S. Ibi Ajayi and Mohsin S. Khan
It is generally expected that developing countries, facing a scarcity of capital, will acquire
external debt to supplement domestic saving. The rate at which they borrow abroad—the
"sustainable" level of foreign borrowing—depends on the links among foreign and domestic
saving, investment, and economic growth. The main lesson of the standard "growth with debt"
literature is that a country should borrow abroad as long as the capital thus acquired produces a
rate of return that is higher than the cost of the foreign borrowing. In that event, the borrowing
country is increasing capacity and expanding output with the aid of foreign savings.
In theory, it is possible to calculate the sustainable level of foreign borrowing, based, for
example, on the terms, maturity, and availability of foreign capital. In practice, however, the task
is nearly impossible, since such information is not readily available. Thus, various ratios, such as
that of debt to exports, debt service to exports, and debt to GDP (or GNP), have become
standard measures of sustainability. Even though it is difficult to determine the sustainable level of
ratios, their chief practical value is to warn of potentially explosive growth in the stock of foreign
debt. If additional foreign borrowing increases the debt-service burden more than it increases the
country's capacity to carry that burden, the situation must be reversed by expanding exports. If it
is not, and conditions do not change, more borrowing will be needed to make payments, and
external debt will grow faster than the country's capacity to service it.
Countries in sub-Saharan Africa have generally adopted a development strategy that relies
heavily on foreign financing from both official and private sources. Unfortunately, this has meant
that for many countries in the region the stock of external debt has built up over recent decades to
a level that is widely viewed as unsustainable. For example, in 1975 the external debt of
sub-Saharan Africa amounted to about $18 billion. By 1995, however, the stock of debt had risen
to over $220 billion. The standard ratios reflect this huge buildup of debt. The region's aggregate
debt-export ratio rose from 51 percent in 1975 to about 270 percent in 1995 (excluding South
Africa, the ratio was above 300 percent). For all low- and middle-income developing countries,
the average ratio of debt to exports was less than 150 percent. Similarly, the debt-GNP ratio for
sub-Saharan Africa was 14 percent in 1975, but by 1995 it had reached more than 74 percent.
Although debt-service ratios have remained relatively low because of the highly concessional
nature of external financing provided to Africa, many countries in the region have been unable to
service their debt without recourse to rescheduling under Paris Club arrangements or by
The massive growth in external debt in sub-Saharan Africa over the past two decades has
given rise to concerns about the detrimental effects of the debt on investment and growth,
principally the well-known "debt overhang" effect. Furthermore, there is now considerable
evidence that the buildup in debt was accompanied by increasing capital flight from the region. In
other words, sub-Saharan Africa was simultaneously an importer and an exporter of capital.
What is the relationship between foreign borrowing and capital flight? Two hypotheses have
gained currency in the literature. First, there is the straightforward view that it is the government
that engages in foreign borrowing while the private sector shifts its funds abroad. This theory
undoubtedly has some validity, since the bulk of financing to Africa has been contracted by
governments and comes from donor countries and multilateral agencies. And of course capital
flight is purely a private sector activity. The drain of foreign exchange resources through capital
flight creates a greater need for governments to borrow abroad.
A second hypothesis, proposed originally by Khan and Ul Haque (1985), argues that the
perceived risk of investment in developing countries is higher than that elsewhere. Residents of
developing countries can expect risk-free compensation for the additional risk on their investment
at home; Khan and Ul Haque (1985) describe this risk as "expropriation risk." That is, domestic
residents face the possibility that their assets may be expropriated by the government, through
outright nationalization, taxes, or exchange controls, whereas the risk on similar assets held
abroad is negligible. An exogenous or policy-induced shock that raises the perceived level of risk
could therefore result in capital flight; at the same time the government would be forced to go
abroad to obtain financing to cover not only the original imbalance but also the loss of resources
through capital flight.
