The Determinants Of FDI In The Five East African Countries:An Empirical Evidence Of Panel Data

This study analyzes the main determinants of FDI for the five East African countries (i.e. Tanzania, Kenya, Uganda, Rwanda and Burundi) from the perspective of countries characteristics, identifying what are the most significant factors in the five east African countries that influence foreign investors’ decision to invest in the region. The author uses Eviews 8.0 by applying the panel data methodology basing on the period from1980 to 2014.In this study the foreign direct investment has been used as the dependent variable while the independent variables were the Market size (lnMKSZ), openness (lnOPEN), Infrastructure development (lnINFRA) and Exchange rate (lnEXR). In this case both long-run and short-run dynamic linkage between the foreign direct investment and the mentioned variables were performed basing on the data covering the five countries.To analyze the data the panel unit root test was performed to avoid spurious regression which was then followed by other test such as the fixed effect model, panel co-integration test, the panel Vector Error Correction Model, panel Granger Causality analysis, Variance decomposition and Impulse response functionThe results of co integration test between FDI and the variables in questions confirmed that there is an existence of a long-run relationship among the variables being analyzed. The hausman test has chosen the fixed effect model over the random effect model and the results showed that all the four variables were significant and had signs as expected at conventional level which were Exchange rate (lnEXR) at 1 percent level and market size (lnMKSZ) at 1 percent level, Openness (lnOPEN) at 1 percent level, Infrastructure development (lnINFRA) at 10 percent level which was consistent with other previous studies.The study also conducted the panel Impulse Response Function and panel Forecast Error Variance Decomposition and the results showed that there is a rising movement near zero for all the variables in the short run which remain positive and constant in the next 20 years. While the variance decomposition in the order of importance shows that the highest contribution was from lnEXR (7.36%) followed by lnOPEN (6.72%), lnINFRA (5.39%) and lnMKSZ (5.1%) respectively which supported the economic theories, the hypothesized signs and the past studies.The Panel granger causality test showed that there is a unidirectional relationship between lnFDI and lnMKSZ at 5% level, between lnEXR and lnFDI at 5% level, between lnOPEN and lnINFRA at 10% level and between lnINFRA and lnEXR at 10% level. While the results indicate the bidirectional relationship exist between lnOPEN and InMKSZ both 1% level between lnEXR and lnMKSZ atl% and 5% level and between lnEXR and lnOPEN at 1% and 5% level respectively implying that there is a feedback effect on these.Furthermore all the variables in this study have been found to have a long run relationship at 1 percent significant level as confirmed by the results of vector error correction model (VECM) which had a negative coefficient sign (-0.42) implying that about 42 percent is corrected for the variable to return to their equilibrium.Therefore the general results from above implies that exchange rate (lnEXR) was significant in both short run and long run for the five East African countries (EAC) and may be well used to forecast foreign direct investment while other variables such as (lnOPEN, lnINFRA and lnMKSZ) in that order are only significant in the long run to foreign direct investment but may also be used to forecast on one another in the short run.Hence basing on the results foreign investors and policy makers can make the appropriate decisionThus, the movements of the exchange rates (lnEXR) should be well stabilized basing on strong macroeconomic policies in the region to attract a significant inflow of foreign direct investment (lnFDI) in the five EAC member countries and policy maker should give this the high priority in decision making process considering the fact on the results of this variable has shown to be a good predictor of FDI in both short run and long run.The market size (lnMKSZ) has been found to be an important variable and significant in the long run which is in line with many previous studies hence suggest that most investors in the region recently come to take advantage of the extended EAC market hence it is recommended that probably more integration with other neighboring countries to be considered such as South Sudan, Somalia, Ethiopia, Malawi, Congo etc so as to attract more the level of foreign investment in the region. However caution should be adopted to encourage this type of investors to avoid the members’ countries to be used as a production base which might lead to the market size factor not to have much influence in the economies within the community.The infrastructure development (lnINFRA) is also significant and exhibited a positive response to FDI in the long run which implies that an improvement of infrastructure in the EAC region such as (roads, railways, ports electricity supply) is still important in determining the significant amount of FDI. This is true basing on the reality in these countries most of the infrastructure are not well developed which has an impact on FDI.The openness of the economy (lnOPEN) within the EAC region should be encouraged as this variable was significant found to be significant in the long run. It is recommended to integrate more with the rest of the world than remain isolated in order to attract more FDI but always with caution taking a lesson from the emerging economies such as china.Finally the study also conducted the analysis of the sectoral contribution among the examined member countries and the results concluded that the Special attention should be given to agricultural, manufacturing and service sectors in the EAC community as it has been observed that more investors are attracted in these sectors, this results is also in line with the recent world investment report for concentration of the intra African projects in this three sectors (figure 1). However the diversification of FDI to other sectors as well should be considered such as by creating the conducive environment in order to maximize the inflows of FDI significantly and generate more value and create employment opportunities which could also help on reaching other developmental goals within the community.On comparison among the five member countries the study has also found out that Kenya was on the lead in FDI in the past but recently Uganda and Tanzania has been on top positions with Kenya on the third position followed by Rwanda and Burundi in the last. The main reason for their improvement of the level of FDI in Tanzania and Uganda might have been attributed to the substantive reforms, the recent discovery of the oil and natural gas, the increase of the number of human capital and the more diversification of the economies recently and the other factors analyzed in this study while the other two countries (Rwanda and Burundi) are still recovering from the turbulent political problem with Rwanda having much FDI on ICT. The source of FDI in most of these countries is mostly related to colonial relationship though recently that even those colonial unrelated countries invest more in these countries basing on the other factors.