Linking External Finance to Growth and Development in Recipient Countries

This chapter explores the relationship between external finance and economic growth, focusing on external debt, Foreign Direct Investment (FDI), and portfolio equity (PE) investments in developing and emerging economies. It highlights FDI as a driver of economic growth, effective especially in environments with sound financial systems and robust institutional frameworks. FDI is noted for its role in providing capital, technology, and management skills, which help stimulate economic integration and growth. The benefits of FDI are most pronounced when they can enhance technology spillovers and improve management practices within local firms. External debt, while a relevant source of capital, poses challenges when levels become unsustainable, constraining economic growth by limiting government development spending and increasing vulnerability during crises. Effective debt management is essential, requiring sound financial markets and strong institutions to leverage debt in a positive way without triggering fiscal crises. Portfolio equity investments, whose impacts vary significantly depending on the maturity of the host country’s financial system, are also discussed. In financially developed systems, these investments can stimulate growth, but their volatility can lead to economic destabilization in less mature markets. The chapter concludes with policy recommendations that advocate the management of external finance to maximize its benefits for sustainable growth while minimizing the risks of economic instability. It suggests careful management of capital flows, emphasizing the importance of attracting stable and beneficial forms of foreign capital, such as FDI, and effectively managing external debt. The analysis, supported by literature reviews and data, stresses the importance of a strategic approach to external finance to foster stable and sustainable economic growth.