Trends in financing development The availability of finance as well as access to finance are important in accelerating economic development in Africa and in increasing the likelihood of the region meeting the MDGs. Since the 2000 United Nations Millennium Declaration, several studies have shown that Africa faces a serious financing gap and that if this gap is not filled, it will be unable to meet any of the goals (UNECA 2006a). Sachs et al.
(2004) provide evidence suggesting that SSA would need approximately $25 billion in additional ODA per year in order to meet the MDGs. In their view, the region is in a poverty trap and so needs a big push in financial aid in order to achieve sustained growth and poverty reduction. The March 2005 Report of the Commission for Africa also provides evidence for similar conclusions.
In recent years, efforts have been directed at finding ways and means to mobilize the additional funds needed to fill this financing gap through mobilization of both domestic and external resources.. In this section, trends in the various sources of development finance in the region are highlighted.
Enhancing domestic savings mobilization can increase investment The mobilization of domestic savings will provide the much needed resources to finance investment in economic and social infrastructure in Africa. At the moment, investment ratios are very low in several countries. Relative to developing countries in Asia and Latin America, SSA has the lowest investment ratios. For example, over the period 2000-2004, domestic investment as a proportion of GDP was 18 per cent in SSA and 31 per cent in East Asia and the Pacific. As can be seen from figure 3.2, the domestic investment ratio in SSA is low because the domestic savings ratio is also low and the region has difficulties attracting sustained private capital flows.
Overcoming this investment and savings constraint is a major challenge for African policymakers and the way in which it is resolved will to a large extent determine the region’s ability to achieve sustained economic growth in the medium to long term.
Historically, SSA saves less than 20 per cent of its GDP. Over the period 1990-1994, the average ratio of domestic savings to GDP was 16 per cent. There was a slight improvement in this ratio to 17 per cent over the period 2000-2004. However, this number is considerably below the average for East Asia and the Pacific (35 per cent), Latin America and the Caribbean (21 per cent), and Middle East and North Africa (26 per cent). Concerted efforts must be made by African leaders to increase domestic savings if the region is to experience sustained growth and increased likelihood of catching up with other developing regions.
The low aggregate savings ratio observed in SSA masks the wide differences in savings patterns across the countries. There are several countries with savings ratio comparable to those in East Asia. For example, over the period 2000-2004, five countries, Algeria, Botswana, Republic of Congo, Gabon and Nigeria, had savings ratios greater than 30 per cent. The ratios range from 32 per cent in Nigeria to 51 per cent in the Republic of Congo. These countries are oil-and or diamond-exporting nations that saw an increase in export revenue due to rises in the prices of these commodities.
As a consequence, they may not be able to sustain the current increase in domestic savings, especially if there is a decline in the world prices of their exports.
Despite this uncertainty and vulnerability, it is worth noting that the increase in savings has enabled the five countries to increase their investment ratios, although the increase in the latter is not as large as in the former. Thus, a key challenge is how to translate these increases in domestic savings into productive investment, especially in non-oil and non-mineral activities, to ensure and increase prospects for sustained economic growth.
Eleven countries had negative savings ratios over the period 2000-2004. Since several of these are either in political crises or are post-conflict economies, it is not surprising that they had difficulties mobilizing domestic savings. For example, Liberia and Sierra Leone are just emerging from very disruptive political conflicts. However, countries such as Lesotho and Malawi had negative savings ratios although they did not have any equivalent political crises during the review period. Twenty-eight countries in the region had positive but low savings ratios, including South Africa, which has a developed financial system and is thus expected to be more able to mobilize sustainable domestic savings.
Official flows increasing Over the past three decades, there has been a shift in the geographic distribution of official flows. In the 1970s, countries in Asia accounted for a large share of ODA.
However, since the 1979 oil price shock, SSA accounts for a larger share of ODA.
During 1993-1994, about 27 per cent of ODA went to SSA, while the other regions of the world got less than 25 per cent each. During 2003-2004, SSA received about 36 per cent of ODA (figure 3.3). This increase reflects recent efforts by OECD countries to scale up the volume of aid to Africa to enhance the prospects for meeting the MDGs.
Historically, official flows have played an important role in the economic development of countries. As is obvious from figure 3.4, total ODA to SSA has been on the increase since the 1970s. It reached a peak of $19 billion in 1992 and declined for most of the 1990s. The trend in per capita ODA also follows a similar pattern. Since the 2000 Millennium Declaration, however, ODA to SSA has been on the increase again, reaching a peak of $26 billion in 2004. That said, it should be noted that when expressed as a percentage of GDP, ODA to the SSA in 2004 was 5 per cent of GDP, which is still below the 6 per cent figure recorded in 1990.
Within the African region, the distribution of aid flows is uneven with a few countries accounting for a significant percentage of the aid flows. In 1990, the big recipients of the aid flows were: Egypt ($US5.4 billion); Kenya ($1.2 billion); Tanzania ($1.2 billion); Morocco ($1.1 billion); Ethiopia ($1 billion); and Mozambique ($1 billion).
