Thursday, February 20, 2020 /6:10 PM / By FDC / Header Image Credit: Research Leap
Foreign direct investment (FDI) can be a catalyst for economic growth. By bringing in new inputs, technologies and knowledge to the host country, FDI increases the amount of physical capital and augments human capital. According to the United Nations Conference on Trade and Development (UNCTAD) 2019 World Investment Report, Nigeria is the third largest recipient of FDI in Africa, behind Egypt and Ethiopia. This is largely thanks to its strong fundamentals such as natural resources, a large market and a young population. However, many problems,including a poor investment climate and a huge infrastructure deficit, continue to pose huge threats to long-term investors.
In Q3'19, not only did the value of FDI flows to Nigeria decline, its share of total capital flows fell by 0.10% to 3.73% from 3.83% in Q2'19.2 The good news is that Nigeria has finally signed the African Continental Free Trade Agreement (AfCFTA) which creates a larger market and will facilitate the free flow of goods within Africa. Nigeria stands to gain from AfCFTA on three fronts.
Firstly, its large market (accounting for roughly 17% of Africa's population and GDP) makes Nigeria an ideal place for business headquarters. Secondly, once these headquarters are established, Nigeria could see a further increase of FDI as companies invest heavily to export from within the AfCFTA and avoid tariffs. Thirdly, as the largest country in Africa, Nigeria offers a cheap labor force, which is a compelling opportunity for investors and should also contribute positively to Nigeria's unemployment problem. However, if Nigeria is to leverage these new opportunities and attract more FDI it must first address its underlying challenges.
Constraints to FDI
inflows in Nigeria
Many economic and social factors have discouraged foreign investors in Nigeria, thereby reducing the flow of foreign direct investments into the country. Between 2014 and 2018, FDI flows fell by 57.36% from $4.69 billion to $2 billion. The two key factors that led to this drop are a poor investment climate and the significant infrastructure deficit.
Nigeria's stringent government policies, bureaucratic bottlenecks for securing permits, high finance costs, low foreign exchange availability, and weak legal framework continue to deter investments. The other key challenge to investments in Nigeria is the country's huge infrastructure deficit. The level of infrastructural development in a country plays a key role in attracting foreign investors. The epileptic power supply, poor road and rail infrastructure, and gridlocks at the ports have all increased the cost of doing business in the country. Manufacturers must resort to alternative energy sources and pay more on demurrage due to delays at the port.
Improving the Investment Climate
There is a need for clear and transparent policies as well as a strong legal framework to improve the investment climate. The Presidential Enabling Business Environment Committee (PEBEC) initiatives such as e-registration of business, e-filing for taxes, and the elimination of lawyer's services in registering a business, among others, have helped to save time and reduce the cost of registering a business. In Kano for instance, businesses can now be registered in less than two days compared to months, previously.
However, the PEBEC programming is currently limited to Lagos and Kano. Expanding these programs across the country is a crucial next step. In addition, foreign exchange policies are vital to attracting foreign investors. It enhances easy entry and exit. Nigeria currently adopts a multiple exchange rate system which creates room for arbitrage, increases transaction costs, and douses investor confidence. For Nigeria to attract more investment flows, an efficient forex market priced in line with market fundamentals is imperative.
This will make transaction settlement seamless, reduce transaction costs, promote transparency in the forex market and boost investor confidence. Vietnam, in a bid to attract more FDI flows, provided a legal framework suitable for both domestic and foreign investors. Its foreign investment law makes the investment environment favorable and narrows the policy gap between domestic and foreign investors.
With this policy, foreign trade restrictions were relaxed gradually, regulations on registration procedures, access to land, capital and foreign exchanges were improved, and tax incentives were initiated to promote greater presence of foreign-invested enterprises. The impact of these initiatives was massive on FDI flows into the country. FDI flows jumped to $4billion in 2005 from $320 million in 1988.
Reducing the Infrastructure Deficit
Finally, Nigeria needs to reduce its huge infrastructure deficit, specifically roads, rail, and power supply. In Vietnam, the government inaugurated the DoiMoi reform in 1986 which was committed to creating and improving the country's infrastructure facilities to attract FDI flows. Some of these facilities included: providing electrical power grids, road networks, telecommunications and water lines.
By 2010 the country's power supply had increased by 3.76 times to 100 billion KWh, up from26.6billion KWh in 2000.5 The country's massive investment in roads, between 2000 and 2010 increased road density to 0.77km per km2 by 2010, up from 0.66km per km2 in 2000. These had a positive impact on the ease of doing business as cost of doing business reduced and productivity improved. Annual FDI flows into Vietnam skyrocketed to approximately $4billion in 2005 from $830 million in 1988,with an annual growth rate of 28 percent.
Nigeria's prospects with
Nigeria has a huge deposit of human and natural resources that are capable of attracting FDI flows into the country. However, for Nigeria to maximize its potential, especially with the signing of AfCFTA, it is important that the government addresses the underlying structural bottlenecks that make Nigeria such a difficult country for business investment.
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