Why is South Africa's capital inflows mix different?

• Pages: 128-129

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Private capital inflows can bring substantial benefits to an economy, including by boosting private sector activity and enhancing economic growth prospects. In particular, foreign direct investment (FDI), generally considered the most resilient form of capital inflows, is also associated with the transfer of new technologies and skills and improved market access. Unlike most other emerging markets, however, capital flows to South Africa since the mid-1990s have been heavily biased toward portfolio flows. A new IMF cross-country study seeks to identify the main determinants of the level and composition of South Africa's capital inflows and suggests that further trade and capital account liberalization would increase the share of FDI. It also finds that exchange rate volatility tends to deter FDI but has little impact on foreign portfolio flows. Faisal Ahmed and Norbert Funke, of the IMF's Policy Development Review and African Departments, respectively, spoke with Jacqueline Irving of the IMF Survey.

IMF SURVEY: Why is the composition of capital flows to South Africa biased toward portfolio investment flows?

FUNKE: South Africa attracts as much or even more combined FDI and foreign portfolio flows taken together as do other comparator emerging market countries-on average 5 percent of GDP annually over 1994-2002. But the proportion of inbound FDI is much less than for comparator countries, and the share of foreign portfolio investment is much higher.

To understand why, our cross-country study looked at both common and specific determinants of FDI and foreign portfolio flows. Our findings suggest that during 1975-2002 South Africa scored lower than its major competitors for capital flows in growth and infrastructure-two important determinants of FDI. Exchange rate volatility also was substantially higher than for comparator countries. Moreover, although South Africa has gradually relaxed capital controls over the past 10 years, it retains some controls, including a requirement that exporters repatriate their export proceeds within six months. And because South Africa is the largest financial market in Africa, it is very attractive to portfolio investors seeking to diversify their portfolios regionally.

IMF SURVEY: Over the past six years or so, a number of primary listings have left the Johannesburg Securities Exchange (JSE), many for the London Stock Exchange. Indeed, the total number of listed companies fell from nearly 700 in 1999...