Financial development, portfolio investments and the real economy in Africa

•We explore the impact of portfolio investment flows (debt and equity) on real sector growth, conditioned on financial development in 30 African countries.•We deploy a newly developed indicator of financial development as opposed to the use of single indices by previous studies.•The Lewbel (2012) instrumental variable which deals the issues of instruments insufficiency or unavailability and endogeneity, was employed as the empirical strategy.•We found that both debt and equity have no positive impact on the real sector, with the impact of debt being more damaging. However, through financial development, both type of capital flows could have a positive impact on growth. According to the conservative view, capital flows enhance economic growth. Focussing on Africa’s real economy, this study investigates the linkage between portfolio investments and real sector growth, and whether financial sector development strengthens this association. The study covers 30 countries over the period 1990–2017. We adopt the Lewbel instrumental variable general method of moments (IV-GMM) two-step robust estimator, which relies on heteroscedasticity for identification, while dealing with instrument insufficiency, unavailability, endogeneity and omitted variable bias. We found that portfolio equity has no growth impact on Africa’s real sector. Debt flows deter the growth of the overall real sector as well as the manufacturing and industrial sectors, but have no impact on agriculture and service growth. We found that financial development does strengthen the positive association between capital flows and economic growth, but this is dependent on the type of sector and portfolio investment, as well as on the degree of financial development. We control for known determinants of economic growth.