Exchange Rate and Capital Flight: An Empirical Analysis

Abstract

Exchange rate volatility and declining capital inflow are important policy issues that inform macroeconomic policies and strategies of developing countries. Most developing economies have small potential resource base, faces foreign exchange volatility and limited market of agricultural products, thus investigating the role of capital flight is significant for these states. Cognizant of this, the study will try to answer the paradox of capital outflow and exchange uncertainty. The research will investigate the influence of exchange rate differential on capital flight in East Africa economies for the year 1988-2018 using panel secondary data. The empirical analysis was guided by investment creation theorem. The study adopted ordinary least squares estimation to analyse the relation between the study variables. The study estimations has identified that exchange rate positively influences capital outflow in East African states. The positive effect of currency change on capital outflow implied that capital outflow was sensitive to currency depreciation. Accelerated currency devaluation erodes domestic investors confidence to hold local currency, citizens will likely move to foreign markets and assets to avoid negative effect of devaluation. Government policymakers should pursue strategies and policies that can slow currency uncertainty in order to tame capital outflow. These policies and strategies include fostering of both fiscal and monetary disciplines and good governance.