The Global Financial Crisis: Time to Rethink Africa’s Financing Options.

Africans must ultimately bear the burden of financing our own development, no matter how painful it may be.

By Dr Mahumudu Bawumia

The global financial crisis occurred against the background of significantly improved growth and macroeconomic performance by African countries as a group over the last decade. GDP growth rates had steadily increased (averaging 6.0% over the last five years), inflation declined to single digits before the fuel and food price crisis in 2008, and external reserve positions improved. These developments were underpinned by structural policy reforms, favourable terms of trade and debt relief. In 2007 for example, the average annual  GDP growth rate in Africa was 6.1%. While impressive when compared to the negative growth rates recorded in the 1980s, this was still below the 7% p.a. growth rate required to reduce poverty by half by 2015.

By 2007, progress towards attainment of the Millennium Development Goals (MDGs) by 2015 was mixed, with the continent as a whole lagging behind the MDGs despite the observed increase in GDP growth. The global financial crisis could therefore not have come at a more inopportune time for the African continent as many countries were just finding their feet and gaining some traction after decades of economic stagnation and macroeconomic instability.

Initially, the conventional wisdom was that African countries were unlikely to be hard hit or at worst have only minimal impact of the effects of the crisis. This reasoning was principally predicated on among others the following:

•    That low-income countries are generally less exposed to the financial contagion than emerging markets, as their financial institutions are not strongly integrated into the global financial system, and because the complex structured financial instruments at the heart of the crisis are rarely used in poor countries.

•    That most banks in Sub-Saharan Africa rely on deposits to fund their loan portfolios (which they keep on their books to maturity) and that their inter-bank markets are small.

•    That in recent years better macroeconomic policies, debt relief, and favourable external conditions (high commodity prices combined with low interest rates) have contributed to lower external debt ratios in many low-income countries, thus helping them better withstand the effects of the crisis.
•    That investors weary of the markets in developed countries may seek opportunities in African and other emerging market economies.

Impact of the Crisis

The evidence thus far however suggests that the global financial crisis has after all, had significant ramifications for Africa (AfDB, 2009):
There has been a significant slowdown in economic growth on the African continent with the onset of the financial crisis. AfDB has forecast a growth rate of 2.3 percent for 2009 (from 5.7% in 2008) which implies that per capita income will contract for the continent as a whole for the first time since 1994.

Export revenues have declined following the downturn in global demand and falling commodity prices. Exports from Africa are estimated to decline by $250 billion in 2009 with Nigeria and Angola accounting for one-third of the export decline, driven by oil export revenues. This decline in export revenues has in turn resulted in a deterioration of the external positions of several countries with widening current account deficits and declining international reserves. The current account balance will decline from a surplus of 2.7 percent of GDP in 2008 to a projected deficit of 5.3 percent of GDP in 2009, a worsening by 8% of GDP in one year.

The financial crisis has also resulted in a deterioration of the fiscal stance of virtually all African countries, with the projected budget deficit for the continent as a whole of 5.8 percent of GDP in 2009 (from a surplus of 2.8 percent of GDP in 2008), a worsening by 8.6% of GDP on average. Fiscal deficits for instance have worsened not only because of the plunge in export revenues but also because of the need to increase social spending and safety nets and to provide the fiscal stimulus required to mitigate the worst consequences of the financial crisis.

Botswana, for example, the historical example of prudent fiscal management on the continent and famous for perennial budget surpluses, recorded a projected budget deficit of some 13% of GDP in 2009 as government attempted to stimulate the economy in the face of a decline in diamond-based export revenues. Ghana, another leading African reformer also recorded a budget deficit of 13.5 percent of GDP in 2008 as government sought to increase the growth of the economy  in the face of the global financial, oil and food crisis. The worsening fiscal stance was not limited only to African countries. The U.S. government budget deficit for 2009 reached a record 13.5% of GDP following President Obama’s fiscal stimulus plan.

