Financial sector development - Sida

A survey report (Appendix 5) analyses the recent development of private capital flows to
Sub-Saharan Africa, with emphasis on the Swedish programme countries. These flows
include FDI, portfolio equity, commercial bank lending and other private flows. The study
focuses on FDI, since this constitutes the most significant net inflows of private capital to
the region. Moreover, FDI seems to have a larger real impact on the recipient countries,
compared with other more short term private flows.
It can be argued that the increase in FDI and other private foreign capital flows to the
countries in Sub-Saharan Africa observed in recent years is important in relation to the
limited private domestic investments taking place. Moreover, even small capital inflows
may have important demonstration effects on domestic and other foreign investors.
These private flows could be crucial for the future growth potential in the region,
especially when official development assistance is on the decline, both in absolute and
relative terms.
Despite the low level of FDI in absolute terms, the share of FDI inflows to gross fixed
capital formation is substantially higher in Sub-Saharan Africa compared with other
developing regions. The relative importance of FDI in capital formation has also
increased markedly over time. Portfolio equity flows and commercial bank lending to the
countries in Sub-Saharan Africa are yet small, but the recent signs of an increase are
encouraging. In addition to recorded capital inflows, we also have substantial private
transfers by individuals, of which a large portion is believed to be related to returning flight
capital.
The current capital inflow episode to developing countries represents a sharp break from
the experience of the debt crisis. While the surge in foreign capital constitutes a welcome
relief from the constraints of credit rationing for many countries, it also poses some policy
challenges. Massive inflows of foreign capital can have problematic macro-economic
effects if not adequately counteracted by economic policy. In particular, large short term
capital inflows might spur inflationary pressure if the resources are not efficiently intermediated
to productive investments. Exchange rate appreciation may also be a problem
during periods of massive inflows.
However, in the case of Sub-Saharan Africa, private flows are mainly attributed to long
term FDI, which has been shown to have a less adverse impact on macroeconomic
stability. FDI is primarily for productive investment in real assets in the host country.
Nevertheless, it is crucial that the countries in the region strive towards macroeconomic
stability, and it should be pointed out that more research is needed about the impact of
FDI and other private capital inflows on stability in Sub-Saharan Africa. Since many
countries in the region still face serious macroeconomic problems, there is a need for
caution and an adequate policy response, including structural reforms, as means of
minimizing possible adverse effects related to capital inflows.
A number of studies have investigated the relationship between economic growth at the
aggregate level and inward FDI. On the whole, the results suggest a positive relationship.
Furthermore, the effect of FDI on growth holds especially when the host country has
a minimum level of educational attainment. This suggest that countries must have a
minimum "receiver competence" in order to gain from spillovers and other benefits
related to FDI. In countries with very low educational attainment, FDI projects are likely to
become "enclaves" relative to a backward domestic economy.
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