This study aims to examine the relationship between international capital flows, and domestic credit expansion in Tanzania during the period between 2004 and 2012. The data used in this study is extracted from World Bank database except credit regulation quality index (CRINDEX), which is taken from the Fraser Institute Index of Economic Freedom. The study disintegrated the variable capital flow into debt and equity flows, and examined the relationship between the two sub-variables and the domestic credit. The findings of this study reveal that the general current account balance is not influential enough to determine the empirical relationship between international capital flows and domestic credit expansion; rather the component of international capital flow, net debt flow, is reported to have more significant relationship with domestic credit. The perceptible empirical relationship reported in this study between net debts flows and domestic credit development brings forward the need for analytical models which can explain this relationship. Particularly, it is imperative to gain a better understanding of both the positive and negative relationships between international debt flows and domestic credit growth. In essence due to the current East African Community Common Market Agreement, the financial integration and free mobility of capital among country members will have a serious effect on productive allocation of bank credit via the rise of inflows into the non-banking sector which crowd out domestic loans to non-financial business sector. This twist in credit allocation may result into real estate booms, financial vulnerability, and poor economic growth. Therefore, creating more investment opportunities could significantly alleviate the adverse effects of capital inflows.
Key words: Foreign capital flow, domestic credit, current account balance, net debt flows, net equity flows.
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