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

I. Executive Summary

1. The overall aim of this paper is to provide a selective review of critical issues facing African policy makers in mobilizing resources to finance development. To set the stage, the paper discusses in Section II the recent performance of African economies and evaluates it against specific, time-bound, poverty- reduction objectives and targets (adapted from the Copenhagen Summit). The indicative scenario (assumptions spelled out in the text) is to reduce poverty by half by the year 2015—a rate of reduction of the poverty level at an annual rate of 4 per cent per annum. The objective is to highlight the growth rates and broad orders of magnitude of the resource needs and the policy challenges implied by the poverty reduction targets. The key conclusion is that macroeconomic performance of the past four years -- 4.5 average annual GDP growth, resulting in positive per capita income rise--- has laid a good foundation for growth. But while commendable, if the growth rates are not raised substantially -- to an average of 7 percent per annum for Africa [8 per cent for Sub-Saharan Africa]—the poverty reduction targets are not likely to be attained. At the projected levels of domestic savings and efficiency of capital, the average annual magnitudes of external resources (measured as a proportion of GDP) needed to realize the set poverty reduction targets are 47 per cent during 1999-20000; 32 per cent during 2001-2005; and 10 per cent for the period 2006-2010 for Sub-Saharan Africa. North Africa needs about 5 per cent of GDP in external resources, which, in light of the present ODA flows -- averaging about 3 per cent of GDP -- leaves a financing gap of 2 per cent of GDP.

2. Considering the strong effort, which led to the good recent performance, the paper notes that attaining and sustaining the GDP growth rates indicated above in terms of resources and policy reforms, is a monumental task. The paper then focuses on reviewing developments and the mix of actions necessary to enhance development financing--focusing on measures to increase the impact of ODA, attract private capital, stem capital flight, raise domestic savings and switch resources from debt service to development. Trade surpluses, if attained, could also be an important source of resource inflows. The impact of the East Asian financial crisis on trade and financial flows to Africa is discussed to raise policymakers’ awareness of important lessons to be learnt from the experience and the issues central to the debate on the possible reform of the protocols and institutions regulating international financial flows. The whole discussion is cast in the context of Africa’s transition from public sector-led development to a private sector-driven partnership, where the public sector enables and supports an environment conducive to non-speculative private investment.

3. The discussion is intended to guide and inform the dialogue at the Joint Conference of the Ministers of Finance and the Ministers of Economic and Social Development and Planning, without necessarily attempting to be comprehensive or exhaustive. But it is expected to contribute to clarifying options in key areas of country policy, and to lead to collective regional and subregional follow-up plans towards agreed objectives in a sub-set of the issues discussed. In particular, a common regional approach is needed for fostering African ownership of the development agenda and the process for building consensus towards that agenda — so as to better focus ODA, and for engaging actively in the process of resolving the debt problem. Similarly, common steps are needed in sensitizing the proposals for reform of the international financial system to the special needs of development financing, and in supporting a subregional approach to capital markets development, in view of its importance for development financing. A similar approach is needed to build the capacity in Africa to participate in the new data and financial reporting and information dissemination systems, which have been designed by the IMF in the wake of the Asian crisis. They are important disclosure processes that are likely to influence investor location decisions. Currently, only South Africa participates in these reporting processes.

4. The rest of this Section I of the paper summarizes the main conclusions and key policy issues for debate and for information and experience sharing. It is organized in seven sections, which relate to the sub-themes of the Conference and the structure of Sections III through VIII of the paper.

5. Prospects and outlook for official development assistance to Africa: The ODA component of development finance is discussed in Section III. The conclusion is reached that large increases in ODA are unlikely, even as the prospects for aid effectiveness in Africa are improving. Yet the contribution from official development assistance is important in terms of strengthening governments' ability to make long-term investments that are vital for private sector-led economic growth. Effective aid enables key public investment programmes in infrastructure and human resources to be carried out in a non-inflationary manner, which lowers operational costs and improves the efficiency of private investment. Studies have shown that in reforming countries, one dollar of aid attracts $1.80 of private investment. Aid is playing a critical and, for now perhaps, irreplaceable role in closing the gaps in financial markets that inhibit investment through its coverage of marginal risks and stretching out maturities. This helps attract billions of dollars of private investment in infrastructure and other forms of direct foreign investment, particularly large-scale, that otherwise would not take place. Aid is most effective in a good macroeconomic policy environment, and is ineffective or even harmful in poor policy environments.

6. Studies have shown that on average, aid has not been as effective as is desirable, and may have nurtured a culture of aid dependency. Reasons given for poor aid effectiveness in the continent suggest that corrective measures would need to include the maintenance of a stable macroeconomic environment; more recipient ownership and less donor-driven programmes and public expenditure decisions; and the implementation by donors of more effective aid modalities. If implemented, such measures are likely to improve the quality of management of aid resources by donors and recipients and to enhance the coordination, cohesion, focus and impact of specific donor-supported programmes and of development assistance in general.