T he other African countries received less than 1 billion dollars each. As a result of the new focus and priorities given to the region by G-8 countries, aid flows to several countries have increased. In 2004, the following ten countries received at least $1 billion dollars of ODA: Angola, Ethiopia, Democratic Republic of Congo, Egypt, Ghana, Tanzania, Madagascar, Mozambique, Uganda, and Zambia. In per capita terms, the main recipients of ODA in the region in 2004 were: Cape Verde ($282); Sao Tome and Principe ($218); Seychelles ($124); Swaziland ($104); Zambia ($94); and Senegal ($92).
Since the launch of the Enhanced HIPC initiative in 1999, there has been a change in the composition of SSA aid commitments. The share of project aid in total aid to the region has decreased while that of debt forgiveness has increased from under 10
per cent in 1990-1994 to about 18 per cent over the period 2000-2003. Nonetheless, project aid still accounts for more than 60 per cent of SSA aid commitments (Gupta et al. 2006). Given the relatively low domestic savings ratios of SSA countries, the region will continue to rely on access to ODA as a major source of financing development, unless drastic steps are taken to boost private capital flows and mobilize domestic savings.
Private capital flows Private capital flows is another key source of external finance in SSA (UNECA 2006a). In the late 1990s, it was a more important source of external finance to the region. In 1998 and 1999, net private flows to SSA were 13.7 and 16.7 billion dollars respectively. Over the same period, net official flows to the region were 10.6 and 10.3 billion dollars respectively. Net private capital flows to SSA were low over the years 2000-2002 due in part to the impact of the Asian financial crises on investor attitudes towards foreign investment. Private capital flows to the region has increased fast since 2003 and they exceeded net official flows in 2005 (table 3.2).
A large part of recent private capital flows to SSA is in the form of equity as opposed to debt. In 2005, net equity flows accounted for 86 per cent of net private capital flows to the region. Furthermore, between 1998 and 2002, the net debt flows were negative, reflecting the fact that, during this period several countries in the region were more interested in servicing existing debt than in accumulating further debt.
The decline in the debt-equity ratio of private capital flows to SSA is a welcome development as it should limit the incidence of debt overhang in several countries. It should also be noted that there has been a shift in emphasis from short- to mediumand long-term debt, which will help to avoid the maturity mismatches that have been a feature of debt in the region.
Recent equity flows to SSA have also been in the form of FDI inflows (table 3.2), as opposed to portfolio equity inflows that are highly volatile and often leave countries vulnerable to sudden reversals and investor sentiments. The increasing reliance of African countries on FDI rather than debt should be encouraged because it will help to avoid debt accumulation with the associated debt service burden. FDI is also a good source of financing development because it has a potentially important role to play in stimulating growth and development. African countries should put more effective policies in place to attract FDI and increase their share of development finance from this source. Table 3.3 shows that the region currently attracts less FDI than most developing countries. In 2005, FDI to SSA represented about 7 per cent of FDI to all developing countries.
The problem of capital flight The analysis of capital flows to and from Africa reveals a curious paradox. On the one hand, African countries have accumulated large volumes of debt, presumably to fill their resource gap and finance their development needs. On the other hand, as discussed in-depth in UNECA (2006a), the continent continues to experience heavy financial haemorrhage in the form of capital flight, some of which is financed by borrowed funds. This loss of capital deprives Africa of a sizable portion of the very resources it needs for development financing.
Remittances In economies with very low domestic savings and poor access to international capital markets, migrant workers’ remittances can play a vital role in development finance.
In several regions of the world, this is indeed growing at an unprecedented rate. In 2004, it accounted for 1.5 per cent of GDP in SSA, 1.7 per cent in East Asia and Pacific, 2 per cent in Latin America and the Caribbean, 4.1 per cent in Middle East and North Africa, and 3.6 per cent in South Asia. In 2005, the total value of remittances from all regions was $232 billion which is marginally below the total value of net inward FDI to all developing countries ($237 billion) for the same year. The true value of remittances may be larger given the fact that some remittances are transmitted through informal channels and so are not reflected in official statistics.
In SSA, remittances are becoming increasingly important, with remittances in 2004 at about 1.5 per cent of GDP. Although this is lower than the 5 per cent figure recorded for ODA in the same year, it is clearly not an insignificant source of financing.
UNECA (2006) discusses the advantages and disadvantages of remittances relative to other flows. In terms of monetary value, the magnitude of remittances to SSA is still relatively small compared to receipts by other developing regions. Estimates available for 2005, suggest that SSA received $8.1 billion in remittances compared to $43 billion and $42 billion for East Asia and the Pacific and Latin America and the Caribbean respectively. The region also received less from this source than countries in South Asia and Middle East and North Africa.
That said, it should be noted that the low figure reported for SSA may be due to the fact that relative to other regions, it transfers more remittances through informal channels. It is also due to the fact that financial institutions in the region are less developed than in the other regions and so it is more difficult and costly to transfers remittances.
