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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 and 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
Copyright ©2019 Journal of Economic Integration
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
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