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Capital Flight and the Growth of the Nigerian Economy

Capital Flight and the Growth of the Nigerian Economy

In Nigeria, the growing rate of capital flight has been one of the unresolved and perturbing macroeconomic problems for the past two decades. Furthermore, the recent global financial crisis and its generated problem of massive movement of funds out of the country has undoubtedly contributed to the regeneration of the growth of capital flight as well as the recent consolidation crisis which is threatening the banking sector .

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According to Sanusi, over $20billion left the country from 2008 – 2009 as a result of capital flight. (Vanguard, 2009) this is one way in which capital flight can adversely affect a country’s economic growth. The IMF (1996) reveals that Nigeria suffered a loss of $7,573million between 1972 and 1978 against a capital flow of $270million within the same period.

This problem as seen is more pronounced in the mid-1960s, with low values (1965, 4.2, 1966, 2.8) of net capital flow. The worsening situation was recorded in 1974 and 2001 with -39.3 and -53.4 respectively. Although this situation appreciated in 2002, it started falling back in 2008. 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 multiplier consequences on other aspect 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.

 2.1.3   Causes of Capital Flight      

The causes of capital flight in the discussed are many. The various factors can be grouped under relative risk, exchange rate misalignment, financial sector constraint, fiscal deficit and external incentives (khan 1989), and disbursement of new loans to LDC’s (cuddington 1987).these are no doubt economic factors, though important, are often ignored. These include consumption of political leaders and extra ordinary access to government fund. The factors are discussed below;

  1. Relative Risk: In a decision making process on investment, the wealth holder looks at the various risk. There are certain inherent characteristics of developing countries which make risk attached to investment larger than those of developed countries. Using the concept of expropriation risk within the context of an inter temporal optimizing model. Khan and Hague (1985) showed that the increase in risk in a rational expectation setting would tend to increase the outflow of private capital from the domestic economy into foreign countries where investments are less risky. The expropriation risk could include a variety of distortions such as differences in taxes and political instability resulting in possible destruction of private property. Eaton (1987) builds on the Khan-Hague model by relating the risk of expropriation to capital owned domestically, which is defined, especially in the case, as higher taxation to public and publicly governmental foreign debt. The tax obligation arising from an inverse in external debt can lead to capital flight. The flight in one investor leads to a rise in the potential tax obligation of other remaining investors. This also may create the incentive for other incentives to move their assets abroad.
  2. Exchange Rate Misalignment: It is generally agreed that one of the principal determinant of capital flight is exchange rate misalignment. It has been amply demonstrated in empirical analysis of several studies like Dornbusch (1985), Cuddington (1981), Lessand and Williams (1987), that the real exchange rate plays a significant role in the direction and magnitude of capital flight from highly indebted countries Under normal circumstances, if a currency depreciation is expected, domestic wealth owners will shift out of domestic assets into foreign assets. In general, it is difficult to measure precisely exchange rate expectation. It is safe however to assume that If a country is overvalued, economic agents would expect the currency to be devalued in the future. Holding forth to their expectation, would cause resident to avoid the potential capital loss by converting into foreign claims.
  • Financial Sector Constraints: Financial sector constraint can lead to capital flight. It is well known that narrowness of capital and money market is a function of developing economies. The market therefore provides only a limited variety of financial instrument in which wealth can be held. There is also in many developing countries the lack of full or credible deposit insurance on assets that are held in the domestic banking sector. As a result of this constraint, resident developing countries look abroad to invest their wealth.
  1. Interest Rates: There are extension controls on interest rates and other aspects of financial market behavior in developing countries. Government policies in the financial sector have resulted in nominal interest rates that are far below the rates on comparable financial instruments. In such situations, it is expected that investors will seek alternative assets that will yield not only positive but higher returns.
  2. Fiscal Deficit: It has also been shown by Dornbush (1985), that capital flight is typically accompanied by fiscal deficit. When a rising fiscal deficit is financed through the printing of money, it leads to inflationary pressure. To avoid the erosion of their monetary balance by inflation, moving out of domestic assets is one way to avoiding inflation tax. When fiscal deficit is financed through sales, domestic residents may expect that at some future date, their tax liabilities may increase to pay for the national debt. These encourage domestic investors to move their assets to foreign countries to avoid potential tax liabilities.
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A number of external factors influence the flight of capital, generally in terms of the opportunities available outside the country, including the attractiveness of interest rates, and the range of financial instruments in which wealth can be held. This is aptly put by (Walter, 1986), ‘flight implies havens, and havens take the place of national statues that provide an attractive range of real and financial assets to foreign based investors, political and economic stability, a favorable tax climate for nonresident and various other attributes that generally are the obverse of condition triggering capital flight in the first place. On some types of deposits, withhold tax are not taken from non-residents deposits. Certain countries allow secret accounts which are attractive to some wealth owners and can facilitate illegal transactions and tax evasion.

Some authors argue that capital inflows in the form of disbursement to developing countries are a major cause of capital flight. In the case of public sector borrowing, the availability of foreign exchange increases the potential for graft and corruption. It is therefore logical to assert that for many developing countries (Nigeria inclusive), abuse of official power can lead to capital flight. There is anecdotal evidence that highly placed public officials using the paraphernalia of their office to siphon some of the money under their care to foreign countries solely for their own private use.

In Nigeria case, it is difficult to rank the various causes of capital flight in order of importance. It is important however to point out that a poor macroeconomic policy stance has resulted in all kinds of distortions. At the same time, the role played by other factions such as access to foreign exchange through various prerequisite of offices and consequent possible abuse cannot be underestimated

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