Managing Foreign Direct Investments in Ghana

7/28/2019 Managing Foreign Direct Investments in Ghana

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Isaac Bruce INTERNATIONAL ECONOMICS, TRADE AND FINANCE

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Managing the Increased InternationalCapital Flows to Ghana

Isaac Bruce

May, 2011


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TABLE OF CONTENTS

Abstract....3

Introduction3

- International Capital Flows..3Literature Review.5

Data and Methodology...7

Empirical Analysis8

Recommendations.10

Conclusion.10

References.11

Appendix.12

- Fig 1:1991 2007 Cedi-Dollar exchange rate- Fig.2: Inward and Outward Investments in Ghana- Fig.3:19902008 Net Inflows of Emerging Markets- Table 1 Composition of stock of Foreign Liabilities- Table 3Sectorial Distribution of Foreign Direct Investments- Table 23Turnover by Sector (Million)- Table 24Investments by Sector (Million)- Table 26Employment by Sector


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Abstract

This paper analyses the recent capital surge in Ghana from the recent oil discovery coupled

with the high growth prospects by growth economies like Ghana. It examines this new

development in Ghana using both empirical evidence and theoretical reasons to make

arguments on the subject. Furthermore it looks at the examples of other emerging markets

like Brazil, Turkey to recommend macroeconomic policies in managing the increased capital

flows. This new development has been characterized by large foreign direct investments, long

term loans and overseas development aid.

Keywords:Capital flow, Emerging Markets, Matured Markets, Foreign Direct Investment

(FDI), Exchange rate determination.

Introduction

In the midst of the countless seminars, workshops, public briefings of the state of the

Ghanaian economy, there have been significant developments in the area of foreign direct

investments to growth economies including Ghana. This has made Ghana part of the group of

emerging economies experiencing a capital flight after the global financial crisis. The

statistics and developments from year 2004 to date show a significant increase in the amount

of investments coming to Ghana. Take for example, the move to allow foreign investors to

participate in debt issues. Just from our knowledge in economics and international trade, this

is a good sign for an economic development in the long term. However, this new

development presents Ghana with new challenges including real exchange appreciation and

effects of other sectors like cocoa. At the same time, these waves of capital flows into Ghana

have the potential to propel growth and increased standards of living amongst the people.


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In this regard, as a country we are tasked to find pragmatic solutions in our context to manage

the increased capital flows into the economy by examining the effects of capital flows on

growth economies like Ghana. Other growth economies like Turkey, Brazil, Korea, etc.

Whilst other Asian countries like South Korea, Indonesia, Malaysia, Thailand and the

Philippines have been hard hit by the mismanaging this development. These economies have

experienced in a single year a turnaround of US$105 billion, reaching more than 10 per cent

of the combined G.D.P. The shift was from an inflow of capital of + US$93 billion in 1996 to

an estimated outflow of US$12 billion in 1997 (Griffith-Jones). Other economists, policy

makers and government officials have provided empirical evidence to on this subject in

addressing the situation.

Ghana is experiencing a wave of capital flows, which refers to a large number of country

prolonged surge occurring at the same time typically reflecting a stock adjustment in investor

portfolios (Reza Moghadam, 2011). Ghanas capital flows have mainly been in the area of

long-term loans, foreign direct investments and overseas development aid. However, a

migrant remittance is another form of capital flows has become a more constant source

income to most developing countries like Ghana which accounts for a large proportion of

Ghanas current account. Remittances have also proved to be more stable to overseas

development aid (ODAs) and private capital flows (Quartey, P., 2010).

Particularly in the case of Ghana, unique macro level structures have sparked this wave of

development in capital flows to Ghana. In our case, some of these factors are growth

prospect, democracy, political stability, oil discovery and above all the rich Ghanaian culture.

It is against this backdrop that I propose that this wave of capital flows will be long term.

Thus, our responses and solutions on how we can manage the increased flow of capital

should then go beyond macro-economic policies. The sectorial analysis of foreign direct


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investment in Ghana shows some industries are not experiencing large increase due to the

transfer of technology, skills, innovative capacity, and organisational and managerial

practices. In Ghana, there has been a much more liberalised regime for FDI, addressing

investors concern, privatising public enterprises and actively promoting investment, all of

which are aimed at creating a good environment to boost investor confidence. Again, the

Ghana government has expanded the scope for FDI by reducing the number of industries

closed to foreign investors (Bank of Ghana , 2004).

