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Research

Foreign Direct Investment In Nigeria

FINANCIAL LITERACY: Making Sense of FDI Vs. FPI.

Just as capital is vital to the smooth running and funding of privately-owned companies, countries also welcome funding from foreign investors to boost their economic activities, since they cannot meet their capital requirements from internal sources alone. While private companies can turn to banks or the capital market for funding, countries can opt for foreign investors for inflows. These could be in the form of Foreign Direct Investment or Foreign Portfolio Investment.

FOREIGN DIRECT INVESTMENT (FDI)

Foreign Direct Investment (FDI) refers to cross-border investments made by a resident in one country in an enterprise in another country or another country’s economy. Foreign Direct Investment (FDI) involves establishing substantial, long-term interest in the economy of a foreign country. Due to the significantly higher level of investment required, foreign direct investment is usually undertaken by multinational companies or global institutions. Foreign direct investment tends to be viewed more favourably since they are considered long-term investments, as well as investments in the well-being of the country itself.

How does FDI benefit both investors and receiving countries?

As mentioned earlier, an investor can make a foreign direct investment by expanding their business in a foreign country. For instance, Twitter establishing an affiliate office in Nigeria. In this instance, Twitter will oversee and manage its operation in Nigeria. Foreign direct investment offers advantages to both the investor and the foreign host country through:

Market diversification: In achieving market diversification, the business must expand to other territories or markets. In doing so, they will need to invest in new markets or regions by establishing and setting up businesses to grow their market share and gain a share of voice.

Tax incentives: In some economies, to increase their foreign investments, they provide tax rebates (for instance for the first 3years of the business in the country) to businesses to encourage them to bring in funds through direct investment.

Lower labor costs: For businesses intending to expand their operation into foreign territory, a huge number of financial resources will be expended to bring in expatriates to manage their business operations if it chooses to standardize their processes. However, with FDI, businesses can maximize the human resources of their host countries by adapting and localizing their strategies to reduce labour cost.

Benefits to host country:

Economic stimulation: Inflow of funds through FDIs will assist in stimulating the host nation’s economy through channeled investment in various sectors of interest, which will help spur growth.

Development of human capital: In most cases, foreign investors bring in expatriates to train and share knowledge with the local workers for a period to bring them up to speed with the business operations. This way, the human capital in the host countries will be developed and empowered with added knowledge and experience in line with global best practices.

Increase in employment: An obvious benefit of FDIs to the host country is increased employment. A good number of workers for these businesses will be recruited or sourced locally.

Access to management expertise, skills, and technology: When investors come in to invest or establish their business in another country, aside from the finance they bring in, they also bring in their skills, technological know-how, and managerial competencies to the host country.

Overall, for businesses, most of these benefits are based on cost-cutting and lowering risk. While for host countries, the benefits are mainly economic.

FOREIGN PORTFOLIO INVESTMENT

Foreign portfolio investment (FPI), on the other hand, involves an investor purchasing foreign financial assets. It entails investing through purchasing financial securities in another jurisdiction or country. Investors invest their money in another economy’s financial market by buying securities such as money market instruments, equities, and bonds, expecting a return on investment.

The transaction is usually routed through the country’s exchange such as the NGX in the case of Nigeria and financial institutions. Today, Foreign Portfolio Investment is a critical tool in which individuals, businesses, and governments diversify their funds by investing in foreign portfolios.

Foreign investment In Nigeria

How does FPI Benefit Investors?

Diversification of Investment: As an investor, you can diversify your portfolio by investing in another jurisdiction to achieve high returns. For instance, if the macroeconomic condition of a country is weak, thereby inhibiting return on investments, investing in another country with a better macroeconomic situation can offset the loss and increase the chance of profit in an investor’s portfolio.

Access to a bigger market with favourable risk-return characteristics: Foreign markets such as emerging markets are riskier and comparatively less saturated; hence, they may offer higher returns and more diversity.

Exchange Rate Benefit: An investor can leverage the dynamic nature of international currencies. Some nations’ currencies are stronger than others as in the case of the Naira and Dollars; hence, investors take advantage by investing in economies with stronger currencies relative to theirs.

A boost to the domestic capital market: For the host country, FPI inflows help boost and increase the domestic capital market in areas of increased liquidity, value, credibility, and assurance, which will ultimately impact positively on the overall economy.

Factors that can impact negatively on FPI and FDI

Growth Outlook: A country’s economy plays a crucial role in foreign investments. If an economy is robust and growing, investors are more inclined to invest in the financial assets of that country. On the other hand, investors tend to withdraw their investments if the country goes through economic turmoil or a recession.

Interest Rates: Investors yearn for a high return on investment. Hence, investors prefer to invest in countries with high-interest rates.

Tax Rates: The tax is levied on capital gains. Higher tax rates reduce the return on investments. Hence, investors prefer to invest in countries that have lower tax rates.

Exchange rate instability: Investors are usually concerned with investing in an economy with fluctuating exchange rates. To avoid exchange rate loss eroding their return on investment, they invest only in countries with a stable exchange rate system.

Foreign portfolio investments (FPI) are often referred to as HOT money, given that they are short-term inflow with a high possibility for foreign investors to liquidate and repatriate these funds at any time; thus, economists are of the opinion that foreign direct investment (FDI) are the engines and bedrock for an economy (particularly developing economy) as they are long term in nature and usually highly capital intensive.

Notwithstanding, FPIs and FDIs contribute significantly to an economy’s growth as they spur economic development across all sections of the economy, as reflected in the current account balance of a nation’s balance of payment. Hence, economic managers and governments must create an enabling environment to attract these investments.