Climate change, institutional quality, foreign exchange rate, foreign direct investment and fiscal sustainability in sub- saharan Africa

Abstract

Fiscal sustainability refers to a government's ability to manage its finances in a way that ensures long-term stability, avoiding excessive debt accumulation while maintaining essential public services. It plays a crucial role in economic stability by fostering investor confidence, reducing vulnerability to external shocks, and supporting steady economic growth. In Sub-Saharan Africa it remains a significant hurdle despite numerous economic bailouts. The fiscal imbalance is majorly influenced by economic instability, weak institutional frameworks, and environmental factors. Though studies have addressed these issues separately, findings being mixed, a comprehensive analysis is lacking. Therefore, this study sought to examine the effect of climate change, institutional quality, foreign exchange rate fluctuations, and foreign direct investment (FDI) on fiscal sustainability in Sub Saharan Africa. The study was informed by Keynesian theory, debt overhang theory, institutional theory, and the Environmental Kuznets Curve (EKC) hypothesis. It was anchored in the positivism paradigm. The study used panel data to establish the casual relationship among the study variables. The research employed an explanatory and longitudinal research design, utilizing secondary data from the World Bank for the period 2000–2023. The target population comprised of 43 countries in Sub-Saharan Africa which resulted to 989 observations. The inclusion/exclusion criterion was based on whether the country consistently had available data from 2000 to 2023. Data analysis involved descriptive and inferential statistical methods, with a multiple regression model applied to test the hypotheses. Findings indicate that climate change (β=0.4098, ρ=0.000) and foreign exchange rate (β= 0.7773, ρ=0.000) positively influence fiscal sustainability, while institutional quality (β2= -0.0631, ρ =0.009) and FDI (β= -0.5381, ρ=0.000) have a negative impact. Generalized method of moment results confirmed the fixed effect model results. Based on the results, the study concluded that climate change, institutional quality, foreign exchange rate, and foreign direct investment significantly influence fiscal sustainability. These results have critical policy implications and underscore the need for targeted policy interventions. It urges policymakers/governments to prioritize investments in climate adaptation and mitigation strategies such as resilient infrastructure, sustainable agriculture, and renewable energy projects. These investments can reduce the long-term costs of climate-related disasters, stabilize revenue flows. Particularly enhancing agricultural resilience and seek international collaborations for climate financing and technical support. Conduct institutional reforms aimed at improving transparency, reducing corruption, and enhancing public financial management systems. Strengthening tax compliance, increasing revenue mobilization, and improving resource allocation are key strategies to ensure that governments can meet their fiscal obligations without undermining long-term development objectives. Reduce dependency on foreign-denominated debt; Countries should aim to minimize their exposure to foreign-denominated debt by developing domestic capital markets and issuing debt in local currencies whenever possible. To optimize fiscal benefits of FDI, governments may revise their strategies to draw investments that foster long-term growth and sustainable development. This entails concentrating on non-extractive sectors such as manufacturing, technology, and services, which are more probable to provide employment and substantially enhance local tax revenue. Moreover, debt transparencies to adhere to IMF framework with clear mechanisms for reporting and monitoring public debt to avoid unsustainable debt accumulation.