L iterature Review

Foreign direct investments refer to an investment in which a nonresident

enterprise/individual has 10 per cent or more equity share in a resident entity (Bank of Ghana

, 2009). Capital flows can be defined as the movement of money for the purpose of

investment, trade or business production. Capital flows occur within corporations in the form

of investment capital and capital spending on operations and research and development. On a

larger scale, governments direct capital flows from tax receipts into programs and operations

and through trade with other nations and currencies (Investopedia ).

There are many factors that determine the inflows of capital into a country ranging from

domestic to international settings. The relative significance of the factors varies from one

country to another as well as types of factors. There have been different schools of thought

from early 1990s that examine the determinants of capital flows. One of them is Calvo et al.

(1993) who assert that the push factor (typically refer to global factors that affect all EMs

across board), hence explaining the accumulation of foreign reserves and appreciating real

exchange rates during this period.

To add to the fact that push factors are the main drivers for capital inflows, Hernandez and

Rudolf (1995) argue that domestic variables such as pull factors (refer to the relative


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attractiveness of different destinations for investment opportunities) are associated with

domestic policies carried out by developing countries. He believes pull factors such as

consumer price index, domestic credit, political stability, democracy which are unique to

Ghana is central in explaining the surge of capital flows. Thus macroeconomic policies that

promote savings and exports are likely to enhance foreign investment (Asraf, Mansor, &

Puah).

Another literature that supports the importance of pull factors in attracting capital inflows to

emerging markets has been explain by Mody et al.(2001). The study concludes that pull

factors such as (consumer price index, domestic credit, industrial production index, domestic

interest rate, credit rating, reserve-import ratio and domestic stock market index) have

significantly attracting capital flows to Ghana (Asraf, Mansor, & Puah). However, with

respect to the economy of Ghana, pull factors such as the consumer price index, political

stability, democracy, etc. proves to create a more stable and equilibrium state in the long run.

Below is the framework of push and pull factors attracting capital flows to most emerging

markets across the world.

Examples of F actors Affecting Capital I nf lows to EMs

PUSH PULL

Low interest rates High commodity prices

Low global risk aversion High domestic interest rates

Strained matured market balance sheets Low domestic inflation

International portfolio diversification Improving emerging market balance sheets

Low matured market potential growth High emerging market potential growth

Trade openness


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Data & Methodology

This study analysis uses data mostly from year 1990 to 2010 which were obtained mostly

from the International Monetary Fund, World Bank, Central Bank of Ghana and university

research papers.

The country under review is Ghana, compared to other emerging markets around the world.

The main dependent variable in this study is capital flows which have been obtained by

summing up all the foreign direct investments, long term loans, overseas development aids,

etc. from year 1990 to 2010. The rationale behind using the aggregated data on capital flows

is to analyse the overall investment environment in Ghana and distinguish the present study

in different sectors of the economy.

The independent variables used in this study include both pull and push factors affecting in

Ghana. For push factors I analysed the potential growth of the market, portfolio

diversification, whilst for pull factors I look at factors like the political stability, democracy

and high consumer prices.

Empir ical Analysis

This section reviews the analysis made by institutions and key individuals in the industry.

First of all, exchange rates are an important factor in controlling capital flows and thus needs

to be monitored to a large extent. During capital flows, real exchange rates increases to a

large extent. Therefore some countries allow the exchange rate to appreciate corresponding to

the extent of their reserve accumulation. From the appendix, Ghanas increased capital flow

from year 2005 to 2010 has a direct relationship with its exchange rate during this same

period (See Appendix, F ig 1&2).


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Ghana stands a huge chance of attracting more capital flows to it based on its untapped

growth potential, future portfolio diversification and strong macroeconomic policies for

private sector development. Therefore it is eminent the country manages the increased flows

to enjoy the full benefits. Therefore from the experiences of other emerging markets, strong

growth prospects and healthy sovereign and private balance sheets are likely to continue

drawing inflows in the future. At the same time, large inflows may result in sharp, sustained

currency appreciation, which can make our already unproductive export sector uncompetitive

(Reza Moghadam, 2011). Therefore government must establish the policies below to secure

this growth for a long period of time. From research, it has been proven that emerging

economies like Ghana are exposed more to sharp changes in capital flows as compared to

matured markets (See Appendix F ig.3).