Debt relief and favourable external conditions (high commodity prices combined with low interest rates) have led to significantly reduced external debt ratios in many low-income countries. As a result of the financial crisis however, many countries will be forced to borrow to cover the widening current account and fiscal deficits and therefore face the risk of compromising debt sustainability as growth rates and export earnings fall.

The global financial crisis is also expected to affect aid flows to Africa which rose from $12.2 billion in 2000 to $38.2 billion in 2006 (driven largely by debt relief). The financial crisis is a potential “triple whammy” for Africa:

•    First, the value of the existing aid commitments has fallen. The value to developing countries of the EU target of 0.56% GNI in 2010 has fallen by nearly $12bn a year since 2007 as a result in downward revisions to estimates of national income following the financial crisis.

•    Second, donors may be less likely to meet their commitments. Available evidence shows that after each previous financial crisis in a donor country since 1970, the country's aid has declined. For example, Japanese aid fell by 44% in the six years after the financial bubble burst in 1990; and Japan ’s aid has never returned to its pre-crisis level.

•    Third, the financing needs of developing countries have increased as a result of slower growth in exports, investment and employment.
In 2005, members of the G7 and of the European Union made commitments to increase aid spending by 2010 and by 2015. In addition, donors made specific commitments to double aid to Africa by 2010. Well, 2010 is here and G8 aid to Africa has increased by only $3.3 billion since 2004, less than a sixth of the increase that they have pledged to deliver by 2010 . Thus, despite recent commitments to improve aid predictability and to scale up official development assistance, progress has been slow and challenges to sustaining these commitments in the current environment are expected to increase.

Financial markets in Africa are also already feeling the impact of the crisis. Stock markets across Africa which had displayed strong resurgence and an energy that had not been seen for years have started to tumble. By April 2009, the All Share Index of the Nigerian Stock Exchange lost 62.2 percent of its value; the Cairo CASE 30 Index lost 46.2 percent of its value, and the Johannesburg All Share Index lost 24.4 per cent of its value. As of end-2009, most African country equity markets (including Kenya , Malawi , Tanzania , Mauritius , Ghana , Uganda , and Zambia ) had given up all or virtually all of their gains since the beginning of 2008 and a number of initial public offerings which had characterized earlier periods have disappeared.

The global financial crisis has served to emphasize the vulnerability of African countries to external shocks. For African countries, the global financial crisis represents a major development crisis.  In the last decade, African countries made significant progress in the areas of economic performance and good governance. The global financial and economic crisis however threatens to reverse the progress that has been made on several fronts. African countries can expect to experience weaker export revenues; further pressures on the current accounts and balance of payment; lower investment and growth rates; increased poverty; unemployment; weaker health systems and more difficulties in meeting the MDGs.

Africa faces a large financing gap to meet its development policy objectives in critical areas such as infrastructure, health, education, agriculture, and ICT. Various estimates have been made on the size of this financing gap:

The MDG Steering Group notes the following financing requirements in their 2008 report:

•    Overall external public financing for development in Africa needs to rise to $72 billion per year to support the achievement of the MDGs.

•    To achieve a Green Revolution in Africa , the international community needs to increase external financing of agriculture from the current $1-2 billion to $8.0 billion by 2010.

•    Approximately $8.3 billion is required annually to achieve the education MDGs.

•    Some $25-30 billion annually is required to meet health goals

•    Some 52.2 billion per year will be required in private and public investment finance to resolve critical infrastructure bottlenecks in Africa (particularly in Energy, ICT, roads, water and sanitation). Of this amount some $23.5 billion will need to be mobilized as external public financing.

•    Devarajan et al (2002) estimate additional financing requirements at between $40-60 billion per annum.

•    NEPAD (Funke and Nsouli 2003) estimates additional requirements at $64 billion per annum

•    Commission for Africa (2005) estimates additional resources at $37.5 billion.

