DETERMINANTS AND IMPACTS OF CAPITAL FLIGHT IN THE NIGERIA ECONOMY

(Banking and Finance)
DETERMINANTS AND IMPACTS OF CAPITAL FLIGHT IN THE NIGERIA ECONOMY
ABSTRACT

The study made attempts to investigate into determinants and impacts of capital flight on the economic growth in Nigeria using the Ordinary Least Square Method, using time series data from 1980 to 2011. The quantitative results reveal that, large capital outflows from Nigeria is accounted by External debt, Exchange rate, Foreign direct investment, Interest rate, Foreign reserves, Inflation rate and Real gross domestic product.
External debt, Population and Exchange rate reported a negative impact on economic growth while Capital flight and Inflation rate has a non significant and negative impact on economic growth.
Therefore, growth and development in Nigeria can be achieved and sustained through alleviation of capital flight. Hence, the adoption of sound monetary policies, effective coordination of external debt, strict enforcement of the rule of law ensuring financial security, etc are recommended
CHAPTER ONE
INTRODUCTION
1.0    BACKGROUND OF THE STUDY
Capital flight is the outflow of capital in form of massive transfer of currency from one country to another. It is usually regarded as the economic responses to the portfolio choices of wealth residents of some debtor countries in recent years [Dombus (1985), Cuddington (1986) and Conesa (1987)]. Investors from developed countries are seen to be responding to investment opportunities while investors from developing countries are said to be escaping high risks they perceive at home (Ajayi, 1997). Thus, according to Schneider (2003), capital flight involves the outflows of resident capital which is motivated by economic and political uncertainties in home country. Such lost of resources do not contribute to the expansion of domestic activities or the improvement of social welfare of domestic residents.
Calvo and Hermandez (1996), Uchenolu (1994), Pierre (1998), Stephens (2003) and Obadan (2004) has attributed capital flight to macro-economic mismanagement, policy distortion, exchange rate ms-alignment and budget deficit respectively. For example, as investors anticipate higher taxes, they divert their investments abroad. When currency devaluation is expected, investors usually move out their domestic assets and invest in foreign countries in order to avoid capital loss that will result from devaluation.
It is widely believed that the study of capital flight is important because of the economic problem such capital flight can create (Khan, 1989). The outflow of capital can cause a shortage of liquidity in the economy and lead to the exertion of upward pressure on the interest rate. Similarly, the shortage of liquidity can cause a depreciation of domestic currency and a loss of reserves will ensue.
According to Obadan (2004), the important question is why capital flight from Nigeria has acquired so much significance over the years. The massive capital flight from the country has often been linked to globalization and to large balance of payment deficits which in turn gives rise to massive waves of currency speculation [Ajayi, (1992, 1997)]. Here, capital flight not only aggravates the shortage of resources for development, it indirectly leads to decline in growth. Growth is reduced partly because investments have been diverted abroad and also because necessary imports are limited by the foreign exchange drain from both the flight itself and the fact that earnings on such assets are often not repatriated (Pastor, 1990).
Looting of funds to more advanced countries is one of the components of capital flight (Nyong, 2003). Morgan Guaranty Company (1986) provides a broader definition. To them, it is “reported and unreported acquisition of foreign assets by non bank’s sector.” Capital flight is seen therefore to have taken various forms, including false bottom suit cases stocked with cash or travelers check (currency smuggling), trade taking (over invoicing of imports and under invoicing of exports), electronic fund transfer from private banking services, overseas investments emanating from illegal activities like corruption, illicit activities particularly those related to tax evasion and exchange rate controls. This is consistent with the view held by Husted and Melvin (1990) that the acquisitions of such foreign assets occurs in response to political or economic crisis in the developing countries. The factors in other countries attracting these capital flows from Nigeria may include the need to put their capital and investments in a more stable economy where there is less financial instability and less risk of currency devaluation and foreign debt. There are also reduced taxes paid on these investments when they are taken abroad.
Findings have shown that most of the capital flights from under developed countries are held in Swiss bank accounts because of the principle of national sovereignty which includes domestic bank secrecy laws and blocking statutes preventing disclosure, inspection or copying of documents without official approval (Nyong, 2003). Nyong also affirms that these capital flights are held not only in bank deposits in these Swiss banks but also in treasury bonds, treasury certificates and bills, equities and physical assets abroad.
