With regard to financial sector policies, the starting point is the clear link between investment and diversification. The contribution of private investment to desirable diversification outcomes cannot be gainsaid. In that respect, the financial sector and its role in financing private sector contribution to diversification is very critical.
Hitherto, the African experience with financial sector reforms has been almost similar to the trade liberalization results. However, the failure of financial sector liberalization to achieve the results expected can be explained from two angles. On the one hand is the failure of liberalization in achieving an efficient financial sector able to play its expected intermediation role for both short-and long-term credit, in an optimal way. On the other hand, comes the failure to achieve reductions in interest rates as was expected, given that interest costs are a major cost of doing business for many private sector firms. These two points are elaborated here in order to point to the need for a rethink of the financial sector architecture, in terms of both policy and institutional frameworks so that proactive financial sector policies can contribute to the deepening of diversification efforts.
With regard to the institutional structure of the sector, financial liberalization in Africa failed to achieve the desired outcomes as a catalyst for financial sector deepening.
The key reason noted is that in the same way that trade policies were never seen as part of an integrated financial sector, financial sector liberalization tended to treat the sector in a compartmentalized manner. This was done to the extent that there was unbalanced focus on some components such as commercial banking, neglecting the significance of other dimensions such as development finance institutions and/or other components that are key to capital markets deepening. The results were that the financial sectors were not integrated, and focused on short-term credit issues rather than on development finance and capital markets development, which would be more relevant to diversification efforts. In this respect, given the importance of the financial sector in diversification, it is important that African countries seek a proactive financial sector policy that aims at integrated development of the whole sector that can effectively and efficiently mobilize the sustainable, long-term capital necessary for financing diversification programmes, and by extension, long-term development.
The significance of proactive financial sector policies compared to what has been the practice can be found in the results that were achieved in the past with interest rate regimes. In many African countries, financial sector liberalization became characterized by wide interest rate spreads. Thus, instead of liberalization resulting in more efficient financial sectors, the results were interest rate regimes where the lending rates rose and remained high over long periods of time, while the deposit rates fell, and, in many cases, were negative in real terms. This discouraged the private sector from undertaking productive investments, such as those required for deepening diversification.
Additionally, the inability of the private sector in Africa to access cheap credit meant that it was not possible to undertake initiatives that would lead to both horizontal and vertical diversification. The high interest rates after liberalization also had the negative effect of raising the interest costs of servicing existing debt. This resulted in reduced profitability for most firms. Given that retained earnings also form a significant component of financing diversification efforts in the private sector in most African economies, financial sector liberalization had the indirect effect of limiting these diversification efforts.
To learn more about this author, visit United Nations Economic Commission for Africa's Website.
Like this article? Share it with your friends
|
|
United Nations Economic Commission for Africa's
Complete
List Of
African-Accounts
Articles
|
|
If you enjoyed this article, get United Nations Economic Commission for Africa's Complete List of African-Accounts Articles For FREE!
|
|
|
|
![[Get Copyright Permissions]](http://license.icopyright.net/images/icopy-w.gif){kind=small}