•    G8 Gleneagles declaration has committed to $25 billion per annum by 2010

•    World Bank and IMF (2006) estimate additional requirements of $23-28 billion per annum for improvements in infrastructure and human resource development.

•    Africa Infrastructure Country Diagnostic (Foster, 2008), estimates that after savings from reducing operating inefficiencies and improving cost recovery, Africa ’s infrastructure gap is $13 billion per annum.

The various proposals for additional financing attempt to address the critical investment needs in infrastructure, education, health, and agriculture amongst others. The proposed interventions would accelerate growth, meet the MDGs, and also enhance the ability of African economies to withstand or quickly recover from external shocks such as the global financial crisis.  The critical question for us however is not whether there is a demonstrable need for additional financing.  That is a moot question because the case for that has been long made. The critical question is where is all this money (a minimum of about $20-25 billion annually) going to come from?

The estimates and proposals presented thus far generally have an eye on the international community to provide the funding either through Official Development Assistance (ODA) or private capital flows.

At the April 2009 G20 summit in London for example, Africa was looking to the international community to help it out of the financial crisis. As it turns out, notwithstanding some important agreements at the summit, the reality on the ground is that the quantum and quality of additional external financing required by Africa is yet to materialize in any significant way.  What is clear is that as a result of the global financial crisis, the developed economies are themselves facing significant economic challenges  with high unemployment and declining growth and increasing focus on reducing budget deficits. In this economic context, it is at the very least very optimistic to expect developed country governments to increase taxes on their populations to meet Africa ’s financing needs.

Only five countries ( Denmark , Luxembourg , the Netherlands , Norway , and Sweden ) have disbursed ODA equaling 0.7 percent or more of their GNI. The unweighted average of aid effort in 2004 was 0.42 percent of GNI, while the income-weighted average ODA/GNI ratio for DAC countries stood at 0.25 percent, suggesting that smaller donors are leading the aid effort. Among them, Norway ranked first with 0.87 percent of GNI, followed by Luxembourg with 0.85 percent of GNI. Italy and the United States ranked last with allocations of 0.15 percent and 0.16 percent, respectively. Over a longer time horizon, donors such as Australia , France , Germany , the United Kingdom , and the United States have seen declines in their ODA/GNI ratios (Gupta et al, 2006).

The difficulty President Obama had in passing the $800 billion stimulus package for the apparent benefit of the American economy demonstrates the domestic  challenges that will be faced by developed country governments in meeting their aid commitments. Increased aid is therefore simply not going to happen in this environment and the earlier African countries realize this the better.
What about private capital flows? Between 2000-2007, Africa benefited from dramatically increased capital flows as the abundance of global liquidity in search of high yields brought in an increasing number of investors eager to participate in the African growth renaissance. Marcias and Massa , (2009) note that:

•    Private equity and debt flows reached a record high of $53 billion by 2007.

•    Total foreign claims on SSA economies held by banks tripled to $205 billion by the end of 2007.

•    Bond flows to SSA for example increased by $7.1 billion between 2006 and 2007 with Ghana, Nigeria , Seychelles , and Gabon issuing bonds internationally for the first time. A few African countries began to contemplate a move towards a greater reliance on international capital markets to finance their development rather than aid.

•    Portfolio equity flows reached a value of $15 billion in 2006 more than double the 2004-2005 levels. However, 88% of the portfolio equity flows went to South Africa .

•    FDI inflows to SSA also increased from $13 billion in 2004 to $33 billion by 2007, with a concentration in resource-intensive countries- e.g in 2007 55% of FDI flows went to South Africa and Nigeria.

The financial turmoil has however resulted in a sharp drop in private capital flows since the first half of 2008 as credit conditions became tighter. Kenya, Tanzania and Uganda have put plans to issue debut sovereign bonds on ice. In fact not a single SSA country foreign currency denominated sovereign bond has come to the market in the last two years (2008-2009). Taken against the background that only a year before, Ghana ’s debut $750 million Eurobond was oversubscribed by four-fold only goes to demonstrate the volatility associated with this important source of financing. African countries are also being crowded out of the international capital markets as the developed countries like the U.S. borrow to finance their deficits.

