Macroeconomic Effects of Foreign Capital Inflows in the East African Community

Abstract

Economic theories acknowledge that foreign capital inflows (FCIs) play a key role in the growth of developing countries. Many studies have been undertaken to examine the effects of FCIs on different macroeconomic variables using different methodologies. Despite the intense discussion on the topic both theoretically and empirically, an agreement is far to be reached on the macroeconomic effects of FCIs among researchers. The results from the analysis are different across countries. Besides, most of the existing research puts their focuses on the effect caused by foreign direct investment (FDI). However, FDI is one of the FCIs that countries rely on for their development. Considering FDI only can lower the reliability of the findings due to the omission of variables, thus causing bias. Therefore, this study estimates the macroeconomic effects of FCIs on three macroeconomic variables such as Economic growth, Domestic investment and Financial development (FD) in five countries of the East African Community (EAC) such as Kenya, Rwanda, Burundi, Tanzania, and Uganda. The study considers three different components of FCIs namely FDI, remittances (REM), and official development assistance (ODA) in the estimation. This paper employs the autoregressive distributed lag model (ARDL) with time series data from 1990 to 2020. The macroeconomic effects of FCIs in the EAC present heterogeneous results depending on the nature of the foreign capital, the significance of the flow into the country, and the regulatory framework in the country. At the country level, here is the summary of the findings . The findings on the effect of FCIs on economic growth show that FDI promotes economic growth in Kenya, Rwanda, Uganda, and Tanzania. However, FDI in Burundi does not have any effect on economic growth. The results for ODA show that ODA spurs the economic growth of Rwanda and Uganda but has no impact on the growth of Kenya, Burundi, and Tanzania. The effects of remittance on growth reveal that remittance stimulates the economic growth of Kenya, whereas it negatively affects the growth of Rwanda. For the role of trade openness on economic growth, trade openness promotes the growth of Tanzania, but it has no impact on Burundi and Uganda. In addition it has a negative impact on the growth of Kenya and Rwanda.

Secondly, regarding the effects of FCIs on domestic investment, the findings from estimations indicate the existence of a positive impact of FDI on domestic investment of Kenya whereas a negative impact on domestic investment was detected for Rwanda and no effects on the remaining countries (Burundi, Uganda, and Tanzania). The results for ODA indicate a positive and significant effect on domestic investment in all five countries. The remittances result indicates a positive effect on domestic investment in Kenya, while a negative impact is observed in Rwanda. Thirdly, the findings on the effects of FCIs on Financial development indicate that FDI affects positively the financial development in Kenya and Tanzania. However, FDI has a negative effect on Burundi's financial development and no effect is found for Rwanda and Uganda. The results for external debts indicate that debts have significant and negative effects on financial development in Kenya, Rwanda, and Uganda while no effect is detected for Burundi and Tanzania. On the other side, the findings on the effects of remittances on financial development reveal that remittances do not have an effect on financial development in Rwanda but have a positive effect on financial development in Kenya.