Domestic Interest Rate and Capital Inflows Policy in Nigeria

Innocent Chile Nzeh; Uche Collins Nwogwugwu; Maria Chinecherem Uzonwanne; Chika Priscilla Imoagwu; Edwin Udochukwu Nwachukwu

doi:10.33119/ERFIN.2024.9.1.1

Innocent Chile Nzeh University of Agriculture and Environmental Sciences (UAES) Umuagwo, Nigeria
Uche Collins Nwogwugwu Nnamdi Azikiwe University, Nigeria
Maria Chinecherem Uzonwanne Nnamdi Azikiwe University, Nigeria
Chika Priscilla Imoagwu Nnamdi Azikiwe University, Nigeria
Edwin Udochukwu Nwachukwu Nnamdi Azikiwe University, Nigeria

DOI: https://doi.org/10.33119/ERFIN.2024.9.1.1

Keywords: Sterilization, Capital Inflows, Monetary Policy, Interest Rate

Abstract

The implementation of sterilization policy has been noted to raise domestic interest rates as it is designed to lower money supply. This occurs due to the inverse relationship between money supply and interest rates, with a rise in interest rates attracting additional inflows into the economy, putting pressure on monetary authorities. The verification of this hypothesis in the Nigerian context formed the motivation for this study. The main purpose of this study is to investigate whether sterilization policy actually raises domestic interest rates in Nigeria. Using a monthly dataset from 2010M1 to 2021M3 and the ARDL estimation technique, total sterilization serves as a proxy for sterilization policy, while the treasury bills rate proxies the domestic interest rate. Findings reveal that sterilization policy has a positive and significant impact on domestic interest rates in both the short-run and long-run. Additionally, money supply negatively affects domestic interest rates in the short-run, while world interest rates have a negative and significant impact on domestic rates in both the short and long runs.

References

Adekunle, W. and Sulaimon, M. (2018). A re-examination of the relationship between foreign capital flows and economic growth in Nigeria. MPRA Paper 87754, University Library of Munich, Germany.

Adrian, T. (2018). Policy responses to capital flows. Speech delivered at LIII Meeting of Governors of Latin America, Spain, and the Philippines at the IMF-World Bank Annual Meetings, Bali, Indonesia, October 11.

Agenor, P.-R., Jackson, T. P., and da Silva, L. P. (2020). Foreign exchange intervention and financial stability. Working Paper 889, Bank for International Settlements (BIS).

Ansari, Z. N., Dar, M. H., and Zafar, S. (2023). Do capital inflows affect domestic bank credit? Empirical evidence from India. Future Business Journal, 9(28).

Arya, V., Cavoli, T., and Onur, I. (2020). Do managed exchange rates and monetary sterilization encourage capital inflows? PLoS ONE, 15(8):e0238205.

Audu, I., Adeleke, A. I., and Adedeji, K. E. (2020). International capital flows and monetary policy reaction in Nigeria: Are there asymmetric effects? West African Journal of Monetary and Economic Integration, 20(1a):23–43.

Blanchard, O., Adler, G., and Filho, I. (2015). Can foreign exchange intervention stem exchange rate pressures from global capital flow shocks? Working Paper 21427, National Bureau of Economic Research.

Cavallino, P. and Hofmann, B. (2022). Capital flows and monetary policy trade-offs in emerging market economies. Working Paper 1032, Bank for International Settlements (BIS).

Cavoli, T. (2005). Sterilization, capital mobility and interest rate determination for East Asia. Discussion Paper 0502, International Macroeconomics and Finance Program Centre for International Economic Studies.

Cumby, R. E. and Obstfeld, M. (1983). Capital mobility and the scope for sterilization: Mexico in the 1970s. In Financial policies and the world capital market: The problem of Latin American countries, NBER Chapters, pages 245–276. National Bureau of Economic Research, Inc.

Djedaiet, A. and Ayad, H. (2017). Hard currency inflows and sterilization policy in Algeria: An ARDL approach. Theoretical and Applied Economics, 24(3):83–96.

Edwards, S. and Khan, M. (1985). Interest rate determination in developing countries. IMF Staff Papers, 32:377–403.