Macias and Massa (2009) also note that FDI is also slowing down as a result of the financial crisis and few planned investments have been postponed in the DRC (mining), Malawi (Uranium), Ethiopia (Electric Power), Tanzania (Aluminum). 

The Case for Domestic/Regional Resource Mobilization
The bottom line is that while external flows (aid, debt relief, FDI and portfolio flows) have an important role to play in closing Africa ’s resource gap, they are not only insufficient but they cannot also be relied on as the current financial crisis demonstrates. Rather, the focus for generating the additional resources for the type of development that will better position African countries to weather future financial crisis should be on domestic and regional resource mobilization.  This is by no means a new insight. In fact, the Monterrey Conference on Financing for Development held in 2002 recognized the critical importance of domestic financial resources for development. The reasons are straightforward (Gayi, 2008):
Both ODA and FDI are highly volatile; four times more volatile than domestic revenues for example;

•    Domestic resource mobilization would improve countries’ fiscal and external account positions. For example a priori, if donors provide a loan to finance of capital expenditure of 5% of GDP you start off with a budget deficit of 5% of GDP.

•    Increased reliance on domestic resources would also reduce the probability of accumulating unsustainable external debts;

•    With no conditionality associated with domestic resource mobilization, African countries can regain the policy space to pursue their development priorities; The reality of the international development game is that one who pays the piper calls the tune.

So if the advantages are that obvious why has domestic resource mobilization not taken center stage in the search for additional resources? The simple answer is that from a policy maker’s perspective and the political economy, domestic resource mobilization is more difficult to do than receiving somebody else’s tax dollars. The policy maker in many African countries faces the constraint of low incomes, a highly informal economy, low financial intermediation, and the political unpopularity of taxes.

The fact remains however that domestic  savings in sub-Saharan Africa (projected by the IMF to decline from 24.5% of GDP in 2008 to 17.6% of GDP in 2009) are the lowest in any region. This compares with 41% of GDP savings rate for East Asia and the Pacific. Furthermore, volatility of income sources (primary commodities) in Africa also means higher volatility of savings and therefore less predictability of investment. Almost all the recorded savings in Africa is in the form of private savings. Public savings are estimated at averaging 2% of GDP over the last decade (Brownbridge, 2007).

A Regional Approach to Resource Mobilization

One of the major constraints facing many African countries is the small size of their economies (excluding Nigeria and South Africa ). For this reason, it is thought that the potential for generating resources domestically is limited, hence the focus on external sources. The potential for mobilizing funds on a regional level in Africa to finance its development has largely been ignored. This potential is however enormous. The total GDP of all 52 African countries (in PPP terms) in 2008 is just below that of France , making Africa the 8th largest economy in the world if viewed in aggregate. Africa at the end of 2008 has higher net international reserves than India for example. Africa is therefore not a poor continent as an entity.   

In the search for additional financial resources to fill the gap, it is time for African countries to recognize that together and with greater effort significant amounts of resources can be generated on the continent from both the private and public sectors.

A Region-wide Tax

My proposal is for African countries to, amongst other policies, impose on themselves a tax that will generate sufficient resources into a Fund that can be used to finance various critical development initiatives whether in infrastructure, agriculture, ICT or education. These funds can be leveraged  to secure private sector participation in relevant initiatives or projects.

A tax on petroleum consumption is one such tax. Africa consumes  about 3,000,000 barrels of fuel a day (2007 levels). An 11.5 cent per litre tax will yield $20 billion per annum, 10 cents per litre tax will yield some 17 billion, 8 cent a litre tax will yield some $15 billion annually while a 5 cents per litre will yield $8.9 billion per annum. These are not small amounts given the resource gaps. A guaranteed additional $10--$20 billion of domestic resources annually, appropriately deployed, can conceivably have a transformational impact. With this amount of funds mobilized annually, major projects such as the Inga dam power project in DR Congo which can generate sufficient electricity (39000MW) for the continent at the cost of some $50 billion, agricultural infrastructure, major road and railways and ports linking the continent, can be easily financed. Given the difficulty involved in getting such a measure implemented, I would recommend a 5 cents a litre tax on petroleum consumption Africa-wide.

