Financial Openness and Growth in Developing Countries: Why Does the Type of External Financing Matter?

Gaies, Brahim; Nabi, Mahmoud-Sami

doi:2019.34.3.426

The Journal of Economic Integration 2019 September;34(3) :426-464.
DOI: https://doi.org/10.11130/jei.2019.34.3.426

Financial Openness and Growth in Developing Countries: Why Does the Type of External Financing Matter?

Brahim Gaies, ¹ Mahmoud-Sami Nabi, ²

¹IPAG Lab - IPAG Business School, France
²LEGI-Tunisia Polytechnic School, Tunisia, FSEG Nabeul, University of Carthage, Tunisia

Corresponding Author: Brahim Gaies ,Tel: +33 7 85 29 19 51, Email: gaies_brahim@yahoo.fr

ABSTRACT

This study examines how external financing (EF) affects growth in developing countries by distinguishing between two forms of external financing: debt and foreign direct investment (FDI). We show that both types favor growth by boosting investment through the credit channel. However, excessive external debt increases vulnerability to financial crises. Contrariwise, FDI plays an amortizing role by reducing a crisis’ effects. The empirical evidence confirms these results and demonstrates that, despite the more secure nature of FDI, mixed financing (debt and FDI) remains more profitable for developing countries because of the inverted U-shaped growth effect of the FDI-to-debt ratio. Moreover, exchange rate stability decreases vulnerability to financial crises, whereas higher stability turns into exchange rate rigidity and thus increases crisis occurrence.

JEL Classification

F41: Open Economy Macroeconomics
G15: International Financial Markets
C02: Mathematical Methods
C58: Financial Econometrics

Keywords: External debt | FDI | Financial crisis | Exchange rate rigidity