Private Capital Flows to Sub- Saharan Africa: Financial Globalizations Final Frontier? John Wakeman-Linn Based on Chapter 3 of the Spring 2008 Regional.

Private Capital Flows to Sub-Saharan Africa:

Financial Globalization’s Final Frontier?

John Wakeman-Linn

Based on Chapter 3 of the Spring 2008 Regional Economic Outlook for Sub-Saharan Africa

Prepared by a team led by John Wakeman-Linn and composed of Corinne Deléchat, Arto Kovanen, Inutu Lukonga, Gustavo Ramirez, Judit Vadasz and Smita

Wagh

African DepartmentInternational Monetary Fund

Outline of the Presentation

Size and composition of private capital flows to SSA:

The facts: portfolio flows to some SSA countries are risingDeterminants of private capital flows across countries

Challenges and opportunities from rising private capital flows

Economic impact of capital flowsPolicy challengesEvidence from case studies

Policy implications and recommendations: How to manage capital inflows to reap the benefits and avoid risks and vulnerabilities: Is Africa different?

Private capital flows to SSA have increased almost five-fold since

2000For the first time in 2006 they overtook official aid flows.

-10

0

10

20

30

40

50

60

2000 2001 2002 2003 2004 2005 2006 2007

LoansPortfolioFDITotal

Private Capital Inflows(Billions of U.S. dollars)

South Africa and Nigeria were the main recipients of private inflows

5.2

3.8

9.1

29.418.2

34.3

Other Sub-Saharan Africa

South Africa

Nigeria

Angola

Chad

Equatorial Guinea

Distribution of FDI Inflows(In percent of total inflows)

87.6

5.8

3.3

3.2

South Africa

Uganda

OtherSub-Saharan

Africa

Kenya

Portfolio Inflows to Sub-Saharan Africa(Percent of total; total inflows: US$58.6 billion)

But portfolio flows to a small group of other “frontier markets” are

also rising

Percent of GDP

0.0

0.5

1.0

1.5

2.0

2.5

So

uth

Afr

ica

Gh

ana

Ke

nya

Ga

bon

To

go

Se

ych

elle

s

Za

mb

ia

Zim

ba

bw

e

Nig

er

Ma

uri

tiu

s

Nig

eri

a

Cô

te d'I

vo

ire

Bo

tsw

an

a

Ug

and

a

Se

ne

ga

l

Ca

me

roo

n

Bu

rkin

a F

aso

Ta

nza

nia

Total Portfolio Inflows

Is Africa reaching emerging market status?

Abundant global liquidity was in part responsible for the surge of capital flows to SSA.

But investors also attracted to Africa because of:improvement in macroeconomic performance

Enhanced democracy and political stability

High expected returns due to appreciating currencies and positive real interest rate differential with other regions

Perception that Africa’s performance is de-coupled from that of other emerging markets

Africa today compares favorably with the ASEAN economies in the

1980sSelected Economic Indicators: ASEAN 1980 and Africa 2007

ASEAN1980

Selected African Countries

20071

Sub-Saharan Africa2007

GDP (growth rate in percent) 7.3 6.4 6.6

Inflation (average in percent) 17.0 7.1 7.9

Financial depth (M2/GDP in percent) 27.2 27.9 52.4

Size of government (expenditure, percent of GDP)

19.4 22.8 25.1

International reserves (months of imports) 3.6 10.0 5.8

Debt (percent of GDP) 3.4 9.9 23.2

Foreign direct investment ($ billion) 2 2.6 13.0 31.8

Portfolio flows ($ billion) 2 0.2 0.9 18.8

Sources: IMF, International Financial Statistics, African Department database.1 Botswana, Ghana, Kenya, Mozambique, Nigeria, Tanzania, Uganda, and Zambia.2For sub-Saharan Africa, 2007 data are IMF staff estimates.

Inflows provide tremendous opportunities, but volatility is a

riskPrivate capital flows can be good for growth – under certain conditions

But they are volatile and can suddenly reverse

StandardMean Deviation Volatility

Total inflows 4.9 8.7 1.8FDI 12.7 7.0 0.6Portfolio 0.2 0.9 3.8Private debt 0.2 2.8 13.0

Source: IMF African Department database.

Table 3.1. Private Capital Flows' Volatility, 2000–07

(Capital flows are in percent of GDP)

Reversals of capital inflows have been modest and

temporary:South Africa: financial markets fell sharply during the Summer 2007, due to a repricing of risk and not withdrawal by foreign investors

Zambia: capital flows slowed down in the run-up to the December 2006 presidential election but increased again in 2007.

Kenya: slowdown but no evidence of reversal of capital flows around the political crisis; the exchange rate has fully recovered its losses.