The tax on petroleum consumption has the advantage that it is one of the easiest ways to get revenue, and the consumption of fuels as a group is relatively price inelastic and income elastic. The revenue yield is predictable. The burden of the tax is also equally shared across the continent and as a carbon-tax it is also environmentally friendly. It will also enhance the fiscal/debt sustainability as well as external payments outlook for the region as a whole. 

While petroleum taxes are politically sensitive, it is actually not the case that petroleum products are overtaxed in Africa compared with other regions of the world. The average tax as a share of final prices for premium unleaded in OECD countries in 2009 was 69% while the estimate for Africa is much lower. The tax component of the final price in Ghana averages some 20.4% while that of South Africa is 27.9% and Nigeria is zero (Adenukinju, 2008) . While petroleum taxes are politically difficult to implement, an Africa-wide tax is more likely to be accepted if its uses are specific and explained properly.

With funds from such a petroleum consumption tax forthcoming, Africa will also be able to negotiate on a more equal footing with countries like India and China who are able to obtain tremendous leverage by dangling $5 billion as investment in the continent or canceling debt worth $1.3 billion. In the present circumstances a Minister of Finance in a country with gross international reserves of $400 million facing the prospect of a $2 billion Chinese government concessional loan will probably not be able to sleep let a lone think straight. What leverage does the Minister have in the negotiations?
The case for such a fund is more imperative as Africa has now become the new frontier for natural resource discoveries with keen interest from countries like the USA , China and India

The management and administration of such a Fund can be given to either to a new institution or an existing institution such as the African Development Bank. Details of access to the Fund and what initiatives or projects are financed can be worked out in consultation with member countries.

Mobilizing Resources from the Diaspora: Diasporan Bonds and Remittances

A regional/global approach to domestic resource mobilization would also call for some attention to be paid by African countries to mobilizing resources through “Diasporan Bonds” as well as Remittances.

“Diasporan bonds” are so named because they are bonds issued with the target market being a country’s’ citizens in the diaspora. India and Israel have successfully raised significant amounts of resources ($11 billion and $25 billion respectively) through such bonds. About 16 million citizens of SSA are estimated to be living in the diaspora with 5 million in high income countries (Ratha et al, 2008), who estimate that $5-$10 billion can be raised annually by tapping into the wealth of this African diaspora.

Remittance flows have become very important in Africa . Sub-Saharan Africa received almost $12 billion in remittances in 2007, and the actual amount could be double this if informal flows are taken into account.  For in small countries such as Lesotho remittances represent up to a quarter of GDP . (Ratha et al, 2008) have argued that the greatest impediment to increasing the flow of remittances is the cost of remittances to Africa compared to other regions of the world, with costs being as high as 25% of the amount remited. Governments should encourage the flow of remittances through formal banking channels as well as reduce the cost of remittances. These mutually reinforcing measures, it is argued, would significantly increase the level of remittance flows which can be leveraged to improve access to the capital markets. 

Mobilizing Resources From The Unbanked

Domestic savings in Africa are mostly held in the form of non-financial assets and therefore outside the formal banking systems. With an estimated 80% of household assets in rural areas held in non financial assets, a significant amount of domestic resources are not available for intermediation. For many SSA African countries (excluding South Africa ), only about 20% of the bankable public have access to a bank account. Financial transactions are dominated by cash payments, with some 90 percent of issued currency held by the non-bank public, with one-third of broad money (M2) being held in the form of currency.

