Effect of Foreign Direct Investment Inflow on Inflation in Nigeria

Abstract

This study investigated the effect of foreign direct inflows on inflation in Nigeria, with a particular focus on the dynamics of trade openness and foreign capital movements. Employing the Autoregressive Distributed Lag (ARDL) model due to the mixed order of integration among the variables, the research analyzed both the short-run and long-run effects of foreign direct investment components on inflation indicators such as the Consumer Price Index (CPI), Producer Price Index (PPI), and GDP deflator. The empirical findings revealed that in the short run, CPI was significantly influenced by trade openness and foreign capital inflows, suggested a vulnerability of domestic prices to external economic conditions. In the long run, foreign portfolio investment (FPI) was found to have a negative relationship with PPI, with only the first lag being marginally significant. This implied that sustained FPI and PPI are inversely related, potentially due to increased financial market activity and improved capital availability that supported production. Furthermore, while trade openness exerts a consistent inflationary effect, especially on the GDP deflator, official development assistance (ODA) appeared to reduce inflation by supporting supply-enhancing sectors. Based on these findings, the study recommended that policies should focus on enhancing domestic productive capacity to cushion inflationary pressures from trade openness and that FPI should be strategically directed toward productive sectors to maximize its long-run deflationary benefits. These insights contributed to a better understanding about the external sector dynamics which are different from the domestic sector dynamics and their implications for inflation control in Nigeria.