Systematic Risk and Foreign Direct Investment in the East African Region: Moderating Role of World Governance Indicators
Abstract
Among the available international capital flows, foreign direct investment (FDI) inflows have been highly prioritised as they generate external finances, are stable over time, and are relatively permanent. Owing to the domestic savings-investment gaps in a majority of developing countries, FDI inflows have greatly helped reduce this. However, these countries, including the East African region, continue to experience challenges in attracting and retaining FDIs. Among the attributable factors are systematic risk emanating from exchange rate volatility, interest rate changes, and inflation volatility. These volatilities create uncertainty, risk, and increased financing costs that deter foreign investors. The magnitude of the effect of systematic risk on FDI inflows has been determined by the quality of governance. Robust governance ensures transparency, minimises bureaucratic bottlenecks, and protects investor rights, while inadequate governance increases uncertainty and lessens the efficiency of monetary policies, which deters investor protection. Therefore, this study sought to analyse the moderating effect of governance on the relationship between systematic risk and FDI inflows in the East African region. The study was guided by the OLI framework, institutional FDI theory, and modern portfolio theory. The data was collected from 9 countries for a period of 28 years and analysed through a pooled OLS regression technique. The results showed that governance had a positive, statistically significant moderating effect on the relationship between systematic risk and FDI inflows in the East African region (EXR × WGI = β = 0.2615, p < 0.001; INF × WGI = β = 0.1885, p = 0.008; and INT × WGI = β = 0.1413, p = 0.003). It is, thus, concluded that the strong governance quality lessens the negative effects of volatility in macroeconomic factors that pose systematic risk on FDI inflows. It is recommended that East African governments and policymakers develop strategies that focus on improving the quality of governance and allocate resources towards its reform to foster an environment favourable to stable and enduring foreign investments
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