## _wp0540 - References

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---

### Appendix and tables
- Appendix
  - 1. List of Countries Included in This Study..............................................................................23
- Tables
  - 1. Comparator Countries and Sovereign Risk Ratings ........................................................... 17
  - 2. Patterns of Capital Inflows.................................................................................................. 18
  - 3. Foreign Direct Investment in Emerging Markets................................................................ 19
  - 4. Portfolio Flows To Emerging Markets ............................................................................... 20
  - 5. Composition of Capital Flows: FDI Inflows to Emerging Markets as a Share 
       of Total Inflows................................................................................................................ 21
  - 6. Determinants of Capital Flows: Performance Comparison Across Countries.................... 22

### Introductory excerpt and key numeric detail
- Excerpt from Introduction:
  - "Over the past decade, South Africa has attracted relatively little foreign direct investment (FDI), but considerable amounts of portfolio inflows. Between 1994 and 2002, FDI inflows amounted to 1.5 percent of GDP a year, on average, whereas portfolio inflows totaled about"
- 3.5 percent of GDP. These outcomes contrast sharply with those in countries with similar risk

### Key stylized facts on capital flows to South Africa and comparators
- During 1994-2002, South Africa attracted three times more portfolio investments, as a percentage of GDP, than the other emerging markets.  
- Some 70 percent of portfolio inflows to South Africa went into equity.  
- Portfolio inflows to South Africa averaged about 6 percent of GDP during 1997-2000.  
- The share of FDI in capital flows during 1994-2002 amounted to only 30 percent in South Africa compared with over 70 percent in the comparator countries.  
- Average FDI in South Africa amounted to only 0.7 percent of GDP if the two large-scale foreign investment transactions—the partial sale of Telecom in 1997 and the Anglo-American takeover of De Beers in 2001—are excluded.  
- The coefficient of variation for portfolio inflows to South Africa is only half that in the comparator countries, implying that South Africa has attracted portfolio flows more consistently than other countries.  
- Memorandum items (Table 2): FDI Share (In percent of total inflows) — All countries85.9, Selected Countries72.7, South Africa29.9.

### Determinants of capital flows — theoretical framing and empirical approach
- Four broad theoretical approaches discussed:
  - sovereign risk literature;
  - optimal portfolio choice (portfolio diversification);
  - corporate finance approach (asymmetric information, agency, corporate control);
  - the “pull and push” literature (domestic pull factors vs external push factors).
- Pull factors emphasized:
  - macroeconomic performance (lagged GDP per capita growth used as proxy),
  - quality of institutions (law and order index from International Country Risk Guide),
  - investment environment (trade openness proxied by ratio of imports and exports to GDP),
  - infrastructure (telephone lines per 1,000),
  - resource availability (fuel export receipts as percent of exports),
  - financial development (domestic credit to private sector; stock market capitalization as percent of GDP),
  - global factors (real short-term and long-term U.S. interest rates).
- Other included variables:
  - Exchange rate volatility proxied by annual standard deviation of monthly changes in the real effective exchange rate;
  - Inflation volatility;
  - Capital account controls (IMF’s Annual Report on Exchange Arrangements and Exchange Restrictions proxies).
- Empirical specification:
  - dynamic panel with lagged dependent variable;
  - estimators used include OLS and Arellano and Bond (1991) First Difference GMM (two-step);
  - instruments: lagged levels for lagged differences; lagged realizations for potentially endogenous regressors (growth, exchange rate volatility);
  - model validity assessed with Sargan test and test of second-order autocorrelation.

