1 Private Capital Flows to Africa: Opportunities, Risks and Way Forward Patrick N. Osakwe UN Economic Commission for Africa

2 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.

3  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

4 II. Forms of Private Capital Flows  Equity Flows FDI (equity stake with control) FDI (equity stake with control) Portfolio investment (equity stake without control) Portfolio investment (equity stake without control)  Debt Flows Bank loans Bank loans Bonds Bonds

5 Trends in Private Capital Flows ( US$ billion ) Developing countries East Asia & the Pacific Middle East & North Africa Sub-Saharan Africa

6 Private Capital Flows to North Africa ( billion $ ) Net FDI Inflows Portfolio Equity Net Debt Flows Worker’s Remittances

7 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)

8  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

9 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

10 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.

11 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

12  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

13  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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