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Finance & Development
A quarterly magazine of the IMF
December 2006, Volume 43, Number 4

Right Time for Africa
Abdoulaye Bio-Tchané and Benedicte Vibe Christensen

Africa needs to build on its recent success to catch up

Africa has come a long way. For decades after independence, countries in sub-Saharan Africa (SSA) suffered from civil strife and "stop-go" economic policies that led to macroeconomic instability and high inflation. Roads, railways, ports, and electricity systems fell into disrepair. Nor was the external environment always cooperative: countries were exposed to droughts, and commodity prices fluctuated. Countries that were rich in natural resources such as oil, gold, copper, and diamonds were often subject to the "resource curse" that left large numbers of their people worse off. External donors, while supporting the continent, did not always finance projects that would have adequate economic returns or that responded to local development needs. In country after country, debt mounted until it became unsustainable. On top of all that, Africa was besieged by malaria and HIV/AIDS, which had devastating economic as well as human effects.

Yet things seem to be changing for the better throughout the subcontinent. In most African countries, leaders are now selected through democratic elections. The decision-making process is becoming more participatory and involving greater segments of civil society. The number of countries in crisis has declined, although conflict persists in some countries and regions. The pursuit of strong macroeconomic policies and economic reforms is bearing fruit: economies are growing faster and more steadily than before, and inflation is falling. Record levels of reserves in both oil-producing and oil-importing countries act as a cushion against external shocks, such as the recent increase in oil prices. Countries pursuing economic reforms have benefited from unprecedented amounts of debt relief from a wide variety of sources. In addition, the international community has promised a significant scaling up of aid resources in the years to come, offering African countries a fresh chance to free up resources and invest in human and fixed capital to promote sustainable growth. These changes have not gone unnoticed abroad. Foreign investors are showing increasing interest in the African continent, both in the domestic debt markets and in direct investment in the extraction of natural resources.

The change in the economic environment owes much to the vision now embedded in the New Partnership for Africa's Development (NEPAD), adopted by the African Union in July 2002. It presents a vision of how Africa, in close partnership with international donors, assumes responsibility for its own development. In support of its governance objectives, NEPAD adopted the African Peer Review Mechanism, which measures progress in terms of political, economic, and corporate governance.

The challenge for African policymakers now is to carry this vision forward. While economic growth has accelerated in many countries, it still needs to translate into greater improvement in the living standards of the broader population. Governments face a dilemma. With unprecedented amounts of debt relief from multilateral and bilateral donors and promises of a scaling up of aid from the international community, which have yet to materialize, the populations hold great expectations for better education and health services, as well as for improvements in infrastructure such as roads, ports, and energy. At the same time, governments have to make sure that increased spending is consistent with absorptive capacity and with maintaining the progress in macroeconomic stability and low inflation, and they must avoid a repetition of past mistakes of misallocation of budgetary resources. This requires a tightrope balancing act.

The improvement in debt sustainability and in the economic situation is also attracting many new lenders, both private and official. Governments are tempted to contract new loans on nonconcessional terms if they cannot meet the needs for greater spending from available concessional resources. At the same time, they need to be very cautious in assuming new nonconcessional loans so as to safeguard debt sustainability. They must also be mindful of the conditions for such lending—for example, ties to bilateral trade or the mortgaging of future exports for repayment. Similarly, on foreign direct investment, whether in natural resources or in other sectors, governments should be careful about granting tax or other concessions, which might be a drain on future income.

These are formidable tasks and challenges, calling for strong governments and institutions. They also call for assistance from the international community, on both capacity building and financial assistance, consistent with each country's own development agenda. If properly implemented, the reforms hold the potential for making a big difference in the lives of people on the African continent.

Strong performance

Viewed over the longer term, Africa's recent growth performance is impressive (see Chart 1). Growth in real GDP in SSA was about 5 percent in both 2005 and 2006 and is projected to pick up to almost 6.0 percent the following year—its strongest performance in decades. Africa's oil exporters, such as Angola, Equatorial Guinea, the Republic of Congo, and Nigeria, have naturally gained from higher oil prices and increased production, but growth is equally strong in oil-importing countries. What is striking compared with the past is that growth is broad-based: half the oil-importing countries can expect to see growth of over 5 percent for both 2006 and 2007.

