Asymmetric Foreign Financial Inflows and Economic Growth: The Moderating Role of Government Effectiveness

The evolving global dynamics underscore the importance of the East African Community partner states restructuring governance frameworks to restrain escalating external debt, attract quality FDI, and ensure the productive use of ODA to stabilise exchange pressures. This study aims to evaluate the asymmetric impacts of external debt, FDI, ODA, and exchange rate shocks on growth in the East African Community bloc and to examine the moderating effects of government effectiveness. Panel NARDL results from 1996 to 2023, validated by the Dynamic Common Correlated Effects and structural breaks, reveal significant long-run asymmetries. The findings, in the absence of government effectiveness, show that positive shocks from external debt are deleterious to growth as debt-overhang effects crowd out FDI and increase ODA fungibility while exacerbating depreciation and appreciation shocks. Government effectiveness mitigates these distortions by substantially reducing debt overhang effects while stabilising exchange rate volatility and improving both FDI and ODA inflows. Based on these findings, a bundle of policy prescriptions addressed towards improving foreign financial inflows’ productivity, governance and institutional reforms should remain a necessity.