hence, it reflects the value of currency being traded at a particular period of time. Movements in exchange rate does not appear from out of nowhere but they are due from a passage of time and presaged by larger movements than usual, in its real sense, whether such movements have the same direction or the opposite, it is difficult to ascertain however, an increase in volatility does not usually presage a further increase. It may go back down again. Volatility does not measure the direction of currency price changes but merely their dispersion this is because the use of standard deviation or variable is adopted in determining volatility and the differences of the variables are squared so that negative and positive differences are combined into one quantity (Farlex, 2012) Two currencies with different volatilities may have the similar expected return however; the currency with higher volatility will have larger fluctuations or swings in values over a period of time.

1.2         Statement of the Problem

Although the problems of sub-Saharan African countries are enormous which ranges from economic, social to resource problems; however, in this research work, our attention shall be focused on exchange rate volatility and foreign direct investment considering empirical evidences from some sub-Saharan African countries.

The ECOWAS community proposed a policy to adopt an integrated monetary system in which a common currency shall be used by ECOWAS countries in order to foster trade relationship and minimize volatility in the exchange rate system. The African market economy has suffered severe distortions in the price system due to pressure from the world financial market because of the adoption of the use of the US dollar in financing transactions in the SSA region.

Exchange rate volatility has also created difficulty for the central banks in SSA countries in making decisions of interest rate and money supply into their economy so as to efficiently regulate the financial sector of their economy risky environment for doing business coupled with insecurity problems.

The recent fall in the oil price which has led to decrease in the foreign reserve of most countries in the Sub-Saharan African (SSA) alongside severe economic crunch affecting the inflow of Foreign Direct Investment (FDI) has increased the rate/degree at which exchange rate changes hence, more volatile and risky for investors to invest their resources in SSA countries. Therefore, volatility in the exchange rate has been a serving issue in SSA countries which as impacted significantly on FDI.

1.3         Objective of the Study

The broad objective of the study is to examine the relationship between exchange rate volatility and foreign direct investment in Sub-Saharan Africa. The specific objectives include:

To measure volatility in exchange rate in some sub-Saharan African countries

To examine the impact of fluctuations in exchange rate on direct investment by foreigners into some SSA countries.

1.4         Research Questions

The following research questions are tested:

How exchange rate does fluctuate in the sub-Saharan African countries?

Does the economy of sub-Saharan African countries has significant impact in attracting foreign direct investment into SSA countries?

1.5         Scope of the Study

This study selects five top SSA countries which are Nigeria South Africa, Ghana, Angola and Ethiopia study attempts to examine the volatility of exchange rate and foreign direct investments with evidences from South-Africa , Nigeria, Ethiopia, Angola and Ghana. The choice of countries is based on the size of their GDP. According to Sarah Boumphery (2014), these countries accounted for 41% of the region’s population and 71% of its GDP in 2013 besides the fact that these countries share large SSA markets therefore they can be used appropriately to represent SSA. The countries also wield much influence on other SSA countries. Since the late 1980s, most African countries liberalized their economies; hence the coverage of the study which is 1990 to 2014 is significant for relevant policies formulation and implementation in the selected countries.

1.7         Organization of the Study

The study is organized into five sections. Section one contains the background of the study, statement of the problem; objectives of the study, research hypothesis scope of the study and the justification of the study. The second section contains a literature review, conceptual and theoretical review, empirical review and the implication of the review for the current study. Section three shall unveil the theoretical framework and methodology, model specification, research design, estimation technique, source and measurement of data. Section four contains the statistical data analysis alongside the discussion of results and comparison of result with previous findings. Section five covers the summary, conclusion and recommendations of the research work.