Chart 1. Right track

Strong global growth has raised the demand for Africa's exports. The economic booms in China and India have helped increase the demand for a range of commodities produced by SSA, including copper, iron, and gold, as well as oil, and have pushed up their prices. Countries that do not export commodities have still benefited from the favorable global growth environment, and aid inflows (including debt relief) have helped cushion the impact of adverse shifts in their terms of trade.

But while this good news translates into growth in per capita income of about 3 percent—well above the 0.8 percent average for 1997–2001 (see Chart 2)—it is far short of the 5 percent rate SSA needs if it is to achieve the Millennium Development Goal (MDG) for income that aims to halve by 2015 the proportion of the population in 1990 living on less than $1 a day. The recent growth surge has helped undo the increase in poverty that many countries experienced in the 1990s, but it will take time before the net gains are significant. Meanwhile, progress toward the other MDGs is imperiled; at least 40 percent of the countries in SSA are not expected to meet the health and education goals (see Chart 3).

Chart 2. Reversing setbacks

Chart 3. Still lagging

Where is growth coming from?

What explains the improvement in growth? To begin with, evidence suggests that more investment is reaching SSA's poorer countries, including oil-importing countries that are benefiting from the Heavily Indebted Poor Countries (HIPC) Initiative and the Multilateral Debt Relief Initiative (MDRI) (see Chart 4). By contrast, investment in oil exporters is falling as a share of GDP, as major oil sector investments are completed, though rapid GDP growth in Africa's oil exporters means that investment there is still very large.

Chart 4. New beneficiaries

Countries where growth has improved have tended to have more macroeconomic stability and higher levels of trade as a share of GDP. Since productivity is the only source of sustained growth in incomes, it is noteworthy that the countries growing more rapidly are those that have had faster growth in total factor productivity (TFP). For instance, rapidly growing countries had TFP growth of 2.3 percent in the second half of the 1990s, compared with 0.7 percent for medium growers and negative TFP growth for slow growers. The financial sectors of the fastest growers also became better established, with banks more widely used.

Fortunately, growth has not come at the expense of macroeconomic stability. Inflation has been trending downward in SSA since early in this decade—an achievement that is especially noteworthy considering that oil prices have been rising steadily the whole time (see Chart 5). Inflation of about 12 percent is expected for the region as a whole in 2006—and just 7 percent if Zimbabwe is excluded from the calculation. True, inflation has edged up a little from its low in 2004 because of the pass-through impact of higher oil prices. But the past plague of persistently rising inflation has been avoided—a major benefit also to the poorest segments of the population.

Chart 5. Watching prices

Oil exporters are saving a relatively high proportion of the increased oil revenue; given the limits on domestic capacity to absorb large inflows effectively, saving is prudent. Oil importers still have deficits—the average deficit in 2006 is expected to be 4 percent of GDP—but the deficits have been consistent with improved macroeconomic stability because of a switch to concessional financing. When grants or concessional loans have been available, countries have had room to substantially increase deficits to achieve spending priorities. For example, Burundi, The Gambia, and Madagascar have seen deficits increase since 2002, but without the additional inflation or crowding out that sole reliance on domestic deficit financing would have implied. Had governments chosen to spend more on subsidies for petroleum products rather than allow price rises to pass through to retail prices, the fiscal space (that is, the government's leeway to spend on health care, education, and other social indicators) would have been substantially compressed.

Barriers to growth

So far, the recent improvements are making only slow inroads in reversing the prolonged divergence between SSA and other regions of the world. Asian countries that in the 1960s had per capita incomes similar to SSA's have since made the transition to middle- or high-income status. SSA's share of world trade, which declined from 4 percent to 2 percent over three decades, is only now showing a slight upturn. Standard indicators of financial depth are much lower in SSA than in other developing regions. Lack of infrastructure has also slowed growth. To reverse these trends, reforms in many areas are necessary, including to improve the investment climate, implement trade and financial sector reforms, and build institutions.

