Isaac Bruce

INTERNATIONAL ECONOMICS, TRADE AND FINANCE

Managing the Increased International Capital Flows to Ghana

Isaac Bruce

May, 2011
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Isaac Bruce

INTERNATIONAL ECONOMICS, TRADE AND FINANCE TABLE OF CONTENTS

Abstract....3 Introduction3 International Capital Flows..3

Literature 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: 1990 2008 Net Inflows of Emerging Markets Table 1 Composition of stock of Foreign Liabilities Table 3 Sectorial Distribution of Foreign Direct Investments Table 23 Turnover by Sector (Million) Table 24 Investments by Sector (Million) Table 26 Employment by Sector

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Isaac Bruce

INTERNATIONAL ECONOMICS, TRADE AND FINANCE

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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INTERNATIONAL ECONOMICS, TRADE AND FINANCE

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).

Literature 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 Factors Affecting Capital Inflows to EMs PUSH PULL Low interest rates High commodity prices Low global risk aversion Strained matured market balance sheets International portfolio diversification Low matured market potential growth High domestic interest rates Low domestic inflation Improving emerging market balance sheets High emerging market potential growth Trade openness

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INTERNATIONAL ECONOMICS, TRADE AND FINANCE

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.

Empirical 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, Fig 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 Fig.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 Capital Flows:The Case of Malaysia . 2. Bank of Ghana . (2004, August 31). Sectorial Analysis of Foreign Direct Investment in 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 DEVELOPING COUNTRIES. 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 in Ghana. Accra : Institute of Statistical, Social and Economic Research (ISSER), University of Ghana. 8. Reza Moghadam. (2011). Determinants of International Capital Flows:Cross-Cutting Themes 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 Economy and Finance Journal, Volume 3, Number 1, pp. 31-43. 10. International Monetary Fund, 2011, Recent Experiences in Managing Capital InflowsCross-Cutting Themes and Possible Policy Framework (Washington: International Monetary Fund).

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Appendix
Fig 1: 1991 2007 Cedi-Dollar exchange rate

Cedi-Dollar Exchange Rate

1.2 1 0.8 0.6 0.4 0.2 0 cedi-dollar exchange rate

Fig.2: Inward and Outward Investments in Ghana Inward and Outward investments Annual
1800 1600 Foreign Direct Investment Inflows 1400 1200 1000 800 600 400 200 0 -200 1972 1974 1976 1978 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 Years Ghana

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Fig.3: 1990 2008 Net Inflows of Emerging Markets

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