Macroeconomic Volatility and Foreign Direct Investment in Africa

Abstract

This study has primarily sought to examine the effect of macroeconomic volatility on foreign direct investment in Africa. The investigation covers the period between 1980 and 2010 for twenty-nine countries. The main variables of concern were Exchange rate volatility and inflation volatility, GDP Growth volatility and Real interest rate volatility. The ARCH and GARCH Models introduced Engle (1982) and Bollerslev (1986) were used to model the volatility of the variables. The volatile variables generated were then used in the FDI determinant function. In the panel analysis the study employed the Arellano and Bond (1990) dynamic panel data estimation method to estimate and analyze the relationship between foreign direct investment and the volatility of the macroeconomic variables. From our empirical results, the conclusion drawn was that Exchange rate volatility, Inflation volatility and Interest rate volatilities exerted significant negative effect on foreign direct investment during the period. Real interest rate, open economy, human capital and inflation were positive and significant in attracting foreign direct investment. As recommendations for policy implementation, the study suggests that policy makers in Africa should target macroeconomic stability. To control for inflation issues involving money supply, government spending, reserve and prime rates should be of prime concern. Controlling for inflation will lead to a rise in the expected return on investment which is the interest rate. With regards to exchange rate, efforts should be aimed at strengthening local industry to boost production of certain commodities. The increase in local production will lead to an increase in exports and a decrease in imports which will lead to strengthening of the local currency. Again, the idea of local firms paying and receiving resident citizens in foreign currencies should be discouraged.