Globalised Financial Flows, Capital Market Deepening, and Economic Growth: the Nigerian Experience

Abstract

Of the whole complexion of globalized financial flows (GFF), Foreign Portfolio lnvestment (FPI) stands out uniquely on account of its dual characterization of being distinct and essential. It is distinct in the sense that it is the only type of GFF that must necessarily utilize the framework of capital markets to transmit from one country to another. Its essential feature derives from its potential to excite economic growth positively. Literature shows that GFF, of the FPI type, can foster financial development through capital market deepening, which then engenders economic growth. Opposing views posit that GFF in the form of FPI is of "foot loose" nature and thus can lead to crisis and contagion and as such should not be relied on for purposes of strategizing for economic growth. Since 1998, the rise in the volume of FPI inflow has been so impressive that it can no longer be ignored. In fact by 2005, the inflow of FPI has surpassed that of Foreign Direct lnvestment (FDI). This study therefore sets out to find whether GFF flow (of the FPI type) into Nigeria has improved under the policy financial globalization and financial integration (financial openness). And also confirm whether this policy has impacted positively on economic growth. The relevance of this study derives from the fact that available studies on FPI inflow are just a handful and recent, and there is no country specific study regarding the effect of foreign portfolio investment on financial sector development and economic growth. This study hopes contribute to the literature in this gray area using Nigerian data. The study applied the dynamic distributed lag model, with error correction, on a set of relevant time series data and finds that FPI inflow has improved under the policy of financial openness. It was also confirmed that the policy of financial openness is positively related to capital market deepening and hence financial sector development. Finally, it was discovered that the inflow of FPI within the policy context of financial openness is positively related to economic growth via capital market deepening. Granger causality tests reveal that: financial openness, and market size, does not granger cause FPI inflow; real rate of return (RRR) of investments granger causes FPI inflow; while market size granger causes capital market deepening. Finally the tests revealed that there is a bi- directional causality relationship between capital market deepening and economic growth. It was therefore concluded that the lure for superior rate of return causes FPI inflow, while the policy of financial openness facilitates it. Financial openness facilitated deepening of the capital market which led to economic growth. Based on the results, it is recommended that there is need that the present reforms going on in the capital market, and the financial sector in general, be sustained given the fact that the Nigerian financial sector has a prominent role to play in channeling resources for investment and productive purposes. Again, government should put in place appropriate policies that will boost continuous inflow of foreign portfolio investment in Nigeria.