Migration is also a source of concern because of the negative impact of brain drain, a phenomenon that reflects the failure of African economies to absorb human capital. In response, governments need to design strategies not only to build human capital but also to retain it.20
From Monterrey to Gleneagles African countries and their development partners have recognized the crucial role of finance in development and are making serious efforts to mobilize both international and domestic resources. However, they face serious challenges in their efforts to use development finance as an effective instrument for development. These challenges include:
• Finding an effective and sustainable solution to the external debt crises facing several African countries so as to release resources for development finance; • Attracting sustained private capital flows, including remittances, and ensuring that they are in sectors with high value-added and employment impact; • Improving domestic resource mobilization through increased savings, higher tax revenue, and reduction of capital flight; • Improving the effectiveness and absorptive capacity of foreign aid; and • Using international trade as a vehicle for resource mobilization.
The Monterrey Consensus, adopted by Heads of State and Government at the International Conference on Financing Development in March 2002, was the first comprehensive and global attempt to address these challenges. It was also the first time that development finance and related issues became the main focus in international financial discussions. In the Monterrey Consensus, world leaders noted with concern the financial gap to be filled in order to attain the MDGs. They called for a new partnership between developed and developing countries and committed themselves to mobilizing domestic financial resources, attracting international capital flows, promoting international trade as an engine for development, increasing international financial and technical cooperation for development, sustainable debt financing and external debt relief, and enhancing the coherence and consistency of international monetary, financial and trading systems for development.
Although the Monterrey Consensus highlighted the importance of aid harmonization for effective development outcomes in recipient countries, there were no clear guidelines and commitments from donors to ensure that the objectives would be achieved, until the High-Level Forum on Harmonization held in Rome in February 2003. In the ensuing Rome Declaration on Harmonization, donors acknowledged the need to reduce transactions costs of aid delivery in recipient countries. They also stressed the need for country ownership of aid programmes and for good practices,standards and principles in implementing development cooperation. Against this background, donors committed to providing development assistance in accordance with partner country priorities, implementing good practices, standards and principles in development assistance delivery and management, adapting harmonization efforts to the country context, and harmonizing donor policies and procedures.
As a follow-up to the Rome Declaration on Harmonization, an international roundtable on Managing for Development Results was held in Marrakech in February 2004. The outcome of this meeting was the Joint Marrakech Memorandum on Managing for Development Results endorsed by the the African Development Bank (AfDB), Asian Development Bank (AsDB), Inter-American Development Bank (IADB), European Bank for Reconstruction and Development (EBRD), the World Bank, and the Chairman of the Development Assistance Committee of the Organization for Economic Cooperation and Development (DAC/OECD). In the Memorandum, they committed to fostering a global partnership and approach on managing for development results and aid effectiveness.
While the Monterrey Consensus, the Rome Declaration and the Marrakech Memorandum defined the main objectives of the aid-effectiveness agenda and led to an expansion in activities aimed at improving the effectiveness of aid delivery, the Paris Declaration on Aid Effectiveness of 2005 represents the first bold attempt by donors and developing countries to take monitorable actions to reform the way aid is delivered and managed. The latter declaration was the outcome of the High-Level Forum on Aid Effectiveness held in Paris, 28 February – 2 March 2005.
The 2005 Paris Declaration on Aid Effectiveness focused on five key areas, namely, ownership, harmonization, alignment, managing for results, and mutual accountability.
Regarding ownership, the Declaration stressed the need for partner countries to exercise effective leadership over their development policies and coordinate development actions. On alignment, donors made commitments to base their overall support on partner countries’ national development strategies, institutions and procedures.
They also made commitments to provide reliable indicative commitments of aid over a multi-year framework and to disburse aid in a timely and predictable fashion according to agreed schedules. Reducing the proportion of aid that is tied is also a key aspect of this area of the Declaration.
In the area of harmonization, donors committed to making their actions more harmonized, transparent and collectively effective. On managing for results, they made commitments to manage and implement aid in a way that focuses on the desired results and uses information to improve decision-making. Finally, regarding mutual accountability, donors and developing countries made commitments to enhance mutual accountability and transparency in the use of development resources, as both parties are accountable for development outcomes. An important feature of the Paris Declaration was that indicators of progress and targets were set for each of the five areas to increase transparency in monitoring the implementation of agreed commitments.
The G-8 Summit in Gleneagles in July 2005 added momentum to the commitments made by world leaders in Monterrey to increase aid flows and reduce the burden of external debt on developing countries, to enhance their prospects for meeting the MDGs. The Declaration issued also recognized the need for substantial increase in ODA to consolidate and build on recent advances in Africa and to stimulate growth to reduce aid dependency. On aid, the Declaration indicated that the commitments of G-8 countries and other donors would increase ODA to all developing countries by $50 billion a year by 2010 compared to 2004. Half of this increase would go to Africa, representing more than a doubling of aid to Africa compared to 2004. On debt, the G-8 agreed to a proposal to cancel 100 per cent of the outstanding debts of eligible HIPC countries to the IMF, International Development Association (IDA)
and African Development Fund, and to provide additional resources to ensure that the capacity of the international financial institutions was not reduced. They also re-affirmed their commitments to the Paris Declaration on Aid Effectiveness and stressed the need for developing countries and their governments to take the lead on development and to be accountable for their actions.
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