### Empirical findings — FDI versus portfolio flows
- Common determinants for both FDI and portfolio flows:
  - better institutional environment (rule of law/law and order);
  - lower foreign interest rates (higher international interest rates deter inflows).
- FDI-specific significant determinants (GMM results):
  - higher growth (lagged GDP growth);
  - greater trade openness;
  - better infrastructure (telephone lines per 1,000);
  - better institutional quality;
  - lower international long-term interest rates;
  - lower inflation volatility;
  - lower exchange rate volatility;
  - current account restrictions in the form of export surrender receipts deter FDI.
- Portfolio flows:
  - higher growth rates, better institutions, and lower international short-term interest rates increase portfolio inflows;
  - well-developed financial markets (stock market capitalization) increase portfolio attractiveness;
  - multiple exchange rate practices tend to deter portfolio inflows;
  - evidence on other capital account restrictions is inconclusive;
  - exchange rate volatility does not have a statistically significant adverse effect on portfolio flows; in some specifications coefficients are even positive but not significant.
- Key quantitative regression signs (selected results from Table 3 and Table 4 preserved exactly as reported):
  - Lagged Dependent (FDI regressions): 0.4873 ***, 0.4371 ***, 0.4590 ***, 0.4241 ***, 0.1967 ***, 0.2426 *** (t-statistics reported).
  - Trade openness coefficients (FDI regressions): 0.0109 ***, 0.0092 ***, 0.0080 **, 0.0078 **, 0.0174 ***, 0.0101 ***, 0.0103 ***.
  - Real US Government bond yield (10 year) (FDI regressions): -0.1078 ***, -0.0797 ***, -0.0694 ***, -0.0724 ***, -0.0906 ***, -0.0303 ***, -0.0440 ***.
  - Lagged Exchange Rate Volatility (ERV) (FDI regressions): -0.0057 ***, -0.0034 ***, -0.0033 ***, -0.0032 ***, -0.0025 *.
  - Stock Market Capitalization over GDP (portfolio regressions): 0.0115 ***, 0.0074 ***, 0.0092 ***, 0.0109 *** (selected specifications).
  - Lagged Exchange rate volatility (portfolio regressions — select coefficients): -0.0610, 0.0090, -0.0720 **, -0.0699 *** (significance varies by specification).
- Composition regressions (share of FDI in total inflows):
  - resource abundance (fuel export proceeds) increases the share of FDI;
  - multiple exchange rate practices favor a larger share of FDI;
  - higher exchange rate volatility reduces the share of FDI.

### Policy conclusions and recommendations for South Africa
- Policies can influence both the level and the composition of capital flows. Specific recommendations:
  - Further trade liberalization is expected to increase both the level of FDI inflows and the share of FDI in total capital flows; South Africa remains less open than major competitors despite extensive liberalization since the early 1990s.
  - Improvements in growth, infrastructure (telephone lines per 1,000 as proxy), and law and order would help attract more FDI. South Africa currently scores lower than major competitors in these areas (Table 6 referenced).
  - Lower exchange rate volatility tends to increase the share of FDI; the rand has been one of the more volatile emerging market currencies. The South African Reserve Bank (SARB) has closed its open forward position and increased net international reserves significantly, but South Africa’s foreign reserves remain somewhat low relative to other emerging markets. An increase in reserves could reduce exchange rate volatility (Hviding and others (2004) evidence cited).
  - Further easing of capital controls, including reconsideration of the requirement that exporters repatriate foreign exchange earnings within six months, could raise FDI; the current strength of the rand may present an opportune time to ease controls.
  - Other measures not fully analyzed (limited data) such as accelerating privatization would likely increase FDI. Preliminary evidence in a smaller sample suggests privatization tends to have a positive impact on FDI inflows.
- Overall policy summary:
  - the relatively low share of FDI in South Africa can be addressed, in part, by government policies including further trade and capital account liberalization, a reduction in exchange rate volatility, and an increase in reserves—accumulated at a pace dictated by prevailing market conditions.

### 1. Macro performance — selected indicators (Table 6 excerpts)
- GDP per capita growth (in percent)
  - 1.62.00.7
  - -0.9 -1.9-0.1
- 2. Investment environment
  - Trade openness (in percent of GDP)
    - 65.771.251.0
    - 3.7 11.613.9
  - Real exchange rate volatility (std dev)
    - 3.12.02.9
    - -1.3 
    - 0.32.0
  - Inflation volatility (std dev)
    - 3.71.11.7
    - -2.0 -0.4
    - 0.5
  - Surrender of export receipts index
    - 0.70.71.0
    - -0.2 -0.1
    - 0.0
  - Capital account restriction index
    - 0.60.51.0
    - -0.2 -0.1
    - 0.0
  - Multiple exchange rate practice
    - 0.10.10.0
    - -0.1 -0.1
    - 0.0
- 3. Infrastructure and human capital
  - Telephone density (per 1000 people)
    - 73.0132.8110.7
    - 29.4 51.98.7
- 4. Quality of institutions
  - Law and order index
    - 3.53.92.8
    - -0.5 -0.6-1.9
- 5. Financial development (In percent of GDP)
  - Stock market capitalization
    - 34.236.3157.7
    - 23.4 
    - -9.0-35.2
  - Domestic credit 
    - 32.462.9127.0
    - 3.4 9.021.5
- Note: 1/ Difference between 1994-96 and 2000-2002 averages.

*Italic: Source — IMF working paper content provided in the supplied PDF excerpt.*

### References .............................................................................................................

