Capital inflows and the real exchange rate: An empirical study of sub-Saharan Africa

Abstract

This paper investigates the question of whether capital inflows, particularly Foreign Direct Investment (FDI), cause the real exchange rate to appreciate. It also examines whether different forms of captial inflow have variable effects on the real exchange rate. The paper estimates an empirical real exchange rate model specifying a set of capital inflow variables using dynamic panel techniques. Based on data for a sample of sub-Saharan African countries for the period 1980 – 2000, the study reveals FDI as the category of private capital inflow that causes the real exchange rate to appreciate. The results also show that an increase in official aid causes a real appreciation, the magnitude being greater compared to that associated with FDI.