Capital Flows, Capital Account Regimes, and Foreign Exchange Rate Regimes in Africa

Abstract

This study examines capital flows and shifts in capital account and exchange rate regimes in African countries over the past two decades. The evidence shows that official lending to Africa has declined while the volume of private capital flows remains low and significantly below the levels observed in other developing regions. Private capital inflows to Africa are limited due to several factors, including the weakness of the macroeconomic environment, underdeveloped financial systems, high country risk, and exchange rate misalignments. The focus of policy reforms must be on alleviating these constraints in order to attract more foreign capital and overcome the shortage of development financing.

Many African countries have pursued reforms aimed at liberalizing their capital account and exchange rate regimes. However, liberalization has not been accompanied by systematic gains income growth, price stability, and trade performance. African countries must pay serious attention to the scope, speed, and sequencing of capital account liberalization to minimize potential adverse effects of openness. It is desirable for countries to maintain selective discretionary control over capital movements and exchange rate markets in order to hedge against adverse shocks to the economy and to maintain macroeconomic and financial stability. To attract foreign capital, any move toward capital account openness and exchange rate liberalization must be supported by reforms aimed at improving credibility of macroeconomic policy and establishing an investment-friendly environment. These reforms will not only attract foreign capital but also encourage domestic investment.

An important aspect of capital movements in Africa is the high level of capital flight. There is an urgent need for policies to stem further hemorrage of capital from Africa and induce the repatriation of private capital held abroad. This will require not only improvement of the macroeconomic conditions to ameliorate incentives for domestic investment, but also reform of the political and legal systems to improve accountability and credibility of economic policy.

JEL Classification: F21, F32, O55