Foreign Capital Inflows, Economic Policies and the Real Exchange Rate in Sub-Saharan Africa: Is there an Interaction Effect?

This paper presents a dynamic heterogeneous panel data model in which the reaction of the real exchange rate to external finance includes interactions with trade openness and the fiscal, monetary and nominal exchange rate policies of twenty-four Sub-Saharan African countries from 1978-2001. As expected, a rise in international transfers exerts a real appreciation pressure in reform-compliant economies. However, the results from this paper indicate that this estimated inflationary effect of capital inflows could be effectively contained by associated policy interventions to contract government expenditure, relax rigidities in factor markets, liberalise trade controls and address problems of credit rationing in the private sector.