Speech

Fostering Africa’s Economic Transformation through Innovative Financing

July 11, 2024

Thank you for the invitation and opportunity to address you this afternoon for the second edition of the Africa Economic Summit. It is a great pleasure to be back to Morrocco after the very successful IMF and World Bank Annual Meetings hosted by the Government of Morrocco last year in Marrakech.

As we gathered there almost a year ago, policymakers were discussing their worries regarding the brutal financing squeeze they were facing and its impact on their capacity to finance development needs.

This funding squeeze reflected several exogenous factors: the sharp tightening of monetary conditions; continued decline in official development assistance flows; and much reduced flows from China and other newer sources of financing. Playing of this, domestic financing conditions have also tightened.

And this has happened as countries were trying to recover from the hugely adverse that the Covid 19 Pandemic has had on livelihoods. To this day, there remain many countries in the region that have not reverted to the pre-pandemic output paths. As a counter point, most advanced countries already have of course.

Last but not least, the surge in cost of living, as elsewhere, has also been a source of huge dislocation in a region where poverty rates are already unbearably high.

In all, it has been and remains among the most difficult economic times for many African countries in a generation or more. And unless we find a way to deal with these challenges, more difficulties still are in store for our people. With the demographic dynamics underway globally, absent making sure that we devote the resources needed now to build human capital and help integrate Africa into the global economy, it is not just slower growth and development progress in the region that is in store but also a much weaker and less resilient global economy.

With the stakes this high, what are priorities and the financing options to promote Africa’s development progress?

At the outset, I want to ask for forgiveness for the generalizations I’m about to make. It is on account of the limited time I have been allotted. Our continent is of course highly heterogenous and the specific policies needed equally so. But there are some challenges that are quite prevalent in most countries, and the direction of travel required broadly similar.

In what follows, I will focus my remarks on: the objective of policies; the development financing options; and, very briefly, touch on the structural transformation challenge.  

Growth and Employment

To be clear, the focus of economic policymaking in our countries has to be to foster economic growth and employment.

Even if you take the fiscal challenge that many government’s in the region are facing at the moment, strong growth is the most critical remedy to eliminate imbalances, and, in particular, reduce debt ratios. For one, historically, large improvements in fiscal positions have taken place in the context of high growth. A growing economy means a growing tax base and greater revenue potential. For the average country in our Continent, an additional 1 percentage point of GDP growth could reduce the debt ratio by about 10 percentage points of GDP after 8 years (the average length of growth upswings in developing economies), provided that additional revenues are saved. This reduction in debt is double that of a typical fiscal consolidation (5 percentage points of GDP).

What reforms are needed? In the broadest of terms, two sets of reform areas are called for:

• Directionally, growth needs to be more private sector oriented. With rising fiscal pressures and public debt, the scope for further public-expenditure led growth witnessed in most countries in recent years is limited. To be clear, much more public spending is still required address human capital development, in particular, and address key infrastructure gaps. But the scope for growth to continue to be as heavily public-spending driven as it has in the recent past is now limited.
• Rather, growth needs to be more private sector driven. As such, a strong focus on eliminating policy-induced constraints to private sector investment growth would be a good starting point for reform. This could then also be complimented by reforms to improve the business environment.

Financing Development

The discourse on development financing often lacks precision and I am just as guilty of this. Take my reference above to the funding squeeze that countries are facing, it is not clear if I am referring to the private or public sector. Nor whether the financing required is to cover transitory (cyclical) pressures or more longer-term development needs. In the main, my focus here is on the financing options of the public sector over the long-term.[1] That is the spending needed to address pressing spending needs on health, education, infrastructure, etc.

Stepping back a bit, it is important to note that governments have three main sources to address their spending requirements:

• the amount of internal revenues (tax and non-tax) that they are able raise;
• access to market borrowing from either domestic or external sources; and
• any aid (grants or concessional borrowing) they have access to.

And by far the most important of these sources of financing public sector activities in practice are domestic (mainly tax) revenues. In sub-Saharan Africa, on average, close to four-fifths of total government spending is covered by such revenues. A further 17-18 percent by domestic and external borrowing, and just around 2 percent from grants and/or other concessional budget support. There is considerable variation around these average numbers. But this shouldn’t detract from the big picture here: the importance of internal resources, and taxation at that, as by far the most and enduring source for countries for addressing their development financing needs.

But increasing tax mobilization is, to put it mildly, a difficult endeavor. We have seen this already over the last decade or so in the region. Countries have done much to invest in human capital and improve public infrastructure. But for political, economic, and technical reasons, they have found it very difficult to capture the returns on these outlays through their tax systems. Hence, the ratio of interest payments on debt to tax revenues has continued to drift upwards in country after country—with the median doubling to 12 percent in just a decade—leading to crowding out of critical spending and heightened debt vulnerabilities that we are seeing in the region.

Turning to market borrowing will always be a limited source of financing development. Starting with external borrowing, access to such flows is expensive and inconsistent as recent experience shows. As such, it can only account for a small share of the government’s funding mix. Domestic borrowing is something that governments in the region have been relying on more and more in the region, to the point where domestic debt now accounts for about half of the public debt stock. With further financial deepening, this can be an important source of supporting development. But such deepening is a gradual process, bounded by limited national savings in most cases.[2] There is a large and still unresolved literature that seeks to explain why some countries save more than others. Many accounts focus on demographics. Others center on market-friendly institutions.

So far then, my remarks have been all about the ways in which financing options are constrained. Is there no way to make progress? At the margin, there is, and will highlight those in a moment. But it is also important to be clear-eyed about the difficult, difficult balancing act facing countries.

