Foreign capital inflows, financial development and sectoral growth in Sub-Saharan Africa
Date
2022-04
Authors
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Publisher
Stellenbosch : Stellenbosch University
Abstract
ENGLISH SUMMARY: Growth in sub-Saharan Africa has not risen to the level required to match developmental needs. The situation has been deteriorated by the current Covid-19 pandemic, where it is estimated that over 2.82% of the African population could fall into extreme poverty in 2021. The problem is likely to worsen both growth and growth volatility conditions in the region. The situation calls for a substantial flow of resources to augment domestic capital to drive growth. Foreign capital inflows have been identified as having the potential to support growth in the region. They have become an integral part of the financing mix for sub-Saharan African countries due to limited domestic capital mobilisation. There is, however, increasing concern from policymakers, particularly in the light of the 2008‒2009 global financial crisis, about the volatility effect of these inflows. Financial development has been identified as a policy tool that could be used not just to drive growth directly, but also to attract foreign capital and limit their volatilities. To understand how financial development affects growth and foreign capital inflows, the study has been structured into four empirical chapters. The study targeted all 44 countries in the Svirydzenka (2016) dataset since it was the main measure of financial development used in the study and reflected in all the objectives. There are however variations based on available data from other variables of interest. The study period covered 1990‒2018, but where volatility is involved, the period is 1990-2017 due to loss of observation in the computation of volatility. The first chapter examines the sectoral effect of financial development. This is significant in the sense that existing studies concentrated on aggregate growth, ignoring the fact that the extent of credit utilisation, as well as productivity of credit, may not necessarily remain the same across sectors. Indeed, using the Generalised Method of Moments, the findings show that while financial development has a positive effect on the service and agricultural sectors, a certain threshold of financial development must be reached before it can positively contribute to the growth of the industrial sector. The results point to the fact that policymakers in sub-Saharan Africa need continue to promote financial development to spur industrialisation. The second objective answers the question of whether financial development has a threshold-specific effect on the volatility of capital inflows in sub-Saharan Africa. This is important because the extant literature in sub-Saharan Africa focuses on the impact of financial development on foreign capital inflow volatility ignoring the possibility of a threshold. The results from a novel dynamic endogenous panel threshold model show that financial development could reduce capital volatility but only after attaining a threshold of 14.5%, 8.8% and 15.02% for foreign direct investment, cross-border bank lending and remittances respectively. From a policy perspective, knowledge about thresholds could assist in mapping out macroprudential policies. In the third objective, the study investigates foreign inflows and volatility–growth nexus and the indirect role of financial development in the relationship. The study takes a sectoral approach given that absorptive capacity may differ across sectors of the economy. The findings from the dynamic panel ordinary least square show that except for cross-border bank lending, foreign capital inflows and volatility have negative effects on the service sector. Except for remittances, foreign capital inflows volatility shows positive effects in the industrial sector while the levels of foreign direct investment and remittances exert a positive effect. Both foreign direct investment and cross-border bank lending had a negative effect on agricultural growth with portfolio equity, aid and remittances posing positive effects. Concerning volatility, only portfolio equity volatility negatively affects the agricultural sector, with the impact of remittances on agriculture being positive. The role of financial development in dampening or magnifying the effect of foreign capital inflows and volatility is ambiguous, however. The conclusion is that sector-specific policies are needed to deal with the effect of foreign capital inflow and volatility given their varied impact across sectors of the economy. The study addresses growth volatility in the final objective, which is one of the critical issues affecting growth and development in sub-Saharan Africa. The study considered the impact of real shocks, monetary shocks and financial openness on sectoral growth volatility. The mediating role of financial development in dampening or magnifying growth volatility effect of shocks and financial openness was also considered. The results from panel Quintile Method of Moment show that while real and monetary shocks exert a robust positive impact on growth volatilities in the service and agricultural sectors, only monetary shock drives industrial volatility. Financial openness, however, appears to magnify growth volatility only in the service sector. The findings on the transmission channells reveal that financial development dampens the effect of real and monetary shocks on growth volatilities in the service and agricultural sectors with the impact on the industrial sector being ambiguous. The policy implication of the findings is that policymakers need to address the underlying issues of shocks to achieve stable growth. Financial development can be used as a complementing tool to achieve the desired policy objective. In general, the study showed that financial development is a critical policy tool in dealing with the volatile nature of inflows and maximising growth. Indirectly, it can also ameliorate the adverse effect of shocks on growth volatility. For these to be realised, however, financial systems will have to be developed to a certain level. However, the role of financial development is found to also vary across sectors. Thus, the main contribution of the study is the focus on the sectoral growth effect of different inflows and their volatilities as well as the role of financial development. Understanding how each inflow and volatility uniquely affect different sectors of the economy could provide an insight into a new policy framework and direction to achieve balanced and accelerated growth. On methodology, the study used techniques that could account for endogeneity in the panel threshold model and also a SUR model that accounts for inter-sectoral linkages. Future studies could explore the role of regulations in dealing with foreign capital inflows. The current study focused on financial development as a policy tool. The use of the macroprudential tool as a way to regulate foreign capital inflows particularly for developing countries has become topical. In this regard, future studies could explore whether the effectiveness of regulations or macroprudential policies in dealing with foreign capital inflow is conditioned on the competitiveness of a sector. The role of information asymmetry in financial development and foreign capital nexus could also be looked at. Though the study mentioned that a developed financial sector enhances foreign capital inflows and limits their volatility by reducing information asymmetry and transaction cost, the mechanism through which this occurs was not tested in the study. On growth volatility, future research could assess whether the impact of shocks on sectoral growth is conditioned on the economy’s level of diversification and resource intensity.
AFRIKAANSE OPSOMMING: Geen opsomming beskikbaar.
AFRIKAANSE OPSOMMING: Geen opsomming beskikbaar.
Description
Thesis (PhD)--Stellenbosch University, 2022.
Keywords
Finance -- Africa, Sub-Saharan, Economic development -- Africa, Sub-Saharan, Banks and banking -- Africa, Sub-Saharan, Financial services industry -- Africa, Sub-Saharan, UCTD