Investment climate. Africa has a long way to go in promoting private sector activity. The World Bank's report Doing Business 2007: How to Reform ranked 175 countries on the ease of doing business; the average rank of an SSA country was 131. There are obstacles throughout the range of private sector activity: licensing, employment, credit, and transactions with the government. For instance, it takes an average of 11 procedures to start a business in SSA compared with 8 in South Asia; it takes two months as opposed to one in South Asia; and it costs three times as much in terms of income per capita.

Despite the recent uptick, investment in SSA measured as a share of GDP is no higher than it was in the early 1990s. Foreign direct investment in SSA, other than in oil-exporting countries and South Africa, is still low, although South Africa has become a growing source of inward investment flows to other parts of SSA, and investment from China and India is picking up. Private sector development in SSA continues to be deterred not only by the costs of doing business, which range from administrative complexities to corruption and cumbersome legal systems, but also by the expense of such critical business services as telecommunications and energy. These costs are reflected in the region's poor showing in global business surveys, such as the World Bank's investment climate indicators. However, the Bank has also found that SSA has begun to reform business regulation: two-thirds of SSA countries made at least one positive reform in 2005–06. Tanzania and Ghana ranked among the top 10 reformers in the world, and planned reforms elsewhere should further reduce business costs throughout the region (see "Taking Care of Business" on page 30 in this issue).

Trade liberalization. The trade landscape has changed. Traditionally, African trade policy was directed at achieving preferential access to industrial country markets. However, the value of trade preferences has been significantly eroded as global tariffs fall and regional trade arrangements (RTAs) proliferate. Past sources of growth in trade with industrial countries (for example, textiles) that depended on specific preferences are diminishing in importance. But while Africa is still hampered by the agricultural policies of industrial countries, it is well positioned to benefit from the high global demand for commodities. In fact, rapidly growing Asian countries, such as China and India, already constitute significant export markets for African products, and their importance will increase in coming years.

Countries in SSA have also been emphasizing intraregional trade, especially through RTAs, though these risk diverting trade from partners outside the RTAs. Even though the Doha Round trade negotiations have been suspended, African countries would benefit from promoting trade liberalization as a way to enhance efficiency. Pending a successful multilateral round of trade negotiations, the best approach to trade liberalization is to reduce trade barriers on a nondiscriminatory basis by opening domestic markets to all trading partners. Meanwhile, SSA should streamline existing RTAs, which are overlapping and often contain inconsistent commitments for countries, and make a concerted effort to reduce tariffs against countries outside the RTAs (see "Unblocking Trade" on page 22 in this issue).

Financial sectors. Financial sectors in SSA countries have improved greatly since the 1990s:

  • Chronically weak banks, often publicly owned, have been strengthened or closed down.
  • Interest rate controls have been removed in many countries.
  • Government-directed lending has been greatly reduced.
  • Compliance with international financial standards is much better.

Still, on standard indicators of financial depth, SSA countries lag far behind other developing countries. For example, bank deposits as a share of GDP in low-income SSA countries are half the level of other developing regions. Also, SSA economies have tended to become more cash intensive over time, exactly the opposite of what would be expected if financial intermediation were becoming more sophisticated. Some SSA banks still persistently violate international banking regulations, especially those that pertain to diversification of risk (see "Bankable Assets" on page 18 in this issue and "Adding Depth" in F&D, June 2006). Interest rates on loans are very high, in part because banks are reluctant to expand their domestic lending portfolios, preferring to accumulate substantial holdings of bonds, loans to large corporations, and foreign assets. Reflecting the poor coverage of the formal banking sector in rural areas, informal finance is expanding, though from a very small base.

