ECA's Thirty-third session of the Commission/Twenty-fourth meeting of the Conference of Ministers/Seventh Conference of African Ministers of Finance
6 - 8 May 1999 Addis Ababa, Ethiopia

VI. Domestic Resource Mobilization

66. The need for African countries to mobilize domestic resources as a medium- to long-term goal is now widely accepted. In the past, savings rates in Africa have been low, as have investment rates. While savings performance varies between countries, African countries have lower savings and investment rates than other less developed countries. In 1997, domestic savings as a percentage of GDP was 17.6 per cent (compared to 24 per cent for all developing countries), while investment was 18.3 per cent of GDP in contrast to the over 32 per cent required for the poverty reduction targets set in Section II. A sustained increase in growth rates requires higher levels of savings and investment, as well as increased investment productivity. Thus, policies to promote savings have a central role to play in driving growth via investment and reducing aid dependency in SSA, particularly in the face of the anticipated global reduction in aid. Identifying policies that promote savings (and the policy distortions that inhibit it) should be an essential element in any strategy for the long-term development of the continent (Elbadawi and Mwega, 1998). This is a basic policy challenge for decision makers in Africa

67. Given that savings come from households, the business sector and from the government, what can be done to promote savings? There is abundant theoretical and empirical literature on private saving behaviour even though different studies focus on one or two aspects of the issue. Surveys suggest that the literature is somewhat fragmented, with no single model able to deal with every dimension of the savings issue (Edwards, 1994). Among the determinants of private savings are economic growth, terms of trade, fiscal and financial policies, macroeconomic stability and demographic factors. However, for most low-income African countries, it is generally recognized that a significant autonomous increase in the domestic savings rate is not feasible as a way of accelerating growth. Rather, efforts would need to be directed at increasing output, income and aggregate savings by greater utilization of existing resources, increased inflows of ODA and by improving the allocation, quality and efficiency of investment.

68. Macroeconomic Stability: Empirical results suggest that macroeconomic stability is critical to stimulating savings. Mason et al (1995) find that saving is negatively correlated with inflation. The rate of savings is, therefore, enhanced in an environment where the rate of inflation and level of budget deficits are low. Uncertainty about the real returns on savings, and about the direction of macroeconomic policies, has deleterious effects on savings (Hadjimichael et al 1995). This conclusion calls for increased transparency and debate in the culture of economic decision making. At the technical level, it calls for the determination of a sustainable growth path for national income consistent with non-expansionary monetary policies and sustainable balance of payments and budgetary positions. Continued strengthening of macroeconomic policy modeling capacity in the government’s key economic and financial policy management agencies should be an element of the reforms necessary to foster higher domestic savings.

69. Financial and Capital Market Reforms: The effects of financial and capital market reforms on private savings work through various channels, and the effects can be negative or positive. First, capital market reforms may reverse capital flight, thereby raising the portfolio share of domestic assets and increasing measured income, measured net exports and measured domestic savings. Second, financial liberalization and capital market deepening may raise the efficiency of intermediation, thereby increasing growth and thus private savings. Third, financial liberalization and the consequent increase in geographical density of financial institutions, the range of financial institutions, and the quality of regulation and supervision in the financial sector, typically lead to financial deepening that will be reflected in more financial savings (Schmidt-Hebel, 1996). The flexibility that investing in capital markets gives to all types of savers and the spreading of risks among them, makes a powerful case for pursuing capital market development strategies. Additionally, as noted earlier, development of capital markets is critical to attracting foreign savings to Africa in the form of foreign direct and portfolio investment. But its role is limited in part due to the dominance of small, nation-state markets in Africa. Policymakers should adopt a subregional approach to the support and development of capital markets, so as to strengthen their catalytic role in mobilizing savings.

70. Financial Deepening: The monetization of a broader range of economic activities and transactions would facilitate financial savings, as would the broadening of the range of flexible savings instruments — all key elements in the process of financial deepening, which is often measured by the ratio of broad money to GDP. There is empirical evidence of the positive and significant effect on savings of the increase in the ratio of broad money to GDP. Thus the process of financial deepening, which is spreading throughout the whole of Africa, has a large pay-off in terms of domestic resource mobilization. With the policy and regulatory framework for financial sector operations established under past and on-going reform programmes, policy makers need to add to their menu of concerns the promotion and development of institutional architecture that will facilitate the process of financial deepening. Innovative, flexible and targeted savings instruments, savings schemes and savings mechanisms appropriate to different segments of the population should be promoted. For example, since research shows (the life cycle model) that the age composition of the population does have an influence on household savings behaviour — with the youth and the elderly saving least — middle–aged working people should be targeted. Instruments such as well-structured, professionally managed retirement funds could be important savings vehicles for this category of the population. Experiences of countries with relatively new savings instruments, such as those of Malawi with Unit Trusts, could be shared among conference participants.

71. Interest Rate Policy: According to available research evidence, the impact of interest rates on household savings is ambiguous because there are both income and substitution effects which work in opposite directions. Higher interest rates increase the opportunity cost of consumption, hence households increase savings (the substitution effect), while the rising wealth of positive savers (as a result of the increase in interest rates) increases consumption (the income effect). Empirical studies usually find a non-significant or small interest rate elasticity of domestic savings. However, it has also been argued that in a situation of financial repression, typical of many African countries before financial sector liberalization, the liberalization of interest rates would increase savings and the supply of investible resources in the economy (McKinnon, 1973; Shaw, 1973; Elbadawi and Mwega, 1998). In any event interest rate policy should be designed to allow a margin appropriate to the risk an investor/saver faces over the term of the savings/investment instrument.

72. Terms of Trade: The management of trade booms and contractions can be critical to private as well as public savings. To the extent that terms of trade shocks contribute to macroeconomic volatility, undermine fixed exchange rate regimes and destabilize the domestic banking system, booms and contractions can have far-reaching consequences for private and public savings. Depending on how the boom is managed and whether more of the adjustment falls on the public or private sector, the outcome will depend on the combination of fiscal, monetary and banking regulation instruments applied, the availability of hedge instruments, as well as the political environment for fiscal decisions. Generally, an improvement in the terms of trade increases incomes, and hence potential private and public saving, especially if the improvement is considered transitory (Mwega, 1997). This effect is important in Africa where exports which are sold in volatile markets are limited to a few primary commodities. During periods of commodity price booms, savings mobilization campaigns and innovative, flexible, publicly and privately issued hedge and insurance instruments should be developed, as well as improved incentives to hedge and self-insure against the risk of a possible contraction. Critical to the success of any hedge strategy is the quality of regulation of financial institutions. The experience of countries with various instruments to manage booms and raise savings, such as that of Uganda with a temporary export tax on coffee in 1996 can be shared among conference participants.

73. Fiscal Reforms, Public Expenditures and Public Savings: Besides fiscal action in the commodity boom situation discussed above, other areas hold prospects for increased public savings: further implementation of tax reforms, cost sharing in the provision of public goods and services and enhancing public expenditure productivity. Taxes are a principal means of public domestic resource mobilization, but the need for revenue must be balanced against the possible adverse effects of particular taxes and the whole tax structure on relative prices and incentives, which may give inappropriate price signals. Broadly, tax reforms should aim at broadening the tax base, raising tax elasticity with respect to economic growth, reducing exemptions, and simplifying tax administration. The sharing of experience by policy makers in implementing public resource enhancement measures in the above areas will be most useful.