Effect of capital account liberalization on external debt in Sub-Saharan Africa

Divine Selase  Amewu; Emmanuel Ashiedu  Codjoe; Bernardin Senadza

Divine Selase Amewu Department of Economics, University of Ghana https://orcid.org/0009-0007-9308-9524
Emmanuel Ashiedu Codjoe Department of Economics, University of Ghana https://orcid.org/0000-0002-8703-7732
Bernardin Senadza Department of Economics, University of Ghana https://orcid.org/0000-0002-6387-3306

Keywords: Capital account liberalization, capital inflows, external debt, SSA.

Abstract

Financial sector reforms in Sub-Saharan Africa (SSA) over the past few decades, including the liberalization of the capital account, have had a positive impact on capital inflows to the region. This paper examines the effect of capital account liberalization on external debt in SSA. We use the Chinn-Ito Index as a measure of capital account liberalization utilizing a robust panel data set from the World Bank and International Monetary Fund databases for the period 2007 to 2021 on 42 SSA countries. The study employs the Dynamic System Generalized Method of Moments (SGMM) estimation technique. We find a positive and significant effect of capital account liberalization on external debt, suggesting that greater capital openness is associated with higher levels of external debt. We also find that the stock of external debt increases the likelihood of further debt buildup, which is indicated by the significant and positive coefficient of the lagged external debt variable. Further results show that economic growth and trade openness reduce external debt, while investment increases it. These findings highlight the dual nature of capital account liberalization: it expands financing opportunities but also raises debt vulnerabilities, underscoring the need for cautious liberalization and stronger debt management in SSA. The study therefore recommends that SSA countries adopt a cautious, sequenced approach to the management of capital accounts, given the existing liberalized regime, strengthen debt management frameworks, and ensure that external borrowing is channelled into productive, growth-enhancing investments. Additionally, promoting sustainable economic growth and trade competitiveness will be essential to reducing the increased reliance on external borrowing and safeguarding long-term debt sustainability.