Interactions between political risk, real exchange rate and foreign direct investment inflows in South Africa

Abstract

It has become evident that for countries to become sustainable and prosperous, a handful of economic variables have to stable; more specifically political risk has been a growing phenomenon in the 20th century and has been prevalent for many economies including Britain’s Brexit; the trade wars between China and the USA. For South Africa, political instability has evolved into one of the most prominent determinant of economic growth, although unmeasured; one can relate this to the immense government corruption, the Nenegate and parliamentary conflicts that have affected the rand’s volatility and investor confidence through FDI outflows. The study’s primary objective was to analyse the interactions between political risk, the exchange rate and foreign direct investment inflows in South Africa, using the autoregressive distributed lag (ARDL) model for a period ranging from 1995 to 2018. The study provided a background by delivering a detailed cultivation from a global observation where the impact of political risk and a fluctuating currency ultimately affects foreign direct investment inflows in a specific country. The study will contribute to political risk literature as well as provide insights to policy makers regarding this variable as an important component to economic growth and other macroeconomic variables. In South Africa, the Apartheid era indicated the first signals of interaction between political risk, the real exchange rate and foreign direct investment inflows in the country. The theoretical and empirical review involves studies of developed and developing countries, regarding the interaction amongst political risk, the real exchange rate and foreign direct investment inflows. It was concluded from the study that political risk and the real exchange rate have no short run changes on FDI inflows, while the added balancing variable the gross domestic product was found to poses that short run relationship. It was also established that a long-run relationship between political risk rating (PRR), real effective exchange rate (REER) and inflows exist. Two causal relationships was established, using the Toda-Yamamoto causality test. The real effective exchange rate Granger-causes political risk rating. Foreign direct investment was established to Granger-cause the gross domestic product, whilst no other causal relationship was identified for the real effective exchange rate and the political risk rating. Other sources of political risk in South Africa was relatively high concerning controlling corruption and political stability; 2017 was also accentuated from various results in the study as an eminent turn of South Africa’s progress where the country downgraded to sub-investment by two major credit rating agencies, Fitch and S&P. According to this study, South Africa reached a stage where politics severely affects the Rand value directly and foreign direct investment no longer holds importance. In this regard, the study recommends that, because evidence suggests that political risk seems to affect these relationships, it should be included in policymaking decision as it clearly performs a vital function in South Africa’s economy. The study also gives a recommendation that a baseline for FDI returns should be established in the light that these returns will give insight to further research. Moreover, a framework for political risk rating can also be established in order to remedy the exposure to political risk; further opportunities for research can be the comparisons of the same study and variables for SADC and Sub-Saharan countries and the utilization of panel data instead of time series.