7. Aid would be even more effective if its allocation by donors between countries was "efficient"; i.e. if it were based on poverty levels and programmes. With sound economic management, financial assistance leads to faster growth, poverty reduction, and improvements in social indicators. New studies show that in the right macroeconomic environment, ODA equivalent to 1 per cent GDP translates into a 1 per cent decline in poverty, and a 1 per cent decline in infant mortality. Additionally, among low-income countries with good economic policies, per capita GDP growth of those receiving large amounts of aid was higher than those receiving small amounts (3.5 per cent versus 2.0 per cent growth per year). It has been found that the impact on poverty reduction of reallocating aid more efficiently can only be matched by a four-fold increase in aid budgets. With a poverty-efficient allocation, aid could sustainably lift roughly 80 million people out of absolute poverty. Thus, the case for reviewing aid modalities to increase aid effectiveness is compelling, particularly in view of the poor prospects for large increases in aid budgets.

8. The Conference may wish to focus on issues of improving the efficiency and impact of public expenditures financed with foreign aid resources and "optimizing" aid’s share in development expenditures, so as to reduce aid dependency in the long run. The Conference may also wish to deliberate on the substance and prospects for new aid modalities, which emphasize a holistic and comprehensive approach, as elaborated particularly in the OECD-DAC, World Bank and SPA proposals. Ministers may wish to share views on how best to foster a new donor-beneficiary relationship in which multi-donor programmes focus on supporting an Africa-driven agenda. With the support of the African Development Bank (ADB) and the Organization of African Unity (OAU), ECA has launched the African Development Forum (ADF) with that objective in mind. Its first meeting will take place in October 1999 on the theme: "The Challenge to Africa of Globalization and the Information Age. How can the ADF process best reinforce the objectives of the proposed new aid modalities?"

9. Other sources of external finance: Non-official sources of external finance (private capital inflows) are discussed in Section IV. Noting that Africa has not benefited from the phenomenal growth in foreign investment, compared say to East Asia, the paper lays out some key conditions and policy challenges to attract foreign investment. Among them are supportive macroeconomic policy and legal and regulatory frameworks; the rule of law and the enforcement of contracts; functioning social and economic infrastructure, financial sector reforms, support for capital markets development; deliberate and explicit attention to the concerns of investor risk rating agencies, etc. Privatization as an instrument for attracting foreign capital is discussed, along with its possible downside — the political risk associated with the declining share of national assets in the total domestic investment portfolio. The policy of promoting capital markets is highlighted as key to attracting long-term investment, including venture capital, and footloose portfolio investment, but the risks associated with globally mobile capital are pointed out, as well as possible mitigating policies, particularly in light of recent evidence from the Asian crisis.

10. The Conference may wish to reflect on the fact that notwithstanding the notable efforts made by many African countries to implement economic and financial reforms, FDI flows to most of them remain marginal. The Conference may further wish to discuss and share experiences of implementing FDI-friendly policies and the different outcomes in various countries. The Conference may also wish to reflect on the role of the International Finance Corporation (IFC) in catalyzing private sector investment and the effectiveness of the Multilateral Investment Guarantee Agency (MIGA) in offsetting the non-commercial risks perceived by potential investors in Africa. How can these agencies’ work be made more effective in the task of financing Africa’s development?

11. Capital flight and its impact on development: While striving to attract foreign savings for development, Africa has a larger proportion of wealth held overseas by residents than any other continent (39 per cent compared with 6 per cent for East Asia before the crisis). Stemming and reversing capital flight could go a long way to solving Africa’s development finance problem. Section V discusses the negative financial outflows due to capital flight from Africa; the policy lapses likely to trigger or contribute to capital flight; and the measures required for stemming and reversing this phenomenon. The paper notes that adverse investor risk ratings, unsustainably high external debts and macroeconomic policy errors — or fear of their possible occurrence — are root causes of flight capital. Policy errors that cause inflation, exchange rate misalignment and high fiscal deficits choke off opportunities for profitable investments. Inconsistent and unsustainable sets of policies can also trigger capital flight even when, in the very short run, everything looks just fine. The absence or weakness of capital markets contributes to the problem. Capital markets spread risks among investors and can create investment opportunities for the non-professional and typically small investor. Additionally, large amounts of corruptly obtained funds, particularly by public officials, are more likely to be stashed away overseas than invested in their country of origin. Corruption raises transaction costs and its unpredictability makes returns on investment uncertain, which discourages private investment. Corruption must be fought using political, administrative and economic policy instruments.

