External financial flows and economic growth in the SADC region: An Application of the Granger Causality Test in Panel Data Model

The majority of countries in the SADC region are experiencing low levels of domestic savings. This calls for the need to explore other sources of capital to bridge the gap between domestic capital demand and supply, and one such source is external financial flows. It is with this background that this study examined the causal relationship between external financial flows and economic growth in the SADC region for the period from 1980 to 2012 employing Panel granger causality test under the fixed effects approach. Panel granger causality tests are more efficient because of the larger number of observations which increases the degrees of freedom as well as reducing collinearity amongst the explanatory variables. In addition, the fixed effects approach does take into account potential heterogeneity of the individual cross sections. Unlike the previous studies, the study disaggregates the different forms of external financial flows. Based on the data from the World Bank, the empirical results reveal that at aggregate regional level there exists a bidirectional causal relationship between economic growth and external financial flows in the region. However when foreign capital flows are disaggregated, the effect is not the same. FDI exhibits bidirectional causality with growth in the majority of the countries in the SADC region. On the other hand cross border bank flows was found to have an insignificant causal relationship with economic growth. ODA and remittances reveal a unidirectional causality from the two types of capital to economic growth. The empirical results also revealed that those countries which are “better off” and sound in the region rely less on aid and remittances and are able to attract private foreign capital such as FDI. At the same time countries which are “worse off” rely more on ODA and remittances. The results imply that the state of the country acts as an important determinant factor attracting foreign capital flows to the SADC region. The other implication which is inferred from the results is that countries in the SADC region should integrate to benefit from cross border bank flows.