The countries that receive the most inflows are also those better able to

reap their growth benefitsCharacteristics that drive capital flows are also positively associated with improved productivity and growth, and lower volatility:

macroeconomic performance (all types of flows)

financial market development (porftolio flows)

quality of the business environment (FDI)

capital controls: not significant but may play some role in maturity composition

Empirical Estimation of the Domestic Determinants of Private Capital Flows

to SSA

Variable Coeff. Prob. Coeff. Prob. Coeff. Prob. Coeff. Prob. Coeff. Prob.

Output growth 2 0.21 0.01 0.23 0.00 0.22 0.00 0.23 0.00 0.26 0.02Fiscal balance, excl. grants 2 0.09 0.01 0.07 0.01 0.05 0.10 0.06 0.01Securities markets 3 0.77 0.00 0.71 0.00 0.66 0.00Capital account openness -0.17 0.34 -0.17 0.38 -0.12 0.54 -0.07 0.84Business environment -0.01 0.51 -0.00 0.98 -0.03 0.01S. Africa and Nigeria dummy 2.28 0.05Oil producer dummy 0.85 0.27 2.58 0.02Constant 4.04 0.00 2.42 0.00 3.04 0.03 2.51 0.07 6.22 0.00

Adjusted R -squared 0.28 0.55 0.55 0.58 0.30

Sources: IMF, African Department database; IMF staff estimates.

2 2000–06 annual averages. Fiscal balance measured as a percent of GDP.

1 Total private capital inflows comprise FDI, portfolio, and debt inflows. Both explanatory variables have been averaged over 2000 –06 and are measured in logarithmic units of their U.S. dollar values. Coefficient estimates (coeff.) and significance levels in percent (prob.) reported for various specifications.

3 The index measures the development of countries’ treasury bill , treasury bond, corporate bond, and equity markets. For each market, the index receives a value of 1 if the market is well developed (otherwise zero). We sum the index values across the four markets for each country.

Total Private Capital Inflows 1 FDI Inflows 1

Domestic Determinants of Private Capital Inflows to Sub-Saharan African Countries, 2000–06

(1) (2) (3) (4) (5)

Key policy challenges posed by sudden surges of portfolio flows:

Large inflows complicate policy:Create real appreciation pressure and competitiveness concerns

In flexible exchange rate regimes, inflows cause nominal appreciation or inflation

In fixed exchange rate regimes, inflows cause increases in monetary aggregates and thus inflation and real appreciation.

Policy Response Complicated by uncertainty of the nature of

inflowsUncertainty about whether inflows are permanent or temporary, and limited data complicates policy response

If inflows are clearly temporary, sterilized intervention to prevent inflation and appreciation is appropriate.

But for long-term flows, such a response is self-defeating

Evidence from country case studies: Uganda, Tanzania and Zambia

Experienced large increases in foreign purchases of domestic securities since 2005-2006All resorted to sterilized intervention first:

Allowed accumulation of reservesLed to higher interest rates and attracted more inflows.

Unsterilized intervention was tried next:Led to money growth in excess of targets, creating inflation.

Evidence from country case studies: Uganda, Tanzania and Zambia

continuedFiscal restraint can help contain appreciation but difficult to implement due to commitments to poverty-reducing expenditures

In Zambia under-execution of the budget helped

Eventually more flexibility in monetary and exchange rate objectives had to be allowed in all countries, meaning appreciation, inflation

Ghana: capital controls shape the composition of capital flows?

Careful sequencing of economic reforms and capital account liberalization:

Successful macroeconomic stabilization and reduction of external debt (HIPC/MDRI)Financial sector reformsPartial capital account opening (2006)

FDI and portfolio inflows reached about 9 percent of GDP in 2007But low reserves and a weakening fiscal performance create vulnerabilities and place a premium on maintaining macroeconomic stability and credibility

Implications of permanently higher private capital flows to SSA: future

policy agendaMacroeconomic management

Adapt monetary and exchange rate policy response to the nature of capital flows and authorities’ objectivesSterilized intervention can help, but only in the short-termPersistent inflows will cause real appreciation; monetary policy cannot prevent that.Tighter fiscal policy could mitigate aggregate demand and appreciation pressures, but at the cost of less spendingGovernments will need to accept either carefully targeted spending cuts or real appreciation

Future policy agenda (ctd)

Capital account policiesMore transparency and consistency: exchange controls in SSA complex and difficult to implement.

Gradual and well-sequenced liberalization strategy can help limit risks associated with capital inflows

Accelerated liberalization in the face of large inflows may help their monitoring (e.g. Tanzania); selective liberalization of outflows may help relieve inflation and appreciation pressures, but further work needed on modalities.

Future policy agenda (end)

Financial sector and structural policies:Better supervision and regulation

Bring capital flows into medium-term debt sustainability analysis

Government debt issuance strategies can support development of domestic yield curves and help broaden the local investor base

Improve institutions: remove structural impediments to enhanced productivity and financial intermediation.

Data collection is key

Thank you !