### _wp0540 - References

### Appendix and Tables
- Appendix
  - 1. List of Countries Included in This Study..............................................................................23
- Tables
  - 1. Comparator Countries and Sovereign Risk Ratings ........................................................... 17
  - 2. Patterns of Capital Inflows.................................................................................................. 18
  - 3. Foreign Direct Investment in Emerging Markets................................................................ 19
  - 4. Portfolio Flows To Emerging Markets ............................................................................... 20
  - 5. Composition of Capital Flows: FDI Inflows to Emerging Markets as a Share 
       of Total Inflows................................................................................................................ 21
  - 6. Determinants of Capital Flows: Performance Comparison Across Countries.................... 22

### Document pagination and headings
- References ............................................................................................................................... 24
- - 3 - (page marker present in supplied content)

### Introductory excerpt and key numeric detail
- Excerpt from Introduction:
  - "Over the past decade, South Africa has attracted relatively little foreign direct investment (FDI), but considerable amounts of portfolio inflows. Between 1994 and 2002, FDI inflows amounted to 1.5 percent of GDP a year, on average, whereas portfolio inflows totaled about"

*Source: _wp0540 - References*

### 3.5 percent of GDP. These outcomes contrast sharply with those in countries with similar risk

### _wp0540 - 3.5 percent of GDP. These outcomes contrast sharply with those in countries with similar risk

### Key stylized facts on capital flows to South Africa and comparators
- During 1994-2002, South Africa attracted three times more portfolio investments, as a percentage of GDP, than the other emerging markets.  
- Some 70 percent of portfolio inflows to South Africa went into equity.  
- Portfolio inflows to South Africa averaged about 6 percent of GDP during 1997-2000.  
- The share of FDI in capital flows during 1994-2002 amounted to only 30 percent in South Africa compared with over 70 percent in the comparator countries.  
- Average FDI in South Africa amounted to only 0.7 percent of GDP if the two large-scale foreign investment transactions—the partial sale of Telecom in 1997 and the Anglo-American takeover of De Beers in 2001—are excluded.  
- The coefficient of variation for portfolio inflows to South Africa is only half that in the comparator countries, implying that South Africa has attracted portfolio flows more consistently than other countries.  
- Memorandum items (Table 2): FDI Share (In percent of total inflows) — All countries85.9, Selected Countries72.7, South Africa29.9.

### Determinants of capital flows — theoretical framing and empirical approach
- Four broad theoretical approaches discussed: sovereign risk literature; optimal portfolio choice (portfolio diversification); corporate finance approach (asymmetric information, agency, corporate control); and the “pull and push” literature (domestic pull factors vs external push factors).  
- Pull factors emphasized: macroeconomic performance (lagged GDP per capita growth used as proxy), quality of institutions (law and order index from International Country Risk Guide), investment environment (trade openness proxied by ratio of imports and exports to GDP), infrastructure (telephone lines per 1,000), resource availability (fuel export receipts as percent of exports), financial development (domestic credit to private sector; stock market capitalization as percent of GDP), and global factors (real short-term and long-term U.S. interest rates).  
- Exchange rate volatility proxied by annual standard deviation of monthly changes in the real effective exchange rate; inflation volatility and capital account controls (IMF’s Annual Report on Exchange Arrangements and Exchange Restrictions proxies) also included.  
- Empirical specification: dynamic panel with lagged dependent variable; estimators used include OLS and Arellano and Bond (1991) First Difference GMM (two-step). Instruments: lagged levels for lagged differences; lagged realizations for potentially endogenous regressors (growth, exchange rate volatility). Model validity assessed with Sargan test and test of second-order autocorrelation.