Hoang, H. T., Nguyen, P. T., and Nguyen, P. T. (2020). Investigating the effectiveness of sterilization in Vietnam. Journal of Asian Finance, Economics and Business, 7(10).

Jume, T. M. (2021). An assessment of the effectiveness of central bank sterilization on capital inflows in Nigeria. CBN Journal of Applied Statistics, 11(2):201–230.

Karahan, O. and Bayır, M. (2022). The effects of monetary policies on foreign direct investment inflows in emerging economies: Some policy implications for post-COVID-19. Future Business Journal, 8(1):39.

Kawai, M. and Takagi, S. (2008). A survey of the literature on managing capital inflows. Discussion Paper 100, Asian Development Bank Institute.

Khushik, A. G., Gilal, M. A., and Taherani, A. (2015). Capital movements and sterilization policies in Pakistan. Grassroots, 49(2).

Khushik, A. G., Hashmi, S. M., and Shaikh, E. K. (2021). Impact of capital movements on sterilization and monetary policies in Pakistan: Evidence from multiple specifications. Estudios de Aplicada Economics, 39(3):3–13.

Kim, S. and Roubini, N. (2000). Exchange rate anomalies in the industrial countries: A solution with a structural VAR approach. Journal of Monetary Economics, 45(3):561–586.

Lavigne, R. (2008). Sterilized intervention in emerging-market economies: Trends, costs, and risks. Discussion Paper 08-4, Bank of Canada.

Ljubaj, L., Martinis, A., and Mrkalj, M. (2010). Capital inflows and efficiency of steril- ization: Estimation of sterilization and offset coefficients. Working Paper 24, Croatian National Bank.

Mannathoko, I. (2020). Sterilization in Botswana: Cost, sustainability and efficiency. Policy Brief 690, African Economic Research Consortium.

Montiel, P. (1999). Policy responses to volatile capital flows. Department of Economics, Williams College, Williamstown.

Nzeh, I. C., Nwogwugwu, U. C., Ibikunle, J. A., Uzoechina, B. I., Chiedo, O. A., and Anyachebelu, U. M. (2020). Investigating the effectiveness of sterilization policy in controlling money supply and capital inflows in Nigeria. Acta Economica, 18(32):127– 150.

Nzeh, I. C., Nwogwugwu, U. C., Nkamnebe, O. E., Eze, M. A., and Okafor, B. O. (2021). Does sterilization policy exert an upward pressure on interest rates as dictated by theory? A Nigerian example. Asian Journal of Economics and Empirical Research, 8(2):48–57.

Ooi, S. K. (2008). Capital flows and financial assets in emerging markets: Determinants, consequences and challenges for central banks: The Malaysian experience. Working Paper 44, Bank for International Settlements (BIS).

Ponomarenko, A. (2019). Do sterilized foreign exchange interventions create money? Working Paper 40, Bank of Russia.

Rishad, A., Gupta, S., and Sharma, A. (2022). An assessment of the effectiveness of sterilization of central bank interventions: Empirical evidence from India. Prague Economic Papers, 31(5):417–440.

Sarno, L. and Taylor, M. P. (2001). Official intervention in the foreign exchange market: Is it effective and, if so, how does it work? Journal of Economic Literature, 39:839–868.

Sunny, D. and Unnikrishnan, A. (2017). Sterilization of capital inflows in BRICS: What does 2SLS regression convey? In Proceedings of ISER International Conference, Hamilton, New Zealand.

Takagi, S. and Esaka, T. (2001). Sterilization and the capital inflow problem in East Asia, 1987-97. In Regional and global capital flows: Macroeconomic causes and consequences, NBER Chapters, pages 197–226. National Bureau of Economic Research, Inc.

Vinayagathasan, T. (2013). Monetary policy and the real economy: A structural VAR approach for Sri Lanka. GRIPS Discussion Papers 13-13, National Graduate Institute for Policy Studies.

Yan, H. D. and Yang, C. L. (2008). Foreign capital inflows and the current account imbalance: Which causality direction? Journal of Economic Integration, 23(2):434–461.