Where there is perhaps the greatest scope to create fiscal space to engender development progress and structural transformation in the near term are:

• For the poorest countries and those impacted by fragility and/or conflict, more budget grant support from the international community is what is needed. The tax mobilization and borrowing constraints are greatest for this set of countries. And development progress without much additional grant or near-grant like support is likely to be limited. Of course, such resources should be provided subject to transparent and effective use of the resources. To gauge this, more focus could be made on outcome (rather than input) based indicators—e.g. human development indicators, infrastructure access, etc improvements.

• For most other developing countries, access to ample concessional financing will be important. This should be provided subject to graduation expectations as per capita incomes increase and development indicators improve.

Now I appreciate that these suggestions go against the recent trends in official development assistance. As I noted above, both grants and concessional resources have withered in recent years. But this does not make the decline in such flows rationale. The case for investment by the international community in global public goods needs to continue to be made forcefully. And I see development progress in Africa, particularly given the demographic changes underway, as important a global challenge as climate change for the future of well-being of mankind and our planet.

Turning to measures more under the control of the region’s policy makers to generate more financing alternatives, I want to suggest one important area worth exploring: private finance of large infrastructure projects. At the moment, the private sector plays a somewhat limited development role—public entities carry out 95 percent of infrastructure projects in sub-Saharan Africa, and despite the continent’s clear potential, Africa attracts only 2 percent of global foreign direct investment. Further, when investment does go to Africa, it is predominantly in natural resources and extractive industries, much less so, towards roads, or the power sector.

To attract private investors and transform the way Africa finances its development, an improved business environment is critical. And beyond this, taking into account the long-term and risky nature of some large infrastructure projects (for example, requirement of large upfront costs while returns accrue only over long periods of time) consideration could also be given to providing incentives for such investments. While these can be costly, the truth is, many projects in development sectors may simply not happen without them. In East Asia, 90 percent of infrastructure projects with private participation receive some government support. Now, there are ways in which governments can maximize impact while minimizing risks and costs. For example, any incentives should be targeted, temporary, and granted on the basis of clear market failures. It should also be transparent, leave private parties with sufficient skin in the game, and should focus tightly on worthy projects that would not happen otherwise.

Here I should say a bit what we at the IMF have been and are doing to support countries. And two aspects of our support to the region are worthy of note:

• First, since 2020, we have provided the Continent with record sums of financing, much of which has gone directly to attenuate the toll exacted by adverse shocks. This includes some: US$34 billion in liquidity support (from the 2021 SDR allocation); emergency lending of US$32 billion; US$40 billion committed to support countries reform programs (of which US$13 billion have been disbursed already); $693 million in debt service relief through the Catastrophe Containment and Relief Trust (CCRT) for 29 countries; and some US$1.6 billion in debt relief for Somalia and Sudan under the Heavily Indebted Poor Countries (HIPC) Initiative for over US$1.6 billion.

• Second, we have established a new trust—the Resilience and Sustainability Trust amounting to US$42 billion, supported by rechanneling SDRs from countries with strong balance of positions. As far as I have been able to trace, this is the single largest source of incremental climate financing to support countries’ mitigation and adaptation efforts. 13 countries are already benefitting from this trust on the Continent.

Structural transformation

I would be remiss not to talk a bit about structural transformation. The focus of the symposium is after all just that, and innovative financing the means to achieve this.

Even where growth has been sustained over many years, and it has in many countries in the region, there is a strong sense that it has not been accompanied by significant structural transformation. And perhaps by far the most important metric of this is the still high share of labor in mainly non-tradable and/or low-productivity endeavors across the region. This has not changed much across the region. Certainly, there are a few activities where convergence to the global frontier has been impressive—fin tech, comes to mind. But in agriculture, manufacturing, industry, and many service sector areas there has not been rapid enough transformation.

The question is how best policymakers facilitate quicker structural transformation with limited resources. And with many experts on these issues here that can contribute more, I will make just two brief points as to what I think is needed:

• Investment in infrastructure services that lower transaction costs for production and international trade, notably reliable electricity supply and transport connectivity.

• Reforms that promote export competitiveness. One of the frustrating things to see over the years in the region has been the extent to which excessively overvalued exchange rates have undermined export growth. Even in the years of ample capital inflows, this was problematic enough. With the dearth of external financing that is in prospect, avoiding this is something that has to be avoided at all costs.

Concluding thoughts

In all, a very difficult juncture.

But I remain optimistic about the region’s prosects. I returned to my country in 1992 as a would-be technocrat at a similarly difficult time for the region. And if anybody had said to me then that Accra, Kampala, and Addis would 30 years on look anything like what they do today, I would have thought they were under the influence of more than just a cup of strong Ethiopian coffee. And the changes go well beyond just the shiny new buildings that we see in these cities: there has been fundamental development progress that has shifted the opportunity set of a generation. I have no doubt that, from this stronger foundation, progress over the next 30 years will be more remarkable still. But only if, as the generation of policy makers from the 1990s did, we take the necessary bold decisions.

[1] Although if going forward growth is to be more private sector led, more attention is needed on all the ways that the domestic private sector has raise more resources for investment.

[2] As Arthur Lewis, some 70 years ago, explained: The central problem in the theory of economic development is to understand the process by which a community which was previously saving and investing 4 or 5 per cent of its national income, converts itself into an economy where voluntary saving is running at about 12 to 15 per cent of national income…We cannot explain any ‘industrial’ revolution until we can explain why saving increased relatively to national income.