Domestic credit to the private sector, institutional quality and tropical deforestation: A panel data analysis of 24 African countries

Abstract

• Domestic financial credit to the private sector significantly accelerates deforestation in Africa • Institutional quality has mixed effect on deforestation in Africa • Private sector lending should integrate forest and environmental safeguards • Climate-smart agriculture should be integrated into traditional African agricultural systems Existing studies have extensively linked deforestation in Africa to foreign direct investment, suggesting that foreign financial flows drive deforestation in Africa. However, the impact of domestic financial flows, mediated by institutions, on deforestation in Africa remains a critical gap in the literature. This undermines forest sustainability efforts and risks intensifying episodic climate vulnerabilities on the African continent if not robustly examined. We bridge this policy and academic gap by analyzing panel data from 24 African countries between 2000 and 2022 using fixed and random effects econometric models. The analysis revealed that domestic credit to the private sector significantly accelerates deforestation. This suggests that expansionary financial policies without conditions for forest sustainability could intensify deforestation in Africa. However, the impact of institutional quality on deforestation presents mixed effects. While government effectiveness reduces forest loss, other indicators, such as political stability, voice and accountability, control of corruption, and the rule of law, are paradoxically associated with increased deforestation in Africa. Based on these findings, the study proposes a "Green Domestic Credit" model that links financial expansion with forest safeguards, including support for climate-smart agriculture. The study highlights the importance of reassessing African-specific financial expansionary policies and environmental sustainability for promoting inclusive growth. Future research should investigate the interplay between domestic credit and foreign direct investment to deepen our understanding of global capital flows and their environmental implications in Africa and other tropical regions.