Exchange Rate Volatility and Foreign Capital Inflows in Nigeria: A Vector Error Correction Model Approach

The aim of this study is to examine the relationship between exchange rate volatility and foreign capital inflows in Nigeria. The results of the past studies were inconclusive and the uniqueness of this work also lies in the consideration of other important variables such as external debt and remittances as parts of strategic variables to capture foreign capital inflows which the bulk of the past studies have failed to recognize. Data were collected from CBN Statistical Bulletin and UNCTAD investment report from 1990 to 2016. Relevant pre-estimation tests such as unit roots and Johansen cointegration were carried out. Because all the study variables were integrated of order onei.e I(1) and have two cointegrating equations vector error correction model was estimated.Consequently, the error correction model reveals that about 32 percent of total disequilibrium due to external shock in the previous year is corrected in the current year. Therefore, it will take about three(3) years for the system to adjust back to its long run equilibrium path. Results further showed that FDI inflows increase the level of volatility in exchange rate in the short run but the volatility dies away over time. Conversely, remittance reduces exchange rate volatility while increases in external debt increase exchange rate volatility. It is recommended that the Central Bank of Nigeria should make more efforts to stabilize the exchange rate. In addition, policies and practices which may ease receipt of remittances from citizens in diaspora should be put in place while external debt should be discouraged as much as possible in the country.