THE NEXUS BETWEEN FOREIGN PORTFOLIO INVESTMENT AND FINANCIAL MARKET DEVELOPMENT: EVIDENCE FROM MAURITIUS.

Author:Makoni, Patricia Lindelwa
Position::Report
 
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INTRODUCTION

Foreign Portfolio Investment (FPI) is stock (share) and/or bond purchases that do not create a lasting interest in or effective management over an enterprise (World Bank, 2014). In their study on FPI determinants in Nigeria, Ekeocha et al. (2012) defined FPI as a component of international capital flows, which involved the transfer of financial assets such as cash, stock or bonds across international boundaries in search of profit. FPI can thus be described as all inward foreign financial investment flows which are primarily targeted at financial assets available in the local financial markets, and yet do not necessarily culminate in permanent investments. FPI, although temporary in nature, is considered to assist in the availing of additional, alternative financial capital resources for the further investment in the physical, human and social capital of an economy. According to Kovalenko et al. (2017), as a result of globalisation, individual country economic efficiency and competitiveness is growingly becoming dependent on regional cluster economic development. Multi-National Corporations (MNCs) are forced to re-evaluate their international portfolios in response to host country dynamics (Hong, 2017). Mikhailovich et al., 2017 asserted that economic activity was increasing due to improvements in information and knowledge management, as well as other factors of production, including capital. Ablaev (2018) added weight to this argument by stating that economic clusters are now one of the most effective forms of financial and knowledge-based capital integration, providing necessary competitive advantages for countries in their quest to attract large inward flows on investment capital. Abdimomynova (2018) further identified several direct and indirect factors of international market regional attraction. These factors included geographical location of the country, financial market development, trade and capital openness, government investment and fiscal policies, as well as institutional quality. In summary, all the aforementioned scholars agree that global integration of countries is dependent on a range of country-specific characteristics such as economic activities, policies and financial capital market development, which are central themes to our study.

According to the African Development Bank (2016), foreign capital flows into Africa have remained relatively stable despite weak economic conditions in other parts of the world. An estimated USD 208.3 billion of external finance in the form of foreign investment, trade, aid, remittances and other sources was attracted by African countries in 2015, an amount 1.8% less than that of the previous year. It is noted that FPI and commercial bank credit flows shrunk, reflecting the tightening global liquidity and risk averse market sentiment. Despite this, African governments acknowledge the need to stabilise financial inflows in the short term and use them for sustained economic diversification for the longer term (African Development Bank, 2016). Compared with foreign direct investment inflows which grew steadily between 2007 and 2013, foreign portfolio investment flows fell from USD 23 billion in 2014 to USD 13 billion in 2015; while bond flows remained relatively stable (African Development Bank, 2016).

Using country-level data for Mauritius for the period 1989 to 2016, the main objective of this paper was to explore factors that give rise to inward FPI flows to the country, looking specifically at the role played by financial market development. The period is justified by the fact the Mauritian Stock Exchange was only established in 1989. We examined the long run relationships between FPI and financial market development using the VECM and ARDL methodologies. The results indicate that there is a cointegrating relationship between FPI and the independent variables that includes; FDI, GDP and Financial Market Development (FMD). Further, in this article we investigated the direction of causality between the variables employing the Granger causality method. Using a PCA-constructed composite index of financial market development, the outcome of this analysis shows that FMD causes FPI, FPI causes FDI. Moreover, jointly FDI, FMD and GDP growth collectively granger causes FPI, while FPI, FMD and GDP growth collectively granger causes FDI. We however find no causality running from FPI, FDI and GDP to FMD.

LITERATURE REVIEW

Mauritian Financial Market Development

African financial markets are growing in recognition as a result of international market integration. These emerging stock markets remained largely unscathed following the 2007/2008 global financial crisis that shook international investor confidence.

According to Makoni (2016), there are 29 national stock exchanges in Africa, including two regional bourses, one of which represents the Francophone countries. Like in other emerging market countries, African stock markets have continuously proven their ability and efficiency in savings mobilisation, resource allocation, liquidity, and risk sharing and portfolio diversification. The economic relevance of stock markets is assessed, based on size (proxied by stock market capitalisation to GDP), efficiency (liquidity which is measured by the value of traded shares scaled by stock market capitalisation), supply of equity capital (based on number of listed counters) and infrastructural adequacy (dependent on the trading or settlement system). Table 11 below illustrates the main stock market development indicators for selected African stock exchanges, against which the performance of the Mauritius Stock Exchange is made. It can be deduced that Mauritius is a leading stock market contender, behind South Africa and Egypt, respectively.

The Stock Exchange of Mauritius Ltd (SEM) was incorporated in Mauritius in 1989 under the Stock Exchange Act of 1988, as a private limited company responsible for the operation and promotion of an efficient and regulated securities market in Mauritius. The SEM started its operations with only five listed companies on the Official Market, with a market capitalisation of nearly USD 92 million. The size of the market has grown from a market capitalisation to GDP ratio of less than 4% in 1989, to its current stock market capitalisation ratio exceeding 75%. SEM operates two markets: the Official Market, as well as the Development and Enterprise Market (DEM). The latter (DEM) was set up in 2006, specifically for Small and Medium-sized Enterprises (SMEs) and start-up companies which possess a sound business plan and demonstrate a good growth potential. It targets companies wishing to avail themselves of the advantages and facilities provided by an organised and regulated market to raise capital to fund their future growth, improve liquidity in their shares, obtain an objective market valuation of their shares and enhance their overall corporate image (Stock Exchange of Mauritius).

As on 30 June 2016, there were 51 companies listed on the Official Market, with a market capitalisation of nearly US $5.5 billion, while the DEM has listed companies, with a market capitalisation of nearly US $1.2 billion (Stock Exchange of Mauritius). Local investors are active participants on the SEM, accounting for about 60% of the daily trading activities, while foreign investors account for the remaining 40%. Institutional investors such as mutual funds, pension funds and insurance companies contribute 75% of the local trading volumes.

In terms of foreign participation, SEM has rules for remote membership in place, with the objective of encouraging membership from foreign brokers and foreign participants. The stock market was opened to foreign investors following the lifting of exchange controls in 1994. Foreign investors do not need approval to trade shares, except for the holding of more than 15% in a sugar company. Foreign investors benefit from numerous incentives such as revenue on sale of shares being freely repatriated and there being no withholding taxes on dividends and no taxes on capital gains, implying capital openness in Mauritius. SEM is also the only African bourse that lists, trades and settles equity and debt products in currencies such as the United States Dollar (USD), Euros (EUR), British Pounds (GBP), and South African Rands (ZAR), in addition to the local Mauritian Rupee currency (MUR) (Stock Exchange of Mauritius). This reinforces the attractiveness of SEM as a listing and...

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