Private Capital Flows to Sub-Saharan Africa: Financial Globalization’s Final Frontier?

1. 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 Department International Monetary Fund

2. Outline of the Presentation • Size and composition of private capital flows to SSA: • The facts: portfolio flows to some SSA countries are rising • Determinants of private capital flows across countries • Challenges and opportunities from rising private capital flows • Economic impact of capital flows • Policy challenges • Evidence from case studies • Policy implications and recommendations: • How to manage capital inflows to reap the benefits and avoid risks and vulnerabilities: Is Africa different?

3. Private capital flows to SSA have increased almost five-fold since 2000 • For the first time in 2006 they overtook official aid flows.

4. South Africa and Nigeria were the main recipients of private inflows

5. But portfolio flows to a small group of other “frontier markets” are also rising

6. 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

7. Africa today compares favorably with the ASEAN economies in the 1980s

8. Inflows provide tremendous opportunities, but volatility is a risk • Private capital flows can be good for growth – under certain conditions • But they are volatile and can suddenly reverse

9. 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.

10. The countries that receive the most inflows are also those better able to reap their growth benefits • Characteristics 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

11. Empirical Estimation of the Domestic Determinants of Private Capital Flows to SSA

12. 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.

13. Policy Response Complicated by uncertainty of the nature of inflows • Uncertainty 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

14. Evidence from country case studies: Uganda, Tanzania and Zambia • Experienced large increases in foreign purchases of domestic securities since 2005-2006 • All resorted to sterilized intervention first: • Allowed accumulation of reserves • Led to higher interest rates and attracted more inflows. • Unsterilized intervention was tried next: • Led to money growth in excess of targets, creating inflation.

15. Evidence from country case studies: Uganda, Tanzania and Zambia continued • Fiscal 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

16. 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 reforms • Partial capital account opening (2006) • FDI and portfolio inflows reached about 9 percent of GDP in 2007 • But low reserves and a weakening fiscal performance create vulnerabilities and place a premium on maintaining macroeconomic stability and credibility

17. Implications of permanently higher private capital flows to SSA: future policy agenda • Macroeconomic management • Adapt monetary and exchange rate policy response to the nature of capital flows and authorities’ objectives • Sterilized intervention can help, but only in the short-term • Persistent 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 spending • Governments will need to accept either carefully targeted spending cuts or real appreciation

18. Future policy agenda (ctd) • Capital account policies • More 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.

19. 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

20. Thank you !