Abstract

Foreign investments, particularly portfolio flows are large and often distortionary as they have tendency to drop during periods of global crisis. They could trigger a crisis because of their volatile nature and depending on the level of country’s exposure to external shocks. The motivation for this study is consistent with the conjecture that high foreign investment inflows is consistent with higher reserve accretion and stability in the naira exchange rate. Overtime, there have deliberate policy measures to encourage foreign portfolio inflows. While these inflows, have always had a positive impact on the external reserves, there is always, the palpable fear of flow reversals or the possibility of sudden stop due to unforeseen crisis. The elasticity of substitution has not received enough attention in studies relating to domestic and foreign investment. In the light of this, our study seeks to investigate how Nigeria’s external reserves responds to changes in the domestic and foreign investment behavior. Thus, this paper investigates how Nigeria’s external reserves level responds to changes in domestic and foreign investment, thereby showing the kind of deliberate monetary policy adjustments that should be pursued overtime to achieve stability. The finding therefore recommends that the government should focus of domestic investment by expanding its revenue sources in order to allocate more resources for annual capital expenditure. The government should also embark on building capital goods to encourage domestic private investment the production of goods and services suitable to replace imported ones and provide opportunity for export of such goods and services.