The Composition of Foreign Capital Stocks in South Africa: The Role of Institutions, Domestic Risk and Neighbourhood Effects

Working Paper 163
Author(s): 
Farayi Gwenhamo and Johannes Fedderke
Publication date: 
March, 2010
Journal: 
Economic Modelling
Classification-JEL: 

This paper investigates the determinants of the absolute volumes and composition of foreign capital stocks in South Africa, focusing on the role played by institutional quality (property rights), domestic risk and neighbourhood effects as potential determinants. The empirical findings show that secure property rights and low risk in the host country positively affect the absolute volumes of both long-term and short-term foreign capital, but tilt the composition of foreign capital in favour of long-term foreign capital. The empirical results also demonstrate the existence of neighbourhood effects where the institutional environment in Zimbabwe has a significant impact on South Africa's foreign capital in.ows. It is shown that weak property rights in Zimbabwe lead to an increase in South Africa's foreign direct investment (FDI), but a reduction in South Africa's portfolio investment. This suggests that Zimbabwe and South Africa compete for foreign direct investment in similar sectors, and present two alternative investment destinations to foreign investors. As such, when property rights in Zimbabwe worsen, FDI appears to switch to South Africa as an alternative. By contrast, poor property rights in Zimbabwe appear to raise the perceived risk for portfolio investment in South Africa.

Publication PDF: 
Total downloads: 
550