Investor sentiment and foreign financial flows: Evidence from South Africa

Foreign financial flows to emerging markets have increasingly become important following the opening of financial markets globally. These financial flows are a function of a country’s fundamentals related to future productivity. However, macroeconomic fundamentals cannot explain some of the patterns in these financial flows, especially in emerging markets. In this study, we tested whether investor sentiment can be used as an alternative explanation for the foreign financial flows in South Africa. We employed net foreign purchases of shares and bonds, and we constructed a composite investor sentiment measure using a set of proxies. We then estimated autoregressive distributed lag models – linear and non-linear – to determine the relationship between sentiment and foreign financial flows in both the long and short run. The results showed that investor sentiment does influence foreign financial flows into South Africa. Therefore, it can be concluded that besides economic performance and stability of a country, it is of crucial importance to improve the perceived outlook for the country as to attract foreign financial flows. This finding is relevant for South Africa as a country that depends significantly on foreign capital flows to fill its widening gap between the savings and the investment needed to support enough economic growth.