Working Paper 99 - Capital Flows and Capital Account Liberalisation in the Post-Financial-Crisis Era: Challenges, Opportunities and Policy Responses

This paper invokes a flow-of-funds framework toscope the challenges, opportunities and policyresponses regarding capital flows and capitalaccount liberalisation as Africa emerges fromthe global financial crisis. The framework is usedto highlight the transmission of the financial crisisfrom the foreign sector to the household sector,company sector, banks and capital markets,as well as the government sector. Financialprices, mainly the exchange rate and stockprices, provide the propagation mechanism forcontagion effects of the financial crisis; forexample, collapse of the exchange rate, collapseof stock prices, and a surge in capital outflowsincluding capital flight. While by the end of 2007,remittances and other private capital flows hadovertaken official aid as the main source ofexternal finance for Africa, the financial crisisseems to be distorting the pattern and predictabilityof capital flows into the continent and posea threat to debt sustainability. Moreover, giventhe intensity of the financial crisis and the bailoutpackages for banks in the USA and UK,among others, it is unlikely that the Gleneaglescommitment of the G-8 heads of state in 2005 todouble aid to Africa by 2010 will be met. But perhaps,“the angel is in the details”: the flexibilityof individual African countries to manoeuvre outof the crisis will very much depend on financialsector reforms, especially relaxation of controlson portfolio investment and FDI, and capitalaccount liberalisation. Hence, the paper highlightsthe magnitude and determinants of capitalflows into Africa and the capital account liberalisationchallenges and policy responses. Thepaper concludes with lessons and policy agendafor Africa in the post-crisis period; in particular,it emphasizes that policymakers face particularchallenges and opportunities in maintainingsound macroeconomic management, transparentcapital account policies, debt sustainability andundertaking financial sector reforms in order toattract inflows in a competitive world and tomanage the inflows to target economic recovery.