It is useful to consider what governments can do in a situation of foreign borrowing and
capital flight. Obviously, providing a stable financial and macroeconomic environment would
reduce domestic uncertainty. Experience has shown that foreign borrowing and capital flight were
most pronounced in those countries that had higher and more variable rates of inflation, larger
fiscal deficits, and overvalued currencies. These factors produced the incentives for governments
to overborrow and for domestic investors to shift their funds abroad. Adopting sound
macroeconomic policies would thus seem to be a key element in reducing reliance on foreign
savings and in inducing capital flight. This strategy, as pointed out by Fischer,
Hernández-Catá, and Khan (1998), is increasingly being followed by a number of
The international economic community can also play an important role in lowering the debt
burden of sub-Saharan African countries. Recognizing this, the IMF and the World Bank in late
1996 implemented the Heavily Indebted Poor Countries (HIPC) Initiative, to help remove the
debt overhang and restore the sustainability of the debt of eligible countries within a reasonable
time frame. The HIPC Initiative stipulates that, after a three-year track record of effective
economic reform under an IMF-supported program, the international financial community,
including the IMF, the World Bank, and official creditors, will provide sufficient debt relief to
reduce the external debt to sustainable levels, subject to the recipient country completing a further
three-year period of strong policy performance. Once the process is under way, it is expected that
eligible countries will exit from debt rescheduling and be in a position to tap global capital
markets. Steps were taken in 1997 to implement the HIPC Initiative for four countries in
sub-Saharan Africa: Burkina Faso, Côte d'Ivoire, Mozambique, and Uganda.
To address the twin issues of external debt and capital flight in sub-Saharan Africa, it is
necessary to understand the nature of the problem at the country level. The chapters in this
volume represent an attempt to provide such an analysis for a selected group of sub-Saharan
African countries at different times in the 1990s. All of these studies were sponsored by the
African Economic Research Consortium (AERC) and are brought together here to compare and
contrast the experiences of different countries. The chapters are grouped into two parts. The five
chapters on external debt cover Nigeria, Ghana, Uganda, Kenya, and the sub-Saharan African
countries as a group. The other four chapters, on capital flight, examine the experiences of
Nigeria, Uganda, Tanzania, and Kenya.
The chapters on external debt deal with the following common set of questions:
- What is the size of the external debt, and how has it evolved over time?
- What is the composition of the debt, particularly between official and private sources?
- What were the causes of the buildup in the debt?
- What are the effects of the debt on domestic economic
In a similar vein, the chapters on capital flight look at the following questions:
- How is capital flight measured?
- What is the magnitude of capital flight?
- What are the conduits of capital flight?
- What are the causes and consequences of capital flight?
- How can capital flight be stemmed or reversed?
Chapter 2, by S. Ibi Ajayi, examines Nigeria's external debt, including its size, structure,
source, type, and composition. The chapter analyzes the indexes for measuring the debt burden
and examines alternative debt scenarios. It distinguishes between the internal and external factors
influencing external debt accumulation, identifies the changes in the international environment
necessary to alleviate the debt burden, and examines the relationship between export performance
and the debt burden. After reviewing the structure of the Nigerian economy and its political
history, the chapter concludes that Nigeria's debt crisis is the result of structural defects inherent
in the economy since independence. The chapter finds that the indicators of the debt burden have
been relatively high. The behavior of these indicators, under varying assumptions, are explored
using a growth-cum-debt model. The external and internal causes of debt accumulation are tested
econometrically, and the results show the most important variables to be the real effective
exchange rate and the terms of trade. The chapter ends with some policy prescriptions for dealing
with the debt crisis.