Although there is continuing debate about the effectiveness of some reforms, there is considerable evidence that certain bottlenecks do suppress the dynamism of the financial sector. Among them are the excessive reliance on regulatory monetary instruments (such as reserve requirements imposed on banks), the lack of reliable sources of information on potential bank borrowers, inadequate land titling that restricts the use of collateral, and legal systems that do not yet accommodate the emergence of financial instruments like leasing. Because financial sectors in SSA are small, it is also important to exploit the opportunities of larger size where possible, for example through better financial integration in existing monetary unions.

Capacity. More than any other region, Africa is handicapped by its inability to implement economic policies. Any effort to support development has to focus on strengthening institutions by providing training and technical assistance to build local capacity; the IMF has contributed to this effort with the establishment of regional technical assistance centers (AFRITACS) in sub-Saharan Africa. Governments need to supplement this effort by making the civil service more effective. Donors providing technical assistance need to better coordinate it with the countries, which should be in the driver's seat. Strong institutions will also help prevent backsliding in economic reforms, thereby supporting sustainable growth.

Managing resource inflows

How can the region ensure that increased resource inflows, whether from oil and other commodities or from scaled-up aid, are used effectively? Oil exporters are now in the fourth year of an earnings surge, and low-income oil importers should see higher aid inflows as the 2005 Gleneagles Agreement on boosting aid from industrial countries is implemented. Debt relief from the enhanced HIPC Initiative and the MDRI has already freed up domestic resources in a number of countries that would otherwise have gone to pay debt service. However, the promised scaling up of aid from the international community still has to materialize.

Each country will have its own list of priorities for the use of these resources, but all are likely to emphasize infrastructure and the social sectors. It is vital that this new spending translate into better service delivery than has been achieved through past efforts. Indeed, as these countries progress toward the MDGs, making current spending more efficient will be complementary to the wise allocation of new spending.

A prerequisite for efficiency is a system of public expenditure management that ensures transparent spending and makes it possible to monitor the disbursement of funds at all levels of government, reducing opportunities for corruption. The World Bank and the IMF help countries conduct diagnostic assessments of their public expenditure management systems and, where necessary, support plans to strengthen them. More broadly, the IMF promotes transparency by encouraging country participation in the General Data Dissemination System, which is designed to strengthen national statistical systems, and the Extractive Industries Transparency Initiative. These measures strengthen checks and balances and facilitate budgetary decision making.

African countries will also be concerned with the macroeconomic consequences of resource inflows, in particular their implications for export competitiveness through their impact on the real exchange rate—the Dutch disease issue. It is important to enhance an economy's supply response to build the country's capacity to absorb higher aid and debt relief. Policymakers may also give growth a pro-poor tilt by avoiding biases against agriculture and undertaking public expenditure to reduce productivity bottlenecks. With appropriate policies, Dutch disease effects can be mitigated, the poor will benefit from higher growth, and services to the poor can be delivered more efficiently.

As the benefits of multilateral debt relief begin to flow, countries in SSA should also take care to avoid accumulating new debt. It is critical that they preserve their hard-won debt sustainability and avoid repeating past experience with nonconcessional borrowing. When concessional debt is accessed, it is important that the terms be transparent so that its implications for sustainability are well understood. The IMF has prepared a handbook on the macroeconomic consequences of scaled-up aid and is working with African countries to incorporate higher projected aid flows into their programs with the IMF. Such planning is more effective when donors deliver their assistance more predictably, do not overburden recipient country capacity, and align their grants with country plans for reaching the MDGs.

Moving forward

The improved economic performance in SSA is encouraging, but the region still has a lot of catching up to do if it is to achieve the MDGs. The current global environment offers opportunities for growth on which to build. A forward-looking reform agenda should aim to maintain macroeconomic stability, improve the business climate, strengthen the financial sector, promote trade, and, most important, strengthen fiscal institutions and improve governance generally. The international community, for its part, has to fulfill its commitment on scaling up aid to Africa. While the scope of the agenda is challenging, success in effecting it would offer enormous opportunities for gains for the people of the region.

Abdoulaye Bio-Tchané is the Director and Benedicte Vibe Christensen a Deputy Director of the IMF's African Department.