Private Capital Flows to Africa: Opportunities, Risks and Way Forward

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Private Capital Flows to Africa Opportunities,
Risks and Way Forward

• Patrick N. Osakwe
• UN Economic Commission for Africa

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I. Background

• The most important challenge facing Africa is how
  to eradicate poverty and extreme hunger
• Africa is still the region with the highest
  percentage of people in extreme poverty and
  deprivation
• The 2007 MDG Report indicates that it is the only
  region at risk of not meeting any of the MDGs.
• Mobilization of finance is crucial to reversing
  the current trend and increasing the likelihood
  of African countries meeting the MDGs by the
  target date.

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• World leaders recognized the importance of
  finance in meeting the MDGs when they adopted the
  Monterrey Consensus in 2002
• The mobilization of private capital flows is one
  of the six core areas of the Monterrey Consensus.
• Mobilization of domestic resources for
  development
• Mobilization of international financial resources
  (Private Capital Flows)
• Promoting international trade as an engine of
  development
• Increasing international financial and technical
  cooperation for development
• External debt
• Systemic issues

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II. Forms of Private Capital Flows

• Equity Flows
• FDI (equity stake with control)
• Portfolio investment (equity stake without
  control)
• Debt Flows
• Bank loans
• Bonds

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Trends in Private Capital Flows (US billion)
1998 2000 2005
Developing countries 193.4 187 551.4
East Asia the Pacific 6.5 28.8 169.7
Middle East North Africa 9.2 3.9 24.3
Sub-Saharan Africa 13.9 10.2 29.6
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Private Capital Flows to North Africa (billion )
1990 2005
Net FDI Inflows 0.96 11.2
Portfolio Equity 0.01 0.80
Net Debt Flows -0.52 3.14
Workers Remittances 7.25 13.97
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III. Theoretical Arguments for Capital Mobility

• Lifts the constraints on domestic investment
  imposed by low national savings
• Leads to more efficient allocation of resources
• Allows countries to smooth consumption over time
• Borrow during a negative shock and repay during a
  positive shock thereby making consumption less
  volatile than income
• In practice investors are reluctant to lend to
  developing countries experiencing negative shocks
  (case of Chile in 1998)

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• Permits domestic residents to diversify risks
  through holding diversified international
  portfolios
• Risks are less correlated between countries than
  within countries
• Provides access to intellectual property
• Technological know-how
• Managerial expertise
• Access to foreign markets
• It subjects countries to the discipline of the
  international market
• Fear of capital flow reversal is often a stimulus
  to more responsible economic policies

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IV. Concerns about Capital Mobility

• Capital mobility increases macroeconomic
  volatility and this has negative consequences for
  an economy
• Exposes countries to new shocks (external)
• Can magnify the effect of domestic shocks
• It increases vulnerability to large and rapid
  reversals of capital flows (often leading to
  financial crises)
• These crises are very costly. In the case of East
  Asia it led to losses of more than 10 percent of
  GDP.
• Large inflows resulting from capital mobility
  also contribute to real exchange rate
  appreciation and loss of competitiveness

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V. The Evidence

• The key question here is whether the benefits of
  capital mobility offset the costs? The evidence
  is mixed
• Several studies found no evidence that capital
  account liberalization leads to faster growth
  (Rodrik 1998 Kraay 1998 Edison 2002 Prasad et
  al 2003)
• Few studies found that liberalization had a
  positive impact (Quinn 1997)
• There are several messages from these results
• If there is a relationship between capital
  mobility and growth, it is neither strong nor
  robust
• The composition of capital flows as well as
  domestic economic conditions may be important in
  determining whether or not capital mobility has a
  positive impact on an economy.

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VI. Managing Capital Flows The Way Forward

• The benefits of capital mobility are not
  automatic.
• They accrue to countries that have taken
  appropriate steps to exploit them
• The key policy challenge facing African countries
  is how to maximize the benefits and minimize the
  costs.
• This requires several actions at the national
  level

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• Adopting a gradual approach to capital account
  liberalization. This gives room for
• Development of financial infrastructure
• Complementary investments in education and
  physical infrastructure to increase absorptive
  capacity of flows
• Paying more attention to the composition of
  capital flows and ensuring that they go to
  sectors with high potential for employment
  creation
• Putting in place policies to limit vulnerability
  to financial crises
• Sound Macroeconomic Policies
• Protection of property rights and the rule of law
• Political stability

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• Managing capital flows to avoid risk of real
  exchange rate appreciations that lead to loss of
  competitiveness
• Adoption of exchange rate regimes that give room
  for dealing with capital flows
• Use of selective capital controls when necessary

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