In Chapter 3, Barfour Osei focuses on the implications of Ghana's external indebtedness for
sustained economic growth. The study attempts to provide a better understanding of Ghana's
external debt problem in order that adequate and effective debt measures can be sought. The
chapter contains a description of the main features of Ghana's external debt, including its size,
type, sources, structure, and terms. The chapter also assesses the sustainability of the external
debt and evaluates its impact on the country's economic growth. The focus of the analysis is on
external debt in the period 1983–90, during which Ghana pursued an economic recovery
program and adopted an IMF-approved structural adjustment program. Using various indicators
of the debt burden and concentrating on two of these, the debt-service ratio and the debt-GNP
ratio, the author finds that the external debt burden has been at critical levels since 1983. This
situation can be attributed directly to the country's inability to generate sufficient foreign exchange
through export earnings, and to the low rate of return on investments to which borrowed funds
are applied. Although it has continued to service its debt, Ghana has maintained an unstable fiscal
stance. The chapter concludes that debt is one of the factors constraining the rapid growth of the
Ghanaian economy. To continue to service its debt, Ghana needs to pursue programs of export
expansion, widen the base of its nontraditional exports, and introduce measures to increase
Chapter 4, by Barbara Mbire Barungi and Michael Atingi, analyzes Uganda's external debt
problem and its implications for sustainable growth. The chapter examines the size of Uganda's
external debt, empirically assesses the internal and external factors influencing external debt
accumulation, and analyzes the country's debt-servicing capacity and the sustainability of its
external debt. A special effort is made to link debt to economic growth. Major findings are the
acuteness of the debt-servicing obligation of the country and the fact that a large proportion of
Uganda's debt is not eligible for rescheduling. Of great concern is whether the economy can
sustain a growth rate of 5 percent per year while maintaining adequate domestic investment, given
the heavy reliance on foreign capital inflows. Debt payments have been identified as the
fundamental cause of slow economic growth. Debt relief is not enough, and continued
government commitment to structural reforms and sound debt management is essential. Although
the need to continue with the ongoing restructuring of the economy and promote further growth
is clear, whether Uganda can keep to this challenging path without accumulating more external
debt is not so apparent.
In Chapter 5, N.K. Ng'eno analyzes the case of Kenya, focusing on the extent of the debt
problem, including the size, structure, and sources of the stock of debt. The causes of the external
debt problem are separated into external and internal factors. Additionally, the available debt
management strategies are discussed, and the sustainability of Kenya's debt is highlighted. The
chapter notes that the external debt of Kenya and the indicators of the debt burden have been very
high since 1980. The external causes of the debt burden are identified as the deterioration in the
terms of trade and the worldwide recession, whereas the main internal causes are public sector
deficits and exchange rate misalignment. To calculate the sustainability of Kenya's debt, two
solvency indexes were calculated using the debt-export and debt-GNP ratios. The chapter claims
that the external debt of Kenya is sustainable.
Chapter 6, by Milton A. Iyoha, begins with an analysis of the poor performance of
sub-Saharan Africa since the onset of the external debt crisis in 1982. After an analysis of the
scope, nature, and severity of sub-Saharan Africa's external debt, the chapter uses a simulation
approach to investigate the impact of external debt on economic growth for the region. In
particular, it undertakes policy simulations (using alternative debt reduction scenarios) to analyze
the effect of the external debt on investment and output in sub-Saharan Africa for the period
1970–97. The chapter concludes that there is a significant debt overhang as well as a
crowding-out effect. In other words, the large stock of external debt and heavy debt-service
payments have had depressing effects on investment. From the policy simulations under
alternative debt stock reduction scenarios, the chapter concludes that debt reduction measures
bring about corresponding reductions in the total debt stock, the debt-GNP ratio, and the
debt-service ratio and have positive impacts on investment and growth of real GDP.
In Chapter 7, S. Ibi Ajayi examines the magnitude and conduits of capital flight from Nigeria
in the period 1970–88 using alternative measurement methodologies. The chapter identifies
the main macroeconomic and other factors responsible for capital flight, considers the major
consequences of capital flight on the domestic economy, and examines the linkages between
capital flight and external debt. The data indicate that Nigeria's capital flight may be episodic. For
example, there is evidence of more capital flight in the oil boom years than in other years. And
even though there seems to have been more capital flight during the military era, it is difficult to
come to any conclusions as to whether capital flight actually occurred more under the military
than under a civilian regime, not only because the military has been at the center stage of
governance since independence, but also because the economic fortunes of Nigeria were not the
same under the two regimes. The chapter also discusses different causes of capital flight. The
mechanisms of capital flight identified include monetary instruments, bank transfers, precious
metals and collectibles, misinvoicing of trade transactions (usually involving the local affiliates of
multinational companies), and transfers by business owners engaged in international trade through
the black market and through commissions and agents' fees. The chapter examines the linkage
between capital flight and external debt and examines policies for containing capital flight.
In Chapter 8, Razaq A. Olopoenia estimates capital flight from Uganda for the period
1971–94, during which Uganda experienced both economic and political crises as well as
regime changes. Various definitions of capital flight and their implied measures are used in the
study. From the estimates, eight variants of capital flight measurement are derived, four of which
are based on the concept of normal capital outflows whereas the other four are based on the
concept of unrepatriated external earnings. All the estimates indicate fairly significant levels of
capital flight during the period covered. The estimates also indicate variations in the degree of
capital flight that reflect changes in the economic and political situations in the country.