To improve domestic resource mobilization, there are the usual recommendations to improve the efficiency of tax collections, through reform of the public financial management system, automation of tax administration, stemming capital flight etc.  However at the heart of the problem of tax collection is the highly informal nature of many economies, underpinned and supported by the predominance of cash transactions in an environment of financial exclusion. Unfortunately, many countries have not made the link between financial exclusion on the one hand and the difficulty of collecting taxes on the other. One of the quickest ways to formalization of the economy and therefore to increasing the tax net is to bank the unbanked. This calls for a reform of the payment system in the context of branchless banking models that places the unbanked at the centre rather than at the periphery.

For Africa, these electronic payment systems should be designed in collaboration with the private sector to work in the rural environment. South Africa , Kenya and Ghana have taken the lead in this direction with smartcard and mobile banking solutions. If undertaken on a comprehensive scale, financial resources locked up in non-financial assets would be brought into the banking system for intermediation and this could be a significant source of resources (representing potentially 3-5 times what is being currently intermediated in the financial system). Furthermore, to the extent that electronic payment transactions dominate, government can easily collect and assess taxes and therefore enhance domestic resource mobilization.
Mr. President, Ladies and Gentlemen, to conclude, African policy makers must not see the global financial crisis as yet another opportunity to bring out the begging bowl. Rather, the financial crisis presents  an opportunity to rethink Africa ’s financing options for strengthening its economies and making them more resilient to shocks of this nature in the future. While aid will remain a critical part of the financing envelope in the foreseeable future, and private capital flows will always be important (and should be encouraged), there is a strong case for a renewed focus on domestic resource mobilization.

In addition to improving domestic tax collection, this can be achieved by inter alia increasing the level of intermediation in financial system through financial inclusion of the unbanked and the move away from cash payments towards electronic payments in the economy. Furthermore, there is a need to adopt a regional approach to resource mobilization. In this regard, initiatives such as a region-wide petroleum tax or other similar taxes should be explored. A five cent per litre tax will generate some US$9 billion  annually, which can be leveraged with private sector funds to secure much more investment. Petroleum taxes are particularly easy to collect and relatively predictable. Other instruments such as “diasporan” bonds or remittances-based instruments are also available.

Overtime, official aid flows would decline, while the focus for raising additional financing for Africa ’s development should be primarily on domestic resource mobilization supplemented by private capital flows. This is because Africans must ultimately bear the burden of financing our own development, no matter how painful it may be, and it will not be painless. Africa cannot realistically expect that the burden for its development should be borne by others.



REFERENCES

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Bacon, Robert (2001).  “Petroleum Taxes. Trends  in Fuel Taxes (and Subsidies) and the Implications”. World Bank Private Sector and Infrastructure Network, September 2001.

Brownbridge Martin (2007) "Mobilizing non debt generating foreign and domestic resources for achieving the MDGs in Africa ", A Concept Paper prepared by Mr. For UNCTAD Expert Group Meeting on “Mobilizing financial resources in Africa”, 16 February, Geneva

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Opportunities and Challenges. IMF Working Paper WP/03/69. Washington , DC : International Monetary Fund. Government of Zambia (2008). "Budget Address by the Hon. Ng'andu P. Magande, MP, Minister of Finance and National Planning, delivered to the National Assembly on 28 January 2008".

Gayi, K. Samuel (2008). “Mobilizing Domestic Financial Resources for Africa ’s  Development”. ATDF Journal, Volume 4, Issue 4.

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Ratha Dilip, Mohapatra, S. and S. Plaza (2008): “Beyond Aid: New Sources and Innovative Mechanisms for Financing Development in Sub-Saharan Africa ”. World Bank Policy Research Working Paper, WPS4609. April 2008

Remarks by Dr. Mahamudu Bawumia, former Deputy Governor of the Bank of Ghana, published in DI Quarterly by permission. Keynote Speaker, African Finance and Economic Association (American Economics Association Meeting). Atlanta, January, 2010.

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