The lack of financial resources for appropriate economic development has pushed most African countries including Nigeria into external borrowing to augment domestic resources in their quest for economic growth. In Nigeria, one of the unresolved and perturbing macro-economic problems for the past two decades is the growing rate of capital flight. Furthermore, the recent global financial crisis and its generated problem of massive movement of funds out of the country has undoubtedly contributed to the growth of capital flight as well as the present consolidation crisis. According to Sanusi, over $20billion left the country from 2008-2009 as a result of capital flight (Vanguard Newspaper, 29 August, 2009). This is just one way in which capital flight can affect a country’s economic growth. The IMF (1996) reveals that Nigeria suffered a loss of $7.573 between 1972 and 1989 to capital flight.
There is no doubt that capital flight has damaging consequences on the economy. For instance, capital that is transferred abroad from the country cannot contribute to domestic investment and other productive activities. International Financial Corporation (1998) and Ndikumana (2000) observed that Nigeria is among many African economies that have achieved significant lower investment levels as a result of capital flight. Such low level investment brought about by high rate of capital flight in Nigeria also has a multiplier consequence on other aspects of the economy including the alarming rate of unemployment as well as pronounced regressive effects on the distribution of wealth in Nigeria. Capital flight is therefore both a cause and symptom of weak investment performance in Nigeria. For example, capital flight leads to reduction in growth potential through fall in investment. The transmission flow is that the fall in growth leads to fall in employment creating opportunities and inability to service debt obligations. Unemployment further leads to poverty, loss of self esteem and death.
Capital flight also leads to erosion of the tax base because funds taken outside cannot be taxed, thereby aggravating poverty and stimulating political-socio unrest and instability.                                                          
Capital flight has been regarded as a major factor contributing to the mounting foreign debt and inhibiting development efforts in the third world countries (Cuddington, 1986). External debt in Nigeria for example increased by 700% from $3.5 in 1980 to $28.0 in 2000 (Ajayi, 2000).  Similarly, the outflow of capital may augment foreign finance problems of heavily indebted poor countries if creditors like IMF and other donors are de-motivated to give further assistance as a result of capital outflow.
1.1    STATEMENT OF RESEARCH PROBLEMS
Capital flight reduces domestic investments directly by reducing the volume of savings channeled through the domestic financial system, hence, retarding economic growth.
Secondly, capital flight affects the government’s budget balance indirectly by reducing the tax base through reduced domestic economic activity. Capital flight is likely to have pronounced regressive effects on the distribution of wealth.
Thirdly, capital flight forces the government to increase its borrowing from abroad which further increases the debt burden and worsens fiscal balance.
The regressive impacts of capital flight is compounded when financial imbalances results in devaluation of the national currency because those wealthy individuals who hold external assets are insulated from its negative effects.
Capital flight exacerbates the resource gaps faced by developing countries and forces them to incur more debt which worsens their international position and undermines overall economic performance.
1.2    RESEARCH QUESTIONS
The research questions which would arise and guide this study are as follows;
What are the determinants and impacts of capital flight in the Nigerian economy?
How does capital flight reduce domestic investments and affect government budget balance?
What is the relationship between capital flight, currency devaluation and external debt?
Why do the regressive impacts of capital flight fall more on the less wealthy individuals of a country?
1.3    OBJECTIVES OF THE STUDY
The main objective of the study is to examine the determinants of capital flight in Nigeria, its effects on the Nigerian economy, the push and pull factor that causes capital flight.
The specific objectives are stated below:
Analyze the economic (mainly macro-economic) and other factors responsible for capital flight.
Identify the major impacts of capital flight on the domestic economy.
Examine the relationship between capital flight, currency devaluation and external debt.
1.4     SCOPE OF THE STUDY
The scope of the study will be looking at Nigeria’s capital flight, trends and determinants from 1980-2011.
1.5    SIGNIFICANCE OF THE STUDY
It is surprising that despite these unspeakable problems high rate of capital flight poses to the Nigerian economy, Nigerian case studies are grossly lacking in significant literature. Based on the problems, this study is therefore taken to fill this gap and to investigate on the determinants and impacts of capital flight on Nigeria’s economy and economic growth.
The study will be of great benefit to Nigeria’s economic policy implementers as it establishes itself that effective monetary and fiscal measure policies are tools for capital flight reversal in Nigeria.

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