Does Foreign Direct Investment Affect Financial Stability in Developing Countries

Abstract

The relationship between Foreign Direct Investment (FDI) and financial stability is of increasing concern among economies. The volume and structure of FDI can affect the financial system's stability. This study examines the effect of FDI on financial stability in Nigeria between 2003:1 and 2019:4. The data were subjected to a stationarity test using the Augmented Dickey-Fuller test, and the test result shows that all variables were integrated in the order of 1. The Johansen cointegration test result showed a long-run relationship between all the dependent and independent variables. The hypotheses were tested using Error Correction Mechanism (ECM). It was found that the short runs deviations will adjust to their long-run equilibrium by 17.3% quarterly. The findings show that FDI as a percentage of GDP positively affects Nigeria's financial stability. In contrast, FDI as a percentage of fixed investment and net FDI have a significant negative effect on Nigeria's financial stability. The study, therefore, concluded that inflows of FDI play a significant role in the Nigeria’s financial stability. Based on the findings, the study recommends that authorities such as Ministry responsible for trade, commerce, and investment create an enabling investment environment such as regulations for protecting investors interests to attract FDI into the system.