Do Sovereign Credit Ratings Matter for Foreign Direct Investment: Evidence from Sub-Sahara African Countries

Arogundade, Sodiq and Biyase, Mduduzi and Eita, Joel Hinaunye (2022): Do Sovereign Credit Ratings Matter for Foreign Direct Investment: Evidence from Sub-Sahara African Countries.

Abstract

This study examines the impact of sovereign credit ratings (SCR) on foreign direct investment (FDI) inflow of 20 SSA countries. In achieving this, the study uses the fixed effect model, fixed effect instrumental variable regression, and the bootstrap panel granger causality test proposed by Emirmahmutoglu and Kose (2011). There are three main important findings from this empirical study: (1) sovereign credit ratings have a significant and positive impact on FDI inflows in the region; this result is robust to sub-regional analysis, the instrumental regression model and an alternative measure of credit rating, (2) the impact of SCR on FDI increases after the global financial crises (GFC), and (3) there is a unidirectional causality running from SCR to FDI in SSA. In increasing foreign investors' appetite, this study recommends that SSA countries get rated, and the ones rated should put in place appropriate policies to get better ratings.

• Item Type: MPRA Paper
• Language: English
• Keywords: Foreign direct investment, Sovereign credit ratings, Global financial crises Bootstrap panel Granger causality test, and Sub-Sahara African Countries
• Subjects: E - Macroeconomics and Monetary Economics > E0 - General > E00 - General; F - International Economics > F0 - General; F - International Economics > F3 - International Finance > F30 - General; G - Financial Economics > G0 - General > G00 - General; G - Financial Economics > G0 - General > G01 - Financial Crises

References

Afonso A, Gomes P, Rother P (2007) What 'Hides' Behind Sovereign Debt Ratings?

Akyuz M, Karul C, Demir I (2020) Life expectancy and trade openness: causality in Latin America. Int J Soc Econ 47(10): 1265-1281 https://doi.org/10.1108/IJSE-01-2020-0013

Alessi C, Wolverson R, Sergie M (2013) The credit rating controversy. Council on foreign relations.

Asongu S (2013) How would population growth affect investment in the future? Asymmetric panel causality evidence for Africa. Afri Devt Rev 25(1): 14-29 https://doi.org/10.1111/j.1467-8268.2013.12010.x

Asongu S, Akpan U, Isihak S (2018) Determinants of foreign direct investment in fast-growing economies: evidence from the BRICS and MINT countries. Financ Innov 4(1): 1-17. https://doi.org/10.1186/s40854-018-0114-0

Barron J, Ni J (2008) Endogenous asymmetric information and international equity home bias: The effects of portfolio size and information costs. J Int Mon Fin 27(4): 617–635.

Bayar Y, Gavriletea M (2018) Foreign direct investment inflows and financial development in Central and Eastern European Union countries: A panel cointegration and causality. Int J Financ Stud 6(2): 55. https://doi.org/10.3390/ijfs6020055

Bokpin G, Mensah L, Asamoah M (2015) Foreign direct investment and natural resources in Africa. J Econ Stud 42(4): 608-621. https://doi.org/10.1108/JES-01-2014-0023

Cai P, Gan Q, Kim S (2018) Do sovereign credit ratings matter for foreign direct investments?. J Int Financ Marke Inst mone 55: 50-64. https://doi.org/10.1016/j.intfin.2018.01.003

Cantor R, Packer F, (1996) Determinants and Impact of Sovereign Credit Ratings. Econ Pol Rev 2(2). https://doi:10.3905/jfi.1996.408185

Cantor R, Packer F, (1994) The Credit Rating Industry. Q R Fed Res Ba Ne Yo 1-26.

Chen S, Chen Y, Chang C, Yang L (2013) How do sovereign credit rating changes affect private investment? J Bank Financ 37(12): 4820-4833. https://doi.org/10.1016/j.jbankfin.2013.09.002

De S, Mohapatra S, Ratha D (2021) Sovereign credit ratings, relative risk ratings and private capital flows: evidence from emerging and frontier markets. Stud Econo Financ. https://doi.org/10.1108/SEF-10-2020-0437

Desbordes R, Wei S (2017) The effects of financial development on foreign direct investment. J Devt Econs 127: 153-168. https://doi.org/10.1016/j.jdeveco.2017.02.008

Dickey D, Fuller W (1981), Likelihood ratio statistics for autoregressive time series with a unit root, Econom J Econs Soc 49(4): 1057-1072. https://doi.org/10.2307/1912517

Druppers B, (2017) FDI in Sub-Saharan Africa: The Importance of Trade Openness.

Dunning J, Lundan M, (2008) Multinational enterprises and the global economy. Edward Elgar Publishing.

Emirmahmutoglu F, Kose N, (2011) Testing for Granger causality in heterogeneous mixed panels. Econ Mode 28(3): 870-876. https://doi.org/10.1016/j.econmod.2010.10.018

Espoir K, Sunge R, Bannor F (2021) Economic growth and Co2 emissions: Evidence from heterogeneous panel of African countries using bootstrap Granger causality.

Frees W (1995) Assessing cross-sectional correlations in panel data. J Econs 69: 393-414.

Friedman M (1937) The use of ranks to avoid the assumption of normality implicit in the analysis of variance. J Ame Stat Assoc 32: 675-701.

Garretsen H, Peeters J (2009) FDI and the relevance of spatial linkages: do third-country effects matter for Dutch FDI?. Rev Wo Econs 145(2): 319-338. https://10.1007/s10290-009-0018-1

Hartmann P, Straetmans S, Vries D (2004) Asset market linkages in crisis periods. Rev Econs Stat 86(1): 313-326.