12. The Conference may wish to consider and discuss measures and policies that can improve the investment climate in African countries in order to stem the flow of resources out of the continent, focussing on policies for creating and sustaining a consistent and stable macroeconomic environment and promoting capital markets. It may further wish to discuss experiences with respect to the impact of simpler classification and administrative procedures in key areas — such as taxation, export and import licensing — on corruption by officials, and the impact of eliminating market distortions on discretionary powers of government officials and corruption. Some changes in the banking regulations of developed countries, where corruptly obtained flight funds are invested, could also facilitate repatriation of capital and forestall capital flight. The Conference may also wish to consider modalities for engaging developed countries on reforming aspects of their banking regulations that create a "safe heaven" for corruptly obtained and exported funds.

13. The challenges of mobilizing domestic resources: In the medium-to-long run, sustainable development will require higher levels of domestic resource mobilization. Section VI considers key issues in raising the savings effort — from its present level of about 18 per cent to about 24 per cent of GDP (the average for all developing countries as a group), which was assumed in the scenario that generates the resource gap in Section II. Policies to raise the savings rate need to focus on macroeconomic stability, financial and capital market reforms, financial deepening through institutional reforms and innovative savings instruments, and interest rate policy management. For public savings, the potential for further implementation of tax reforms, cost-sharing in the provision of public goods and services, the management of the terms of trade-related booms and the enhancement of public expenditure productivity are important policy areas on which to focus.

14. The Conference may wish to discuss ways of raising private savings, including strengthening and improving reliability of thrift institutions and incentives to save, as well as the need for broadening the range of flexible financial savings instruments. Ministers at the Conference may also wish to review and share experiences with tax reforms in their countries and associated problems, and discuss burden-sharing arrangements in the provision of public goods and services, as well as measures they have implemented to raise the effectiveness of government expenditure.

15. The development of capital markets has emerged as important in raising the level of domestic savings, and as critical to attracting foreign private investment, stemming and reversing capital flight. In 1996, ECA organized in Accra, Ghana, a major conference on "Reviving Private Sector Partnerships for Growth and Investment," out of which the African Capital Markets Forum was born. Its functions are to serve as a clearing-house for the exchange of views and to provide training and other services needed to build and strengthen the capacity of capital markets in Africa. Because of the limitations of small nation-states – from economic and financial points of view – and the advantages to be gained from operations in the context of larger financial markets, a subregional approach to capital market development, including the provision of support services, is very appealing. Ministers may wish to discuss practical steps for a subregional approach to capital market development. How can the African Capital Markets Forum be further supported and rendered more effective in its functions?

16. Africa's external debt problems: Excluding a few less impacted countries, at over 100 per cent of GDP for the better part of this decade (leaving out South Africa and Nigeria data), Africa’s debt is essentially non-payable and certainly unsustainable under any sensible growth-oriented macroeconomic scenario. Section VII analyses issues of external debt and their resource implications. It concludes that what African countries need is the release of more resources from debt servicing for financing development and for creating conditions that encourage inflows of private foreign investment. The current HIPC Initiative, while an important instrument for delivering debt relief, is rather restrictive in its eligibility criteria and its technical basis for determining such eligibility — including the length of the "track record".

17. Any credible solution to Africa’s debt problem must entail substantial debt cancellation — besides better debt management by Africa in the future, of course. But many creditors, particularly multilateral institutions, are extremely sensitive about the idea of debt cancellation, which is a political, rather than a technical, issue. That said, one has to note that the political will to cancel debts does exist — the UK, for example, has already unilaterally cancelled portions of debts owed it by the poorest countries, mostly African countries. New initiatives by key Group of Seven (G-7) creditors now underway could entail substantial debt cancellation, particularly if Africa’s voice could be heard. Research shows that relieving the debt overhang could be the most effective way to stem and reverse capital flight and to attract private foreign investment, as the sustainability of a stable macroeconomic framework would look more credible in the eyes of investors.

18. Five variants of enhanced debt relief proposals have been put forward for consideration at the forthcoming G-7 meeting in June 1999, in Cologne, Germany. The proposals are aimed first and foremost at strengthening and accelerating the implementation of the HIPC Initiative with a view to enabling as many countries as possible to make the necessary adjustments and receive debt relief quickly and comprehensively, but with certain important quid pro quo caveats. In a way, the proposals represent a shift in the official position of the industrialized creditor countries, which hitherto rallied behind the existing mechanisms and terms of the HIPC, without entertaining pleas for their revision. There is a lot of common ground between the proposals—the significant exception being the proposed additional sale of IMF gold. If adopted, the proposals could significantly reduce the waiting period before effective debt relief is granted (the German proposal would reduce it from six to three years) and result in significantly more countries becoming eligible for debt relief, in contrast with the current HIPC process.

