FX regime, key to stimulating investment in Nigeria – Report


Nigeria’s capital budget for 2017 is NGN2.2 trillion. Assuming this is channeled towards investments, it would only meet 11% of the estimated funding to bring investment as a share of GDP to of 20%.

In Nigeria’s Economic Recovery and Growth Plan (ERGP) which aims to attain important infrastructure targets within the next 3 years, the government acknowledges its limits and emphasizes the need for private investment to drive 3 infrastructure development.

Our report which examined the ERGP identifies two critical factors for unlocking private investment: (i) improving the business environment, and (ii) having a sustainable foreign exchange regime. We note that the country has made some progress towards improving the business environment through several reforms, including a 60-day action plan implemented over the past 6 months.

However, more needs to be done, in particular, with respect to paying taxes, getting access to electricity and other infrastructure, which are critical to bolster investment.

While foreign exchange liquidity has improved in recent times as the Central Bank of Nigeria (CBN) allows for more flexibility in the foreign exchange market, the existence of multiple exchange rates with significant variances poses a risk to investment. In our view, a market-determined exchange rate, where all rates are harmonized, is fundamental to boosting domestic and foreign investments.

Estimating the size of investment needed to drive growth
In the decade preceding the recession, Nigeria recorded growth at an average of 6.3% per annum. To estimate the size of investments required to drive growth back to the
historical growth trend, we adopt the following approach:
Economic Literature Review
An extensive review of 26 economic papers was conducted to identify the key determinants of economic growth, particularly in the emerging and developing
economies. We find that investment is the most fundamental driver of growth, with positive and statistically significant coefficients.
Quantitative Techniques
Using a panel data of 13 emerging economies between 1991 and 2016, we analyze the impact of investment on output growth. To achieve this, we utilize a panel
regression of output growth on labour productivitygrowth and investment (% of GDP). Specifically, we incorporate one year investment lag to avoid a model specification error, since investment is unlikely to propel growth within the same year. After a series of analyses and robustness checks, we arrive at our estimates using:

Real GDP growth = a+b (Labour productivity growth)
+ c (Investment share of GDP)
where a, the intercept of the regression, captures the effect of other variables that independently affect GDP growth but are not included in the model. The other parameters of the equation, b and c, represent the coefficients of the explanatory variables ( labour
productivity growth and investment share of GDP).

Impact of exchange rate flexibility on investment and economic
A number of academic literature have shown the positive impact of exchange rate flexibility on investment and economic growth. Broadly, it has been argued that a flexible
exchange rate regime has a positive effect on investment and economic growth compared to a fixed or intermediate regime.

  •  Ihnatov and Capraru (2012) using data from 16 Central and Eastern European Countries find that flexible exchange rate regimes have a superior positive effect on growth in per-capita GDP relative to intermediate and 4 fixed regimes .
  • Levy-Yeyati and Federico Sturzenegger (2003) studied the relationship between exchange rate regimes and economic growth using a sample of 183 countries, and finds that median annual real GDP per capita growth for floaters was 0.7 percentage points higher than pegs. For developing countries, less flexible exchange rate regimes were associated with slower growth, as well as with greater 5 output fluctuations
  • Eregha (2017) also studied the impact of exchange rate regime on FDI in the West African Monetary Zone using data for the period of 1980 t0 2014 and finds that exchange rate uncertainty suppressed FDI inflows to the selected countries, and the magnitude of the impact was 6 significantly high .

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