1. 1 Background to the Study

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1.2 Statement of the Problem

Capital flight reduces domestically available investible capital. Domestic investment is expected to have a negative correlation with capital flight. Given that inflows of Foreign Direct Investment (FDI) should complement domestic capital, capital flight has constituted a problem. Domestic investment of either autonomous or induced type was not considered in earlier studies in relation to capital flight. In spite of governments’ continuous campaigns for foreign investors to invest in the domestic economy, capital flight has continued unabated. This raises a concern on the effect of capital flight on domestic investment. Where previous studies were done on capital flight, they were not specific on Nigeria. Investments that lead to increase in capital formation for the economy and act as the foundation for infrastructure or framework for the development of the country cannot be made in the face of inadequate capital.

Capital flight being a challenge to domestic investment is exacerbated by the process of financial globalisation that enables capital to move freely between countries. Since capital seeks the best avenue where it can earn the highest return given a level of assumed risks, the domestic investment environment has not been clement enough for investment. Financial globalisation, in some cases, has rendered some national governments’ monetary policies ineffective. Since financial globalisation connotes the liberalisation of the capital account, it enables capital to move in and out of the domestic economy with reduced level of restrictions. Emerging economies that have been forced to open up their economies have faced episodes of capital flight as results of financial globalisation induced crises. Countries that that liberalise their capital accounts are more prone to financial crashes or at least financial volatility because of the multifarious impacts of unrestricted capital flows involving them. Studies of financial globalisation induced volatility and flights of capital have generally left Nigeria out even where less prominent countries like Namibia were empirically investigated. Financial globalisation is expected to impact negatively against capital flight as a result of inflow of capital into the economy. This is expected to boost domestic income and lead to financial and real development. But its effects in those countries have not been so productive but have rather brought market failures.

Capital flight has been caused partly by lack of confidence by domestic investors in the economy and has encouraged domestically generated capital to flee from the economy. While foreign capital that has been invested in the economy can leave after some time if the investors’ objectives are achieved, domestically generated capital flowing offshore should generate and report returns. However, a situation that encourages domestically generated capital to find solace and investment grounds abroad leave much to be desired. The concern here is that the level of autonomous investment that should be undertaken suffers because capital has relocated out of the economy. Given the level of infrastructural deficit (the main situate of autonomous investment) facing the country, the required capital to construct, replace and rehabilitate infrastructure is either not domestically available or would be sourced at some expense. A second issue on resident capital is that per capita income goes down as capital flees. This reduces per capita income productivity. The scenarios generate macroeconomic challenges for policymakers as to how to retain resident capital in the economy in the face of competing real rates of return in developed and mature financial markets.

The study of capital flight and aggregated financial savings in the investment process is important since a cycle has been established between income, savings and investment. The loss of investment that happens when capital flight occurs means equally that some savings are lost to the economy. Research on capital flight seems not have reached this point of discourse. Since income is also a strong determinant of savings, the impacts of this scenario on financial savings under the golden rule level of capital in conditions of capital outflows and flight is also a financial concern. The golden rule level of capital is defined as a steady state with the highest level of consumption that benevolent policymakers should achieve for individual’s well being. With this, the rate of investment is detrimentally affected especially under increased domestic consumption propelled by population increases. This ultimately affects further capital formation. The role and the impact of the exchange rate is in the process is exemplified by the understanding that capital in the domestic economy has alternative uses in capital formation

1.3 Objectives of the Study

The major objective of this study is to analyse the impact of capital flight on the Nigerian domestic investment in a financially globalising world, with the aim of finding out if capital flight can increase through financial globalisation and thereby reduce domestic investment in the process. The specific objectives are:

  1. To examine the relationship between capital flight and domestic investment, and sum up the challenges posed by capital flight to domestic investment during the period of financial globalization in Nigeria.

  2. To evaluate the impact of capital flight on financial savings since it is the primary source of financing investment.

  3. To find out the type of capital flight and estimates that is more significant and therefore relevant to Nigeria.

  4. To investigate the role of the nominal exchange rate and its impact in encouraging capital outflows and domestic investment in the economy.

1.4 Research Questions

To achieve the earlier stated objectives, the following research questions become pertinent:

  1. What is the existing relationship between domestic investment and capital flight in Nigeria?

  2. Given that capital flight and outflows have continued as proved by earlier studies, how has this affected domestic savings that drive investment

  3. With the export performance in the period from 2000 to 2007, especially of the petroleum sector and prices of other commodities that resulted in a seemingly buoyant accumulation of external reserves. What has happened to capital fight?

  4. What is the impact of the incidence of capital flight in the era of financial globalisation indicated by a high level of openness and capital account liberalisation?

  5. With the uneven level of development between the different countries of the world, and especially the developed countries and Nigeria, how can Nigeria limit further capital leakage out of the economy when the return-risk dimensions in investment paradigm are taken into account?

  6. What is the role of the exchange rate in the capital flight process, given that the flotation of the currency has been on since 1986 when the currency has been on managed float?

  7. With continuous flights of domestic capital from the economy, how has domestic investment in Nigeria fared within the current financial globalisation period?

1.5 Statement of Hypotheses

  1. H0: Capital flight has not significantly affected domestic financial savings in Nigeria.

  1. H0: Risk in the macroeconomic conditions of the country does not have a long run relationship with capital flight out of the economy.

  1. H0: There is no significant relationship between the process of financial globalization and capital flight out of the country.

  1. H0: Capital flight in the Nigerian economy does not have a significant relationship with domestic investment.

1.6 Significance of the Study

Given the fact that capital flight is an established phenomenon in the Nigerian economy (Ajayi 1992, Onwuodokit 2000, Collier et al 2003 and Lawanson 2007), the understanding of its major negative impact on investment in Nigeria is important. The need to empirically investigate the relationship that exists between capital flight and investment cannot be overemphasised. Various studies have always concluded a priori that capital flight brings about the lack of investible funds in the economy and pushes the country to seek external resources to meet developmental needs (Ajayi, 2000). The implications arising from this would bring about a decision that would enable resident capital to be profitably invested in the economy rather than having to seek alternative investment outlets outside. This area has not been addressed by any previous study on Nigeria, though some studies have been done on other countries. It is believed that this study bridges this gap.

Financial globalisation has become an observable fact following the liberalisation of most countries’ capital accounts and especially the floating of the exchange rates. This study investigates the impact of the financial globalisation process on capital flight in Nigeria. Nigeria had to implement the floatation of the Naira as part of the cross-conditionality of the International Monetary Fund to secure support for its Structural Adjustment Programme (SAP) in 1985/1986. Also, this study enables the understanding of the impact of the adoption of a floating exchange rate regime on capital flight and empirically tests if the process has had negative or positive impact on capital flight in Nigeria. In the process, the determinants of the financial globalisation and the current status of Nigeria can be easily understood.

The study brings out the effect of accumulation of reserves on capital flight out of Nigeria. Also the use of the reserves over the years can be fully understood, and the possible more productive ways to direct the reserves in future years. For instance, the external reserves of Nigeria which have gone up to about $60 billion in 2007 had dropped to less than $30 billion dollars as at December 2010.
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