Substantial capital outflows are reported for the periods 1971–74, 1976–79, and
1981–87. These periods were characterized by political and economic instability. Reverse
capital flows have been observed during the 1990s (except for 1994), when both political and
economic conditions improved. The stock of residents' external assets ranged from 5 percent of
the external debt stock in 1971 to 86 percent in 1979. The ratio declined consistently from 1988
to 1993, however, when it fell to 30 percent, less than half its 1987 level. Attempts to identify the
factors that influence the flow of capital were not encouraging. The regression model identified
the rate of inflation as the only statistically significant variable influencing capital flight. This might
be associated with the way the measurements have been derived and the poor quality of the data.
Chapter 9, by Timothy S. Nyoni, focuses on capital flight from Tanzania during the period
1971–93. Given the controversy surrounding the definition of capital flight, the author
chooses to define capital flight as all resident capital outflows rather than abnormal outflows only.
Resident capital outflows from Tanzania are measured by three approaches: the balance of
payments, the residual, and cross-border bank deposits. The chapter argues that the Morgan
Guaranty Trust measure is preferred, since it is more comprehensive and dominates the other two.
Important mechanisms of capital flight include corruption, trade misinvoicing, and smuggling.
From the econometric analysis, the main cause of capital flight in Tanzania is the differential
between the growth rates of the United Kingdom and Tanzania. Other influences include domestic
inflation, external and political shocks, lagged capital flight, and parallel-market premiums. The
chapter concludes that, to control capital flight, it is important in the first instance to get the
macroeconomic fundamentals right.
Finally, in Chapter 10, N.K. Ng'eno analyzes the magnitude of capital flight in Kenya using
different methods of estimation and empirically determines the causes of capital flight, with an
emphasis on the role of macroeconomic variables. The author concludes that the World Bank and
Morgan Guaranty Trust methods provide the best estimates for Kenya. By these estimates, capital
flight peaked in the years of balance of payments crisis, implying that capital flight was used to
hedge against the poor economic conditions. Trade misinvoicing is a problem in Kenya. Evidence
from the study shows that underinvoicing of imports is greater than underinvoicing of exports,
suggesting that trade policy plays a role in the misinvoicing of trade. Using a simple regression
model, the chapter finds that a real appreciation of the currency encourages capital flight. It also
suggests that, in the absence of credible reforms, growth of the economy would lead to increased
capital flight: the increase in incomes would simply provide the means for increased accumulation
of foreign assets. Appropriate macroeconomic policies are the principal way to reduce capital
In summary, the chapters in this volume provide a wealth of data and some useful insights for
individual sub-Saharan African countries on external debt and capital flight. What emerges from
the studies on external debt is that the authors generally consider the size of the debt, in all the
countries considered, to be so high as to be unsustainable. All the authors view policies of debt
reduction as unambiguously good, in that reducing the debt burden would yield positive benefits
in terms of both investment and growth. In addition, all the countries studied experienced
large-scale capital flight, caused mainly by inappropriate domestic macroeconomic policies. Thus,
the remedy for capital flight would be the adoption of sound macroeconomic policies, including
lower fiscal deficits, reduced monetary expansion, positive real interest rates, and an appropriately
valued exchange rate. All in all, the sub-Saharan African countries require international assistance
to get control over their external debt burden, and they need to follow sensible domestic policies
to limit the loss of critical foreign exchange resources through capital flight. By 1997 it was
already evident that this type of strategy was emerging in a few sub-Saharan African countries.
This process clearly needs to be strengthened and widened to cover other countries in the region,
so that sub-Saharan Africa as a whole can see a sustained higher rate of economic growth and
improved living standards for its population.
Khan, Mohsin S., and Nadeem Ul Haque, 1985, "Foreign Borrowing and Capital Flight: A Formal
Analysis," Staff Papers, International Monetary Fund, Vol. 32 (December).
Fischer, Stanley, Ernesto Hernández-Catá, and Mohsin S. Khan, 1998, "Africa:
This Is a Turning Point?" paper presented at the American Economic Association meeting,
Chicago, January 3–5.