A more practical policy countries in this situation usually adopt is sterilization. Sterilization

can be defined as a form of monetary action in which a central bank or federal reserve

attempts to insulate itself from the foreign exchange market to counteract the effects of a

changing monetary base. The main objective of these interventions is to allow countries to

manage exchange rate volatility, while keeping monetary aggregates under control. For

Brazil and Peru, this has been a dominant line of response against surging inflows. Sterilized

interventions are also an important tool for Indonesia, Peru, and Thailand in smoothing

exchange rate volatility and slowing the rate of appreciation at least in the short term (Reza

Moghadam, 2011). Therefore, the best time to allow the exchange rate to appreciate is when

the exchange rate is undervalued on a multilateral basis.

In addition, government should enforce certain fiscal policies in their quest to sterilize their

local currencies. Therefore, to reap the full benefits of this new development, the government

should increase their foreign exchange reserves especially when inflation is a concern.


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Nevertheless, the first line of defence when confronted with increased capital flows are

macroeconomic policies. these policies have proved over the years to propel growth and

improve the economic development and standard of living amongst the people (Reza

Moghadam, 2011).

A positive effect on the Ghanaian economy due to the increased capital flows is that is has

safeguard the economy after the recession to increase consumption and production in order to

increase the economic growth and the standard of living of the people. It also encourages

spending and rendering the export market more competitive in the long run of the economy.

Conclusion

From the analysis made using both empirical analysis and the theoretical reasons on this

subject, to sustain this increased capital flow to Ghana, the government needs to set major

macroeconomic structures like portfolio diversification, technology advancement, political

stability, human resource development, etc. However, what is more important to Ghana is

sustaining and creating opportunities for the citizenry. Therefore, the government must make

sure there is local content in the development. From the appendix, employment and turnover

generated from the various sectors from the investment opportunities have helped propel this

growth to a large extent. Therefore, Ghanaians should be the main focus for this

development.


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Bibliography

1. Asraf, A. M., Mansor, S., & Puah, C.-H. (n.d.). Determinants of International CapitalFlows:The Case of Malaysia .

2. Bank of Ghana . (2004, August 31). Sectorial Analysis of Foreign Direct Investmentin Ghana. Retrieved May 11, 2011, from Bank of Ghana :

http://www.bog.gov.gh/index1.php?linkid=160&adate=31%2F08%2F2004&archivei

d=229&page=1

3. Bank of Ghana . (2009).Monitoring Cross Border Capital Flows in Ghana. Accra :Bank of Ghana, Research Department .

4. (n.d.).Financial Flows to Developing Countries: Recent Trends and Prospects.Global Development Finance 2007.

5. Griffith-Jones, S. (n.d.). STABILIZING CAPITAL FLOWS TO DEVELOPINGCOUNTRIES. Sussex: Institute of Development Studies.

6. Investopedia . (n.d.). Sterilization . Retrieved May 08, 2011, from Investopedia:http://www.investopedia.com/terms/s/sterilization.asp

7. Quartey, P. (2010). The impact of migrant remittances on household welfare inGhana. Accra : Institute of Statistical, Social and Economic Research (ISSER),

University of Ghana.

8. Reza Moghadam. (2011). Determinants of International Capital Flows:Cross-CuttingThemes and Possible Policy Framework.INTERNATIONAL MONETARY FUND.

9. Abdullah, A. Muhammad, Shazali A. Mansor and Puah Chin Hong, 2010,Determinants of International Capital Flows: The Case of Malaysia. Global Economyand Finance Journal, Volume 3, Number 1, pp. 31-43.

10.International Monetary Fund, 2011,Recent Experiences in Managing CapitalInflowsCross-Cutting Themes and Possible Policy Framework(Washington:

International Monetary Fund).


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Appendix

F ig 1:1991 2007 Cedi-Dollar exchange rate

Fig.2: Inward and Outward Investments in Ghana

0

0.2

0.4

0.6

0.8

1

1.2

Cedi-Dollar Exchange Rate

cedi-dollar

exchange

rate

-200

0

200

400

600

800

1000

1200

1400

1600

1800

1972

1974

1976

1978

1980

1982

1984

1986

1988

1990

1992

1994

1996

1998

2000

2002

2004

2006

2008

ForeignDirectInvestmentInflows

Years

Inward and Outward investments Annual

Ghana


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Fig.3:19902008 Net Inflows of Emerging Markets


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Managing Foreign Direct Investments in Ghana

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