Foreign Capital Inflows, Financial Development and Growth In Nigeria: A Structural VAR Approach

The role of foreign capital inflows in the growth of developing countries cannot be overemphasized as they help in facilitating the transfer of sophisticated technology and management expert, creating new job opportunities, and broadening the financial market. Some scholars, on the other hand, have stressed that foreign capital inflows can leads to inflationary pressure, expose developing economies to external shocks, and limit the effectiveness of domestic policy instruments. Despite the debate on the impact of foreign capital inflows on growth, extant literature has emphasized the role of financial development in the link between foreign capital inflows and growth. Proponents of financial development argue that financial development provides a good platform for better monitoring, efficient allocation of resources, and fewer information asymmetries, which are important predictors of economic performance. As a result of the debate, this study investigates the growth effect of foreign capital inflows and financial development in the Nigerian economy between 1986Q1-2016Q4. Employing the impulse response function (IRF) as well as forecast error variance decomposition (FEVD) of structural SVAR, the outcome of the study shows that shocks in foreign direct investment (FDI) inflows and financial development have a positive and significant effect on economic growth while portfolio investments, official development assistance, and remittances have no significant impact on economic growth. The FEVD reveals that shocks in FDI exert the most significant impact on growth, followed by the level of financial development. The study recommends that the government should promote a favorable macroeconomic environment for existing and potential foreign investors to ensure that FDI continues to stimulate sustainable economic growth. Also, the government should promote sound economic policies to strengthen the financial system as this will stimulate the inflows of portfolio investments. Further, the government should develop and implement strategies that will help to develop the financial market in other to instill confidence in both local and foreign investors.