19. The Conference may wish to revisit the ministerial statement issued at the conclusion of the 1997 Sixth Session of the Conference of Ministers of Finance, which addressed these issues. The Conference may then wish to deliberate on the various proposals laid before the forthcoming Cologne G-7 summit meeting, as well as those of other stakeholders that are geared to finding a "lasting solution to the problem". These include the UNCTAD proposal of applying established national insolvency procedures, with independent assessment to determine a country's debt sustainability, and calling for immediate write-off of all non-collectable debts. The Conference may further wish to discuss and share experiences of the application of non-HIPC debt relief instruments, such as debt conversion, intended to benefit middle-income countries, mainly in North Africa. In light of recent developments, the Conference may also wish to adopt a plan for Africa’s active participation in the unfolding new debt initiatives (including putting up credible alternative proposals) — a plan where Africa speaks with one voice that is coherent, loud and clear.

20. Impact, lessons and policy implications of the East Asian crisis: Section VIII discusses the impact, lessons and policy implications for Africa of the East Asian crisis and issues related to the possible reform of the international financial system. It concludes that the crisis has had a differing impact on different national economies. While oil-exporting countries are bearing the brunt of the crisis, others have experienced offsetting effects from lower oil prices and lower commodity prices. Because most African economies are relatively unintegrated in the world economy, the impact has been minimal from the point of view of financial flows. This is testimony to the fact that despite the recent good economic performance, the diversification of sub-Saharan Africa’s economies remains an elusive objective. Nevertheless the banking and currency crisis in Asia is a wake-up call for Africa and has profound policy lessons. Transparency in financial transactions must be enforced and bank supervision and regulation by central monetary authorities in Africa must be strengthened and they must remain vigilant at all times. One can also expect a second-round impact from the point of view of demand for Africa’s commodity exports due to currency realignment. The devaluation of currencies of some Asian countries that produce commodities in competition with Africa — e.g. oil palm — could result in lower demand for African exports because of higher costs in foreign currency terms of buying from Africa. So, Africa must take the necessary steps to remain competitive.

21. The Conference may wish to discuss and share experiences of the direct and indirect impact of the recent East Asian crisis on the economies of Africa, and more specifically, on trade and investment flows. The Conference may further wish to consider strategies for forestalling an East Asian-type crisis in Africa's financial markets in light of the likely increase in private capital flows to the continent in future. Additionally, the Conference may wish to discuss measures to prevent possible loss of markets due to more competitive agricultural products from East Asia, following recent currency devaluation.

22. At the international level, proposals are being debated on how to strengthen or reform the present international financial system to prevent a re-occurrence of further crises; to respond and resolve them quickly — should they occur, and to strengthen institutional mechanisms to best support stable global financial markets. Central to the crisis prevention debate is the question of fostering better policies and more effective institutions at the national level, including sound macroeconomic policies, robust financial systems and sound infrastructure — economic, social, governance, judicial, accounting, auditing and reporting. The issue here is how to develop and agree on international standards, principles and practices on all aspects of national policy and institutions that are judged to be of central importance for successful integration in the international financial system. A key element in the crisis response and resolution debate is the contentious issue of how to strengthen the international lender-of-last-resort function, while addressing moral hazard and ensuring that the private sector is sharing appropriately in the risks. Coping and transition issues for countries in crisis are also under active debate — provision of emergency financing, financial restructuring and mitigation of the social and human costs of financial crises. Institutional strengthening or reform has elicited hot and sometimes emotional debates, including calls — mostly by non-G-7 countries — to scrap the IMF and possibly start regional financial institutions to parallel the IMF. However no proposals have been comprehensively and openly debated; nor have alternative architectural forms of a possible new system been unveiled to the public by G-7 countries, which hold the trump card. The G-7 meeting in Cologne is expected to look at these issues.

23. An additional concern for Africa, in the debate on the possible new international financial architecture, is how to accommodate the legitimate need of poor developing countries for development financing in a situation of volatile trade, finance and capital markets. In this connection, the timing of the liberalization of the capital account is an issue of interest to Africa, as premature liberalization could prove disastrous to the development effort. Another concern should be the new stringent and streamlined reporting requirements under consideration by the IMF. The General Data Dissemination System (GDDS) and the Special Data Dissemination System (SDDS) are intended to foster transparency in financial flows under globalization. Currently, only South Africa is a participant in the systems, which are likely to become important disclosure mechanisms that private investors are likely to follow keenly in their decisions on where to invest. There is a clear need to widen Africa’s participation in the GDDS and SDDS. Already thin in statistical capacity, Africa will be hard pressed to comply with these requirements.

24. The Conference may wish to share views on the options — currently being debated in the international community — on how best to reform or strengthen the international financial architecture. Ministers may further wish to discuss and adopt a follow-up plan to make the voice of Africa heard in the deliberations. They may also wish to adopt a pro-active strategy for accessing bilateral or multilateral technical cooperation facilities to strengthen national and regional capacities for reporting international trade and financial flows in compliance with the new requirements to be applied by the IMF