The Consequences and Management of Capital Inflows: Lessons for Sub-Saharan Africa

Some of the questions that emerge from the African experiences were echoing those of capital-importing countries in other regions: To what extent are the capital inflows driven by external fundamentals? Or conversely, what role have domestic macroeconomic policies and structural reforms played in attracting (or repelling) the flows? What is the appropriate policy response? Are the high domestic real interest rates a byproduct of financial liberalization or of monetary policy? Is there evidence of regional “contagion effects?” Do capital inflows make the recipient economies more vulnerable to financial crises, such as those in Mexico in 1994-95 and in Asia in 1997-98? Other questions are more specific to the African experience: Why has SSA not attracted more flows, despite a substantive improvement in economic performance? What are the prerequisites for attracting portfolio flows? Are the policy instruments limited by the relatively undeveloped nature of the financial sector? Is an undeveloped financial sector an asset or a liability when it comes to avoiding Asian-style crises? The purpose of this paper is to answer some of these questions at both the conceptual level as well as in the African context. The paper presents a framework to analyze the macroeconomic effects of and the policy responses to a surge in capital inflows. We examine the monetary consequences, the implications for the exchange rate and domestic inflation, and the issue of the current account and its sustainability. The analysis places much emphasis on the role played by the financial sector and the stock market. At the empirical level, we investigate the possible links between the structure and depth of existing capital markets and the volume and composition of the capital flows a country attracts.