Capital flight and its determinants in the Franc Zone

Abstract

The phenomenon of capital flight appeared in the Franc Zone (FZ) before the debt crisis of the early 1980s, and is today of greater importance because of its increasing magnitude. This report examines the determinants of this phenomenon in the period 1970 to 2005. The econometric analysis indicated that in the context of poor governance and bad institutional quality, external debt, aid and natural resources, revenues are used in part to finance capital flight. The results also revealed that capital flight arises in the presence of macroeconomic instability that occurs in the forms of an increase in inflation, an exchange rate overvaluation, a decline in terms of trade, uncertainties in government consumption, real interest rates and budget deficits. Furthermore, capital flight episodes arise in the context of less developed financial systems, resulting in reduced deposits and in credit to the private sector. Exploring the effects of other factors, this study found that past capital flight, foreign direct investment and remittances are important in explaining current capital flight, while rate of return differentials and armed conflict have insignificant effects. The policy implications of these results are analysed to determine how to induce capital flight reversal. JEL classification: F20; F34; F35; O17