Capital Flows and Capital Account Liberalisation in the

Capital Flows and Capital Account Liberalisation in the Post-Financial Crisis Era: Challenges, Opportunities & Policy Responses Victor Murinde Birmingham Business School University of Birmingham 1

Introduction African economies enjoyed huge increases in private capital inflows during 2000 -2007 All change: The global financial crisis and uncertainty The complexity of capital flows and capital account liberalisation in Africa in the postfinancial crisis period 2

The route map of the presentation Capital flows: The flow of funds framework The global financial crisis and recent financial crises Capital flows, the typology of capital controls and capital account liberalisation in Africa Policy and research challenges 3

Capital flows: A flow-of-funds framework A “…main function of the flow of funds accounts is to reveal the sources and uses of funds that are needed for growth …” (Klein, 2000, p. ix). Flow of funds models: why agents in one sector hold specific assets and substitute assets within their portfolio. Balancing domestic assets with foreign assets Important assets: private non-bank lending, corporate debt and equity, FDI, ODA (aid), and remittances. 4

Table 1: Flow of Funds Framework Household Sector Company Sector Banks Sector Government Sector Foreign Sector H P B G F 1. 1 Income (Y) YH YP 1. 2 Taxes (T) TH TP TG 1. 3 Consumption (C) CH CP CG CF 1. 4 Investment (I) IH IP IG IF Net acquisitions (S) SH SP SG SF 2. 1 Capital (K) KH KP KG KF 2. 2 Loans (L) LH LP LB LG LF 2. 3 Domestic money (M) MH MP MB MG 1. Income-expenditure 2. Assets and liabilities: Balance-sheet accounts RG 2. 4 Foreign money (R) Net worth (W) WH WP WB RF WG WF 5

The Global Financial Crisis: What do we know? Mexican Peso crisis December 1994 1997 East Asia financial crisis Russian financial crisis of August 1998 Current global financial crisis When the crises occurred, key financial prices (exchange rates, stock prices, short-term interest rates, asset prices) deteriorated in the large African economies. Lessons and uncertainty in capital flows. 6

Table 7: Impact of the crisis on selected African financial markets in an international context Country/ Region Index name Index code Benchmark Value at end week 12. 02. 2009 31. 07. 2008 Losses during financial crisis (%) AFRICA 　　 Cote d'Ivoire BRVM Composite Index BRVM CI 242. 54 169. 34 -30. 18 Egypt CASE 30 Index CASE 30 9251. 19 3600. 79 -61. 08 Kenya Stock Index KSE 4868. 27 2855. 87 -41. 34 Mauritius All Shares SEMDEX 1735. 77 1005. 69 -42. 06 Morocco Casa All Share Index MASI 14134. 7 10352. 81 -26. 76 Nigeria NSE All Share Index NSE 52916. 66 23814. 46 -55. 0 South Africa All Share Index JALSH 27552. 65 20650. 38 -25. 05 Tunisia Tunis se Tnse Index STK TUNINDEX 3036. 87 3049. 6 0. 42 　　　 7

Table 7: Impact of the crisis on selected African financial markets in an international context (Cont’d) Country/ Region Index name BRIC 　　 Brazil Bovespa Index IBOVESPA Russia RTS Index RTSI India BSE SENSEX 30 BSESN China Shanghai Composite SHANGHAI COMPOSIT OECD 　　 UK FTSE Index FTSE 100 USA Dow Jones Industrial France Japan Benchmark Index code Value at end week 12. 02. 2009 31. 07. 2008 　　 Losses during financial crisis (%) 　 59505 41674 -29. 97 1966. 68 624. 21 -68. 26 14355. 75 9634. 74 -32. 89 2775. 72 2320. 79 -16. 39 　　　 5411. 9 4189. 6 -22. 59 DJ Index 11378. 02 7850. 41 -31 CAC 40 Index CAC 40 4392. 36 2997. 86 -31. 75 Nikkei 225 Index N 225 13376. 81 7779. 4 -41. 84 8

Table 8: Exchange rates for selected African countries (local currency per US Dollar) Country Botswana Ghana Nigeria South Africa Tanzania Dec-06 Dec-08 Feb-09 % change (Dec 2008 - Feb 2009) 6. 03 7. 52 7. 96 5. 89 0. 92353 1. 21 1. 34115 10. 84 126. 5 130. 75 145. 35 11. 17 6. 9737 9. 3035 9. 9498 6. 95 113. 209 128. 03 130. 246 1. 73 9

Capital Flows and Capital Account Liberalisation in Africa The current trends in capital controls and capital account liberalization in Africa Table 2 shows the typology of controls on portfolio investment and FDI in Africa Table 3 presents examples of capital account liberalisation process Do these matter? 10

Table 2: Typology of controls on portfolio investment and FDI in African countries Debt Control type / Country Inflows Equity and FDI Outflows E&FDI Inflows E&FDI Outflows No controls Bonds: no controls Shares: no controls Money market securities: no controls FDI: no controls Derivatives: no controls Zambia Bonds: no controls Money market securities: no controls Uganda Derivatives: no controls Bonds: no controls Shares: no controls Money market securities: no controls FDI: no controls Derivatives: no controls 11

