Linking foreign direct investment to financial deepening: Evidence from sub-Saharan Africa

Abstract

In this study, the nexus between Foreign Direct Investment (FDI) and financial deepening is critically examined. The study employed a robust dynamic panel cross-sectionally augmented distributed lag method for 31 countries in sub-Saharan Africa (SSA). The results reveal that: (1) a strong significantly positive long run impact of FDI on financial deepening exists; (2) real gross domestic product (GDP), trade openness and government effectiveness stimulate the positive FDI–financial deepening nexus; (3) the strength of the FDI–financial deepening nexus also depends on the percentile position in the income distribution of SSA countries (countries in the upper strata of the income distribution evidently had stronger FDI–financial deepening relations than those in the lower strata and (4) real GDP, trade openness and government effectiveness also enhance financial deepening in SSA. The study recommends that governments in SSA should foster fiscal, financial and regulatory incentives for attracting FDI for improved financial depth in SSA by: strengthening the regulatory frameworks and institutions of governance through the removal of unwarranted governmental interferences in the administration of justice and electoral processes; removing multiple tax regimes; and stabilizing prices and exchange rate volatility via stimulating local productivity and guaranteeing the rule of law, political stability and security of life and property in the region.