A new breed of legal support

Driving Africa’s growth through foreign capital inflows

2017-02-12 21:38:08

By Krispinana Shirima

Although concerns exist regarding the negative effects of foreign capital inflows, including Foreign Direct Investment (FDI) and portfolio equity and debt flows (e.g. great competition for “home-grown” African companies), a variety of empirical studies have demonstrated that the inflows stimulate economic growth with the transfer of new technologies and innovations, human capital formation, and integration in global markets.

Notwithstanding these enormous benefits, UNCTAD’s World Investment Report 2016 shows that FDI inflows to Africa “fell to $54 billion in 2015, a decrease of 7 percent over the previous year”.

So, what should Africa’s economies expect of foreign capital inflows in 2017 given the UK’s protracted ‘Brexit’ process, the U.S. Federal Reserve interest-rate hike, and President Donald Trump’s plans to re-negotiate major U.S. trade deals, including AGOA? And, are Africa’s economies ready to absorb the inflows should they surge?

For clarity’s sake, in its Africa Attractiveness Program for 2016 (year-end update), international audit firm Ernst & Young noted that it does not expect “a sharp decline in overall FDI levels in Africa”.

Indeed, as the December 13-14, 2016 Minutes of the U.S. Federal Reserve released on January 4, 2017 showed, Fed officials, who discussed the impact of President Trump’s economic policy proposals, signaled a gradual pace for future interest-rate increases and the extant U.S. benchmark interest rate of 0.75 percent will likely remain stable for 2017 and 2018.

What is more, several of the most economically developed countries in the world have an excessive amount of savings (boatload of cash) problem. According to data from, China has an investment rate of 43.4 percent and a savings rate of 46 percent; Singapore has an investment rate of 26.2 percent of GDP and a savings rate of 45.9 percent; Norway has an investment rate of 28.5 percent of GDP and a savings rate of 37.5 percent; and Switzerland has an investment rate of 22 percent and savings rate of 33.2 percent.

Given the availability of these excess savings from developed countries, it would seem that FDI and other forms of foreign capital inflows easily pour into Africa’s economies. This, however, does not occur because of high dependency on commodities: gas, oil, coal, minerals, and agricultural raw materials.

With the collapse of commodity prices, many of Africa’s economies are struggling to attract foreign capital flows, despite having fast growing youth populations, rapid urbanization rates and cheap labour costs.

Nevertheless, as the economies of China, Singapore, Norway, Switzerland and other developed economies mature, and become increasingly difficult to trade in due to, in part, heightened regulatory scrutiny, opportunities and prospects for corporate growth are limited.

This means Africa—now home to 1.2 billion people—is the place where bold, creative and determined investors can identify options for accelerated deployment of the excess savings from developed countries and bring value and find enduring growth.  

As this occurs, African economies must adopt and implement further reforms to attract foreign capital inflows and policies that enhance their ability to absorb the inflows.

Reforms needed to attract the capital inflows, such as, flexibility of labour laws, successful tax regulations, rule of law and respect for private property rights, etc, are pretty well documented. Here below, focus is on the issue of absorption capacity, on which less deliberation has occurred.

Africa’s capacity to absorb foreign capital inflows depends on a number of factors. In a 2004 working paper, the International Monetary Fund (IMF) considers that the depth of a financial system allows a country to attract capital inflows with minimum strain on monetary and exchange rate policy.

Until now, most central banks in Africa have been very cautious of the impact of foreign capital inflows and have been sterilizing the inflows (i.e. limiting the effect of the inflows on money supply) by holding regular auctions to sell Treasury bonds (T-bonds) and Treasury bills (T-bills).

As a result, growth of reserve money (M0) has been constrained and Tanzania’s central bank, for instance, is now targeting a 13 percent growth of average M0 in the current financial year 2016/17.

Similarly, growth in extended broad money supply (M3) has been constrained, with Tanzania experiencing a 14.6 percent decline during the year ending November 2016, according to the Bank of Tanzania’s Monthly Economic Review for December 2016.

With such tighter stance, what’s the idea in seeking greater foreign capital inflows if African countries are not willing to let them flow through their economies? And why are African central banks keeping liquidity so tight?

Even though inflation targeting has been the focus of most discussion, anxiety about the capability of financial systems in Africa to allocate foreign capital inflows efficiently to productive investment opportunities seems to be the implicit reason.

African central banks are, perhaps, concerned that taking less effort to manage liquidity would lead to dressing up of bad loans and non-sterilized intervention in the capital inflows, would result in a lot of liquidity building up.

It is in this context, therefore, that Africa’s economies urgently need to carry out financial sector reforms. Such reforms should aim to develop deep and efficient financial systems in Africa by promoting capital markets, improving institutional and regulatory environment, and designing strategies to direct African diaspora remittances into productive investments.

There is also the sensitive issue of enforcement of financial contracts, and good investor protection that enhances financial development. A range of possible innovations may impact on the enforcement of contracts.

Donor-funded legal reform programs can tackle gaps in statutory laws and the functioning of the judiciary (e.g. reducing litigation costs and strengthening the capacities of courts and judicial officers). All of these have some bearing on the speed and effectiveness of contract enforcement.

African policymakers must, however, not forget that reforms in one country will not always work well in another country. Legal and financial sector reforms may require substantial modification in specific situations, and so any proposed reforms should not be seen as a check-list that every African country has to follow precisely.

As noted hereinabove, there is ample foreign capital available from the developed world. However, it will bear maximum benefits and drive growth for Africa’s economies if they enhance their ability to attract and absorb the capital inflows by aggressively pursuing strategies for increasing the depth and efficiency of financial systems.

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