Herzer D, Donaubauer J (2018) The long-run effect of foreign direct investment on total factor productivity in developing countries: a panel cointegration analysis. Emp Econs 54(2): 309-342.

Herzer D, Vollmer S (2012) Inequality and growth: evidence from panel cointegration. J Econ Ineq 10(4): 489-503.

International Monetary Fund, World Economic Outlook, 2020. Retrieved from https://www.imf.org/en/Publications/WEO/weo-database/2021/April

Jaiblai P, Shenai V (2019) The determinants of FDI in sub-Saharan economies: A study of data from 1990–2017. Intl J Financ Stud 7(3): 43.

Kaur M, Yadav S, Gautam V (2013). Financial system development and foreign direct investment: A panel data study for BRIC countries. Glo Bus Rev 14(4): 729-742.

Kiff J, Holland A, Kisser M, Nowak S, Saab S, Schumacher L, Westin A (2010) The uses and abuses of sovereign credit ratings. Glob Financ Stab Rep 10.

Kumari R, Sharma K (2017). Determinants of foreign direct investment in developing countries: a panel data study. Int J Emer Mars. https://doi.org/10.1108/IJoEM-10-2014-0169

Lu W, Kasimov I, Karimov I, Abdullaev Y (2020) Foreign Direct Investment, Natural Resources, Economic Freedom, and Sea-Access: Evidence from the Commonwealth of Independent States. Sus 12(8): 3135. https://doi.org/10.3390/su12083135

Nkoa O (2018) Determinants of foreign direct investment in Africa: An analysis of the impact of financial development. Econ Bull 38(1): 221-233.

Nsiah C, Wu C (2014) The role of spatial dynamics in the determination of foreign direct investment Inflows to Africa. Afri Dev Rev 26(3): 494-507. https://doi.org/10.1111/1467-8268.12106

Nunnenkamp P (2004) To what extent can foreign direct investment help achieve international development goals?. Wor Econ 27(5): 657-677.

Paul, J, Jadhav P (2019) Institutional determinants of foreign direct investment inflows: evidence from emerging markets. Intl J Eme Mark. https://doi.org/10.1108/IJOEM-11-2018-0590

Pavlova A, Rigobon R (2008) The role of portfolio constraints in the international propagation of shocks. The Review of Economic Studies, 75(4), 1215-1256. https://doi.org/10.1111/j.1467-937X.2008.00509.x

Pesaran H (2004) General diagnostic tests for cross-section dependence in panels. Cambridge Working Papers in Economics 435.

Pesaran H, Ullah A, Yamagata T (2008) A bias‐adjusted LM test of error cross‐section independence. Econom J 11(1): 105-127. https://doi.org/10.1111/j.1368-423X.2007.00227.x

Pretorius M, Botha I (2016) A panel ordered response model for sovereign credit ratings in Africa. Afri Financ J 18(1): 20-33. https://hdl.handle.net/10520/EJC191951

Reinhart C M, Rogoff K S (2004) Serial default and the" paradox" of rich-to-poor capital flows. Ame Econ Rev 94(2): 53-58. https://10.1257/0002828041302370

Reinhart C M (2002) Default, Currency Crises, and Sovereign Credit Ratings. Wor Ban Econ Rev 16(2): 151-170. https://doi.org/10.1093/wber/16.2.151

Rodríguez‐Pose, A., and Cols, G. 2017. The determinants of foreign direct investment in sub‐Saharan Africa: What role for governance?. Regional Science Policy & Practice, 9(2), 63-81. https://doi.org/10.1111/rsp3.12093

Sandleris G (2008) Sovereign defaults: Information, investment and credit. J int Econ 76(2): 267-275. https://doi.org/10.1016/j.jinteco.2008.07.008

Swamy P A (1970) Efficient inference in a random coefficient regression model. Econo: J Econ Soc. 311-323. https://doi.org/10.2307/1913012

Toda H Y, Yamamoto T (1995) Statistical inference in vector autoregressions with possibly integrated processes. J Econ, 66: 225–250.

Turedi S (2018) The effect of corruption and country risk on FDI inflows: empirical evidence from developing countries. Ulus İkti İda İncel Derg. (21): 151-172.

UNCTAD Statistics. (2020). Statistical Release. Retrieved from https://unctadstat.unctad.org/wds/TableViewer/tableView.aspx

UNCTAD. (2018). World investment report, 2018: Investment and new Industrial policies. Geneva: United Nations. Retrieved from https://unctad.org/en/PublicationsLibrary/wir2018_en.pdf

Van N S, Veldkamp L (2009) Information immobility and the home bias puzzle. J Financ 64(3): 1187-1215. https://doi.org/10.1111/j.1540-6261.2009.01462.x

Violante G (2016) Do Credit Ratings Matter? An Examination of the Relationship Between Sovereign Ratings and Capital Flows Pre and Post Financial Crisis.

World Bank (2018, September 19). The number of extremely poor people continues to rise in Sub-Saharan Africa. Retrieved from https://blogs.worldbank.org/opendata/number-extremely-poor-people-continues-rise-sub-saharan-africa.

World Bank PovcalNet. 2019, Retrieved from http://iresearch.worldbank.org/PovcalNet/povDuplicateWB.aspx.

World Bank World Development Indicator (WDI), 2019. Retrieved from https://databank.worldbank.org/source/world-development-indicators