Table 2: Typology of controls on portfolio investment and FDI in African countries (Cont’d) Debt Control type / Country Inflows Equity and FDI Outflows E&FDI Inflows E&FDI Outflows Minimal controls Bonds: no controls Shares: no controls Money market securities: controls on resident purchases abroad FDI: no controls, only registration FDI: no controls Derivatives: no controls South Africa Bonds: no controls Money market securities: controls Nigeria Derivatives: no controls Bonds: controls on resident sale or issue abroad Bonds: controls Shares: controls on resident sale or issue abroad Shares: limits on resident purchases abroad Money market securities: controls on resident sale or issue abroad Money market securities: controls FDI: no controls FDI: controls Derivatives: controls on resident sale or issue abroad Derivatives: controls 12

Table 2: Typology of controls on portfolio investment and FDI in African countries (Cont’d) Debt Control type / Country Inflows Equity and FDI Outflows E&FDI Inflows E&FDI Outflows Controls Bonds: controls Shares: controls on issuing, advertising, and sale of foreign securities of more than CFAF 10 million Shares: no controls Money market securities: controls FDI: no controls if below CFAF 100 million Derivatives: Not applicable Cameroon Derivatives: Not applicable Source: Adapted from IMF (2009), Table A 3. 1, page 69 -70. 13

Table 3: Examples of Capital Account Liberalisation Process Status/ Sequencing Fully Open Partially Open Fairly Open One-step opening Uganda (1997) Liberalization part of a broad package of marketoriented reforms, privatization and trade liberalization Sequenced opening Zambia (1990 -95) 1993 -94: liberalization of capital transactions Ghana (1995 -2006) Mid-1990 s: partial liberalization of portfolio and direct investment 1995: banks allowed to accept foreign currency deposits 2006: Foreign Exchange Act, allowing nonresidents to buy government securities with maturities of three years or longer, minimum holding period of one year Cameroon (2000 to present) 2000: Harmonization of national foreign exchange regulations and liberalization of capital flows within CEMAC Liberalization part of broad reforms focused on economic stabilization, competitiveness, and debt restructuring, accompanied by financial market reforms Liberalization following economic stabilization and debt restructuring: parallel reforms in the primary government debt and stock markets; efforts to develop interbank money and foreign exchange markets and to strengthen financial sector supervision and soundness Prudential limits on banks' net open foreign positions Residents' foreign exchange deposits prohibited Continued administrative restrictions remain on most capital outflows No immediate plans for further opening 14

Table 3: Examples of Capital Account Liberalisation Process Status/ Sequencing Sequenced opening Fully Open Partially Open Fairly Open Nigeria (1985 -2006) Economic reforms initiated in the mid-1980 s and subsequently reinvigorated in the mid-1990 s, starting with treatment of dividends and profit repatriation, then later removal of controls in other areas such as derivatives and real estate; some remaining administrative restrictions Foreign exchange market reformed at various points from the mid-1980 s to wholesale Dutch auction system initiated in 2006, along with growing importance of interbank market, and the effective unification of the parallel and official exchange rates Tanzania (1990) 1990: start of FDI liberalization 1997: full liberalization of FDI flows 1998: supporting foreign exchange regulations Senegal (1999 to present) 1999: elimination of controls on inward FDI and foreign borrowing by residents Continuing restrictions on portfolio investments (government securities) Continuing administrative restrictions remain on capital outflows to non-WAEMU countries FDI liberalization coinciding with privatization program, creation of one-stop shop, and investment promotion policy Source: IMF (2009), Table A 3. 2, p 71; and Ndikumane (2003), Table A 2, pp 56 -59 on the evolution of these figures 15

What really matters? PULL FACTORS: for total capital flows into Africa include: macroeconomic performance (both real GDP growth and fiscal balance), the index of securities market development, and a dummy for South Africa and Nigeria. But for FDI: growth performance, the quality of the business environment, and a dummy variable for oil producers. Remittances: (push and pull factors) foreign income and booming sector; financial sector reforms But, institutions also matter for capital inflows to Africa The variable for capital account liberalisation is not significant in a model of the determinants of capital flows 16

Capital account liberalisation challenges and policy responses The policy challenges associated with private capital inflows have been similar across countries (Table 10) The policy responses have varied depending on the institutional factors as well as the monetary and exchange rate regime. Lesson: African countries should redesign their capital account liberalisation regimes, alongside their institutional and financial sector policies in order to tilt the composition of inflows toward longer-term flows. 17

Conclusion: Lessons and Policy Agenda for Africa – Short run The African regional networks of national finance ministers and central banker governors is timely: but publish the news. Improve the capacity to monitor movements of the main financial prices that provide the propagation mechanism for contagion effects, namely exchange rates and stock prices. Improve the capacity to monitor inflows Keep fiscal expenditures steady during episodes of large capital inflows; this has been shown to help recovery in the aftermath of the crisis. 18

Conclusion: Lessons and Policy Agenda for Africa – medium and long term ADB: A regional strategy is desirable Pay attention to ‘pull’ and ‘push’ factors for each of the 4 types of capital flows (FDI, GPI, debt, and remittances) Countries also need to implement supportive institutional and regulatory reforms that will strengthen their capacity to manage capital inflows and the associated vulnerabilities. There is no “one-size-fits-all” prescription. 19

Hence, the research challenge Further research: the flow of funds framework, with asset demand equations for capital flows (FDI, debt, aid and remittances) against each type of economy (resource-rich, non-oil exporting, other) and the pull factors that maximise capital flows for the economy. Stochastic simulations of: (a) response of flows to ‘pull’ and ‘push’ factors post-crisis; (b) policy response 20

Thank you for your attention 21