Do Foreign Portfolio Investment Inflows have Stabilizing Effects on the Recipient Economy? Evidence from Nigeria

Abstract

In theory, Foreign Portfolio Investment (FPI) inflows can help stabilize the macroeconomy by increasing the host economy’s foreign exchange reserves, which, in turn, stabilizes the currency and prevents the inflation surge associated with exchange rate depreciation. Based on this theoretical reasoning, the Central Bank of Nigeria (CBN), in the last decade, has encouraged FPI inflows through monetary policy tightening and other incentives, including allowing foreign portfolio investors to hold Open Market Operations (OMO) bills as a means of supporting reserves accretion to stabilize the Naira in the face of declining crude oil receipts. However, FPI is easily reversed, especially when spooked by any threat to economic stability thereby generating instability in the recipient economy. Against this backdrop, this study investigates the impact of money market - based FPI inflows on macroeconomic instability in Nigeria using a five-variable Structural Vector Autoregressive (SVAR) model with quarterly data spanning from 2010Q1 to 2021Q4. The key finding of the study is that net money market-based FPI inflows destabilized the macroeconomic environment of Nigeria due to a significant reversal of the short-term FPI inflows. Accordingly, the study recommends that the CBN should improve on the conduct and efficiency of its policy response to the developments in the global monetary policy stance to forestall short-term FPI inflow reversal and macroeconomic instability.