Financial Openness, Capital Flows and Risk Sharing in Africa

Abstract

Empirical literature suggests that while there is low but improving risk sharing in developed countries, risk sharing in the developing countries is low and has remained low. We confirm this observation using panel data for the period 1986–2011. Overall we find weak evidence that an increase in capital account liberalization reduces the dependence of idiosyncratic consumption on idiosyncratic gross domestic product (GDP) in sub-Saharan Africa (SSA). An interaction of capital account liberalization proxy with capital flows produces a mixed effect on consumption risk sharing, calling for caution in capital account liberalization policy design. On the other hand, while we find no evidence that financial integration, as measured by cross-border capital flows in terms of the ratio of foreign assets to GDP, is helpful in consumption risk sharing in SSA, equity appears to hold the potential of precipitating a reduction in consumption risk while foreign direct investment (FDI) and debt are particularly noticeable to have a facilitative role in unhinging idiosyncratic consumption from idiosyncratic output in East African Community (EAC) and Southern African Development Cooperation (SADC) regional groupings, respectively. FDI liabilities in particular elicit a significantly positive enhancement of risk sharing in EAC and are economically meaningful in SADC. The impact of individual assets and liabilities is overall mixed, both in SSA and regional groupings, pointing to an underdeveloped capital markets scenario in need of urgent attention in terms of well-planned policies and strategies directed towards developing competitive capital markets in Africa for purposes of risk sharing.