Foreign Capital Inflows and Domestic Investment Nexus: A Case study of the East African Community (EAC)
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According to existing literature, many countries especially developing countries rely on foreign capital inflows (FCIs) to close the gap between domestic savings and investments and therefore securing growth. From historical view, the liberalization of capital account was first suggested to countries with low supply of capital, due to the high cost of it by IMF and the World Bank in the 1980s. The success of this policy would increase the level of investments in those countries. However, debate is still open on whether the opening up of economies and removal of restrictions on cross-border financial transactions have brought positive results on receiving countries. The existing studies show inconclusive results. Some studies found out a positive effect, whereas other studies showed a negative effect between FCIs and investment. Moreover, most empirical studies focused on the relationship between FDI and domestic investment. However, taking into account only FDI as FCIs would be ignoring other potential external sources of investment. Accordingly, this study examines the effect of FCIs which are disaggregated into foreign direct investment (FDI), official aids (ODA) and remittances on domestic investment in five members of the East African Community (Rwanda, Kenya, Burundi, Tanzania and Uganda). This paper applies the auto regressive distributed lag model (ARDL) on time series data from 1990 to 2019. The findings indicate that FDI positively affects domestic investment of Kenya while a negative effect on domestic investment is observed for the case of Rwanda and no effect on the remaining countries ( Burundi, Uganda, and Tanzania). The results for ODA show that ODA positively affects domestic investment in all five countries. The remittances results show a positive impact on domestic investment in Kenya, while a negative effect is observed for Rwanda.
Abstract
According to existing literature, many countries especially developing countries rely on foreign capital inflows (FCIs) to close the gap between domestic savings and investments and therefore securing growth. From historical view, the liberalization of capital account was first suggested to countries with low supply of capital, due to the high cost of it by IMF and the World Bank in the 1980s. The success of this policy would increase the level of investments in those countries. However, debate is still open on whether the opening up of economies and removal of restrictions on cross-border financial transactions have brought positive results on receiving countries. The existing studies show inconclusive results. Some studies found out a positive effect, whereas other studies showed a negative effect between FCIs and investment. Moreover, most empirical studies focused on the relationship between FDI and domestic investment. However, taking into account only FDI as FCIs would be ignoring other potential external sources of investment. Accordingly, this study examines the effect of FCIs which are disaggregated into foreign direct investment (FDI), official aids (ODA) and remittances on domestic investment in five members of the East African Community (Rwanda, Kenya, Burundi, Tanzania and Uganda). This paper applies the auto regressive distributed lag model (ARDL) on time series data from 1990 to 2019. The findings indicate that FDI positively affects domestic investment of Kenya while a negative effect on domestic investment is observed for the case of Rwanda and no effect on the remaining countries ( Burundi, Uganda, and Tanzania). The results for ODA show that ODA positively affects domestic investment in all five countries. The remittances results show a positive impact on domestic investment in Kenya, while a negative effect is observed for Rwanda.
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