### Empirical findings — FDI versus portfolio flows
- Common determinants for both FDI and portfolio flows: better institutional environment (rule of law/law and order) and lower foreign interest rates (higher international interest rates deter inflows).  
- FDI-specific significant determinants (GMM results): higher growth (lagged GDP growth), greater trade openness, better infrastructure (telephone lines per 1,000), better institutional quality, lower international long-term interest rates, lower inflation volatility, and lower exchange rate volatility. Current account restrictions in the form of export surrender receipts deter FDI.  
- Portfolio flows: higher growth rates, better institutions, and lower international short-term interest rates increase portfolio inflows. Well-developed financial markets (stock market capitalization) increase portfolio attractiveness. Multiple exchange rate practices tend to deter portfolio inflows; evidence on other capital account restrictions is inconclusive. Exchange rate volatility does not have a statistically significant adverse effect on portfolio flows; in some specifications coefficients are even positive but not significant.  
- Key quantitative regression signs (selected results from Table 3 and Table 4 preserved as reported):  
  - Lagged Dependent (FDI regressions): 0.4873 ***, 0.4371 ***, 0.4590 ***, 0.4241 ***, 0.1967 ***, 0.2426 *** (t-statistics reported).  
  - Trade openness coefficients (FDI regressions): 0.0109 ***, 0.0092 ***, 0.0080 **, 0.0078 **, 0.0174 ***, 0.0101 ***, 0.0103 ***.  
  - Real US Government bond yield (10 year) (FDI regressions): -0.1078 ***, -0.0797 ***, -0.0694 ***, -0.0724 ***, -0.0906 ***, -0.0303 ***, -0.0440 ***.  
  - Lagged Exchange Rate Volatility (ERV) (FDI regressions): -0.0057 ***, -0.0034 ***, -0.0033 ***, -0.0032 ***, -0.0025 *.  
  - Stock Market Capitalization over GDP (portfolio regressions): 0.0115 ***, 0.0074 ***, 0.0092 ***, 0.0109 *** (selected specifications).  
  - Lagged Exchange rate volatility (portfolio regressions — select coefficients): -0.0610, 0.0090, -0.0720 **, -0.0699 *** (significance varies by specification).  
- Composition regressions (share of FDI in total inflows) show: resource abundance (fuel export proceeds) increases the share of FDI; multiple exchange rate practices favor a larger share of FDI; higher exchange rate volatility reduces the share of FDI.

### Policy conclusions and recommendations for South Africa
- Policies can influence both the level and the composition of capital flows. In particular:  
  - Further trade liberalization is expected to increase both the level of FDI inflows and the share of FDI in total capital flows; South Africa remains less open than major competitors despite extensive liberalization since the early 1990s.  
  - Improvements in growth, infrastructure (telephone lines per 1,000 as proxy), and law and order would help attract more FDI. South Africa currently scores lower than major competitors in these areas (Table 6 referenced).  
  - Lower exchange rate volatility tends to increase the share of FDI; the rand has been one of the more volatile emerging market currencies. The South African Reserve Bank (SARB) has closed its open forward position and increased net international reserves significantly, but South Africa’s foreign reserves remain somewhat low relative to other emerging markets. An increase in reserves could reduce exchange rate volatility (Hviding and others (2004) evidence cited).  
  - Further easing of capital controls, including reconsideration of the requirement that exporters repatriate foreign exchange earnings within six months, could raise FDI; the current strength of the rand may present an opportune time to ease controls.  
  - Other measures not fully analyzed (limited data) such as accelerating privatization would likely increase FDI. Preliminary evidence in a smaller sample suggests privatization tends to have a positive impact on FDI inflows.  
- Overall: the relatively low share of FDI in South Africa can be addressed, in part, by government policies including further trade and capital account liberalization, a reduction in exchange rate volatility, and an increase in reserves—accumulated at a pace dictated by prevailing market conditions.

*Italic: Source — IMF working paper content provided in the supplied PDF excerpt.*

### 1. Macro performance

### 1. Macro performance

### GDP per capita growth (in percent)
- 1.62.00.7
- -0.9 -1.9-0.1

### 2. Investment environment
- Trade openness (in percent of GDP)
  - 65.771.251.0
  - 3.7 11.613.9
- Real exchange rate volatility (std dev)
  - 3.12.02.9
  - -1.3 
  - 0.32.0
- Inflation volatility (std dev)
  - 3.71.11.7
  - -2.0 -0.4
  - 0.5
- Surrender of export receipts index
  - 0.70.71.0
  - -0.2 -0.1
  - 0.0
- Capital account restriction index
  - 0.60.51.0
  - -0.2 -0.1
  - 0.0
- Multiple exchange rate practice
  - 0.10.10.0
  - -0.1 -0.1
  - 0.0

### 3. Infrastructure and human capital
- Telephone density (per 1000 people)
  - 73.0132.8110.7
  - 29.4 51.98.7

### 4. Quality of institutions
- Law and order index
  - 3.53.92.8
  - -0.5 -0.6-1.9

### 5. Financial development (In percent of GDP)
- Stock market capitalization
  - 34.236.3157.7
  - 23.4 
  - -9.0-35.2
- Domestic credit 
  - 32.462.9127.0
  - 3.4 9.021.5

- 1/ Difference between 1994-96 and 2000-2002 averages.

*Table 6. Determinants of Capital Flows: Performance Comparison Across Countries — Average 1994-2002 Change 1994-2002 1/*

*Appendix 1. List of Countries Included in This Study (as presented in the source).*

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