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FDI and Financial Market Development in Africa by Isaac Otchere, Carleton University Issouf Soumaré, Laval Universi

FDI and Financial Market Development in Africa by Isaac Otchere, Carleton University Issouf Soumaré, Laval University (presenter) & Pierre Yourougou, Syracuse University 2011 African Economic Conference Addis Ababa, Ethiopia , October 25-28, 2011. Introduction.

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FDI and Financial Market Development in Africa by Isaac Otchere, Carleton University Issouf Soumaré, Laval Universi

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  1. FDI and Financial Market Development in Africa by Isaac Otchere, Carleton University Issouf Soumaré, Laval University (presenter) & Pierre Yourougou, Syracuse University 2011 African Economic Conference Addis Ababa, Ethiopia, October 25-28, 2011

  2. Introduction The surge of Foreign Direct Investment (FDI) in emerging markets in the 90’s was mainly due to: Huge decline of commercial bank lending following the Bank crisis of the 80’s; Policy reforms (World Bank/IMF) in terms of liberalization of capital control and financial markets; Worldwide excess liquidity. 2

  3. Evolution of FDI in the World Africa

  4. FDI holds steady in Africa during the recent crisis… During the recent crisis, debt flows decline in 2008 by $15bn and Portfolio equity flows fell by $10bn in 2008 but … Net FDI inflows increased from $28.6bn to $32.4bn (Africa was the only continent to experience an increase)

  5. Motivation The surge has renewed the research interest on the effects of FDI and its interaction with FMD and economic growth (Alfaro et al. (2004, 2010), Allen et al. (2010)): Theoretically, FDI accelerates economic growth through Transfer of technology and other resources Increased productivity by fostering competition Theoretical rationales for causal relationship between FDI and FMD: FDI net inflows would increase liquidity and depth of financial market, hence reduce the cost of capital and accelerate economic growth FDI would contribute to enhance transparency (listing on stock market) and enhance efficient allocation of capital resources and therefore increase economic growth 5

  6. Review of theoretical arguments • FDI to FMD: • Increase in FDI net inflows would lead to more financial intermediation (e.g. Desai et al. (2006), Henry (2000)). • Companies involved in FDI more likely to be listed on local stock market • Increase in FDI would reduce relative power of the elites in the economy and force them to adopt market friendly regulations (e.g., Kholdy & Sohrabian (2008), Rajan & Zingales (2003)). • FMD to FDI • Well functioning financial market perceived by foreign investors as sign of vitality, openness and market friendly environment, (e.g., Henry (2000)). • Developed stock market increases the liquidity of listed companies and reduce the cost of capital, thus attract foreign investments (Desai et al. (2006), Henry (2000)).

  7. Empirical hypothesis Several studies provide evidence of a link between FDI, FMD and economic growth, but not yet clear how FDI, FMD and growth interact with each other The aim of the paper is to fill this gap in the African context FM in Africa are characterized by a lack of depth, broadness, liquidity and transparency. FDI can be an impetus for FMD Well functioning financial markets can contribute to a more efficient allocation of FDI resources and create value for investors, hence attract more FDI. Hence, we expect bidirectional causality between FDI and FMD Africa is a good laboratory to test the interaction and the direction of causality between FDI and FMD because of significant differences between African countries in terms of the level of FMD 7

  8. Data and variables FDI and FMD variables as suggested by Alfaro (2004), Allen et al. (2010), Levine et al. (2000), Levine & Zervos(1998) FDI variables FDIGDP: FDI/GDP FDIGCF: FDI/GCF FMD variables STKMKTCAP: Stock market capitalisation / GDP STKTUR : Stock market turnover ratio STKVALTRA: Stock market value traded / GDP CREDIT: Total credit by financial intermediaries to private sector / GDP LLIAB: Liquid liabilities of the financial system/GDP CCB: Commercial bank assets/(Commercial bank + Central bank assets) Economic growth variable GDPGROWTH :Real GDP growth 8

  9. Data and variables (Cont’d) Control variables based on previous studies: Asiedu (2002, 2006), Alfaro et al. (2004), Allen et al. (2010), Allen, Otchere and Senbet (2010), Levine et al. (2000), Gohou & Soumaré (2011) Economic Policy Variables Size of economy; Education; Infrastructure; Government Spending; Inflation; Interest rate; Exchange rate; Openness; Natural resources; Current account balance Governance and institutional quality variables KKM index (developed by Kaufmann, Kraay and Mastruzzi (2009) from WGI): Average of six indicators (i-Voice and accountability, ii-Political stability and absence of violence, iii-Regulatory quality, iv-Government effectiveness, v-Rule of law, vi-Control of corruption) 9

  10. Empirical analysis design We use panel data over period 1996-2009 Possible problems with earlier studies: Unobserved country specific effects Simultaneity bias not fully controlled (control for endogeneity) We conduct Granger causality between FDI and FMD variables We conduct multivariate regressions analysis: 3-Stage Least Squares (3SLS) Dynamic panel data estimation of Arellano-Bond 10

  11. Table 4: Stationarity (Unit root tests) Panel A: Level Panel B: First Difference

  12. Table 5: Causality tests • Bidirectional causality between FMD and FDI variables • However, the causality structure is not homogenous

  13. Multivariate analysis of the relationship between FDI & FMD Bi-directional relationship means FDI and FMD variables are endogenous FDI= a0 + a1FMD + a2 EDUCATION + a3 SIZE + a4 INFLATION + a5 OPENNESS + a6 INFRAS + a7 EXHRATE + a8 NATRES+ a9 GOVERNANCE, (4a) FMD = b0 + b1FDI + b2 BALANCE + b3 EDUCATION + b4 SIZE + b5 INFLATION + b6 EXHRATE + b7 INTRATE + b8 GOVERNANCE, (4b) 13

  14. Table 6: 3SLS regression (All Africa)

  15. Table 6: 3SLS regression (All Africa)

  16. Table 7: 3SLS regression (excl. SA)

  17. Table 7: 3SLS regression (excl. SA)

  18. Table 8: Arellano-Bond dynamic panel data estimation method

  19. Table 8: Arellano-Bond dynamic panel data estimation method

  20. Simultaneous equations of FDI, FMD and Economic Growth FDI= a0 + a1 FMD + a2 GDPGROWTH + a3 EDUCATION + a4 SIZE + a5 INFLATION + a6 OPENNESS + a7 INFRAS + a8 EXHRATE + a9 NATRES+ a10 GOVERNANCE, (7a) FMD = b0 + b1 FDI + b2 GDPGROWTH + b3 BALANCE + b4 EDUCATION + b5 SIZE + b6 INFLATION + b7 EXHRATE + b8 INTRATE + b9 GOVERNANCE, (7b) GDPGROWTH = c0 + c1 FDI + c2 FMD + c3 EDUCATION + c4 SIZE + c5 INFLATION + c6 EXHRATE + c7 OPENNESS + c8 GOVSPEND + c9 GOVERNANCE, (7c) 20

  21. Table 9: 3SLS regression

  22. Table 9: 3SLS regression

  23. Conclusion We have shown that the causal relation between FDI and FMD is bi-directional FDI can foster financial market development Well functioning financial markets contribute to attract more FDI We also find that FDI impacts positively and significantly on economic growth in Africa when we control for the simultaneous effects of both FDI and FMD. Therefore studies involving both FDI and FMD should account for this potential endogeneity issue. 23

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