Sources of Macroeconomic Instability: Implications on Foreign Direct Investment Inflow in Sub-saharan Africa, A PMG/ARDL Approach

Abstract

This study investigates the short and long run effect of diverse sources of macroeconomic instability on the inflow of foreign direct investment (FDI). The stability of the business environment of a host country will determine the extent to which these economies will absorb shocks and make the economy attractive to foreign investors. We evaluate the role played by macroeconomic instability conditions in determining the inflow of FDI in Sub-Saharan African (SSA) economies, where FDI inflow have been relatively low and macroeconomic instability variables like inflation, external debt and exchange rate has persistently shown volatile trends as compared to other regions in the world. This study employs the Pooled Mean Group (PMG), Mean Group (MG) and Dynamic fixed effect (DFE) autoregressive distributive lag (ARDL) estimation approaches which account for both non-stationarity and heterogeneity effects, in a panel of 31 SSA countries and covers the period 1990 to 2017. We equally employ first and second generation panel unit root test, cross sectional dependence test and cointegration test. The Hausman test is used to select the most efficient estimation technique between the MG, PMG and DFE techniques. The results reveal a negative but insignificant effect of inflation on FDI both in the short and long run. Equally, a positive but insignificant effect of external debt and a negative but insignificant effect of exchange rate are observed in the short run. In the long run, external debt significantly crowds out FDI while exchange rate significantly crowds in FDI in the sub-Saharan African sub region. Based on the findings, we recommend that debt contracted in the sub region should be channeled to productive use like road infrastructure and renewable energy, while currency depreciation should be encouraged in order to render investors within this region more competitive. The used of monetary and fiscal policies should be employed to tackle macroeconomic uncertainty. Capital account regulation should equally be adopted to ensure a competitive real exchange rate. Equally, the debt carrying capacity of each economy should be identified in order to avoid debt unsustainability or payment and servicing default.