## 1. Evolution of debt and public investment

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---

### I. Introduction — key observations
- Many SSA countries pursued a public investment scaling-up during the last decade to close infrastructure gaps.
- Examples cited: Rwanda, Benin, Senegal.
- Investment scaling-up has been associated with a sharp increase in public debt.
- About half of SSA countries with debt increases since 2013 recorded higher public investment spending during 2013–18 relative to 2008–12.
- Three main policy messages from successful transitions:
  - Improvement of the business environment to boost private returns.
  - Better access to finance to lower the cost of investment.
  - Policies supporting agriculture and avoiding deindustrialization.

### II. Figure and trends (SSA)
- Figure 1 (descriptive): plots Gross fixed capital formation, constant prices and General government gross debt, percent of GDP (RHS) over 2008–2017 for SSA (source: AFR REO database).

### III. Challenge and aim
- Medium-term challenge: maintain or elevate growth while scaling down public investment.
- Given modest progress in revenue mobilization, fiscal consolidation will require sharp rationalization of public spending.
- Greater private sector participation is essential to sustain or generate high growth.
- Paper focus: episodes where contraction of public investment is offset by increases in private investment (transition from public- to private-led investment growth).

### IV. The context of Benin — facts and figures
- Growth and investment scaling-up:
  - 2016: growth about 4 percent.
  - 2017: real GDP growth 5.7.
  - 2018: real GDP growth 6.7.
- Public investment envelope and schedule:
  - Government adopted a public investment envelope of CFAF 1,400 billion to be spent over three years.
  - Investment started in 2017 at CFAF 500 billion and was expected to decrease to CFAF 450 billion in 2019.
- Financing strategy and debt outcomes:
  - Over 2015-17 authorities increasingly relied on domestic and regional financial markets to finance public investment projects at non-concessional terms.
  - Domestic public debt tripled from 7.8 percent of GDP in 2014 to 23.7 percent of GDP in 2017.
  - Total public debt:
    - 22.3 percent of GDP in 2014;
    - 30.9 percent of GDP in 2015;
    - 41.2 percent of GDP in 2019.
- Authorities committed to a fiscal consolidation plan to reverse rising public debt.

### V. Definition and selection of successful investment-transition episodes
- Baseline definition — a “successful transition” requires:
  1. Public investment declines by, at least, 2 percent of GDP over the first two years of the transition.
  2. This decline is compensated by an increase in the private investment ratio over the five years.
  3. The average real GDP growth during the transition period exceeds the average growth rate in the 2 years prior to the transition.
- Data: WEO database; sample of 162 countries; period 1987–2017; baseline selection yields nine episodes across Asia, Africa, Middle East and across decades.
- Robustness: four alternative selections with modified criteria; nine baseline episodes generally hold under alternatives though additional episodes may be included.

### VI. Comparison with Benin and illustrative episodes
- Benin’s private investment ratio: about 18 percent of GDP between 2015-17.
- Except China, Benin’s pre-transition private investment ratio is similar or superior to ratios recorded in selected countries prior to their transitions.
- However, Benin’s private investment declined subsequently, whereas successful-transition countries (e.g., Bahrain, Botswana, Kosovo, Ethiopia) recorded significant private investment increases and persistence 5 years after.
- Example episodes from an alternative selection (2 percent, 3 years, 5 years) — key metrics (Change in Public Investment; Change in Private Investment; Change in Total Investment; Change in real GDP growth):
  - Bahrain 2003-05: -3.4; 7.7; 4.2; 4.0
  - China 2004-06: -4.7; 7.2; 2.5; 2.0
  - Ethiopia 2013-15: -2.6; 5.6; 3.0; 0.4
  - India 1995-97: -2.6; 3.4; 0.8; 1.1
  - Jordan 1990-92: -2.5; 5.0; 2.4; 9.0
  - Kosovo 2005-07: -4.5; 5.9; 1.3; 0.4
  - New-Zealand 1991-93: -2.1; 2.9; 0.8; 1.6
  - Rwanda 2000-02: -4.9; 7.3; 2.3; 2.1
  - Thailand 1987-89: -2.3; 6.5; 4.2; 5.9
  - United Kingdom 1986-88: -3.9; 6.5; 2.6; 0.3
  - Uzbekistan 2003-05: -2.4; 6.0; 3.6; 3.0

### VII. Econometric estimation (Annex IV) — GMM results and interpretation
- Empirical objective: estimate private investment response to public investment in successful fiscal consolidation episodes using dynamic panel GMM (Arellano–Bond, Arellano–Bover, Blundell–Bond).
- Sample: 162 countries, 1987-2017; panel: unbalanced, 2244 observations.
- Baseline regression includes lagged private investment and controls: real GDP growth, real interest rates, government investment (% of GDP), domestic credit to private and public sectors.
- Key estimates (selected):
  - Lagged private investment coefficient (PRIVATE INVESTMENT (-1)):
    - EQ1: 0.642514 (p-value (0.0004)**)
    - EQ2: 0.646283 (p-value (0.0002)**)
    - EQ3: 0.649748 (p-value (0.0013)**)
    - EQ4: 0.652387 (p-value (0.0010)**)
  - PUBLIC INVESTMENT coefficient:
    - EQ1: -0.279417 (p-value (0.0025)**)
    - EQ2: -0.320778 (p-value (0.0006)**)
    - EQ3: -0.423437 (p-value (0.0045)**)
    - EQ4: -0.400297 (p-value (0.0049)**)
  - Interaction PUBLIC INVESTMENT*D1 (effect during successful episodes):
    - EQ1: -0.153355 (p-value (0.0519)**)
    - EQ2: -0.140980 (p-value (0.0373)**)
    - EQ3: -0.155394 (p-value (0.0548)**)
    - EQ4: -0.082602 (p-value (0.0403)*)
  - Other controls:
    - DOMESTIC CREDIT TO PRIVATE SECTOR e.g., 0.095450 (p-value (0.0022)**)
    - REAL GDP e.g., 0.110087 (p-value (0.0004)**)
    - REAL INTEREST RATES: negative and significant in reported specifications.
- Diagnostics:
  - J-statistics and Prob(J-statistic) indicate instrument validity (examples: EQ1 J-statistic 107.87, Prob 0.4583).
  - AR(1) p-values: 0.0000 (expected).
  - AR(2) p-values: 0.1647, 0.1648, 0.1577, 0.1572 (no rejection of absence of second-order serial correlation).
- Quantitative interpretation:
  - Short-run private investment response in successful episodes: a decrease in public investment ratio by 1 percent of GDP is associated with an increase in private investment by 0.3 + 0.15 = 0.45 percent of GDP (sum of PUBLIC INVESTMENT coefficient and PUBLIC INVESTMENT*D1).
  - Long-run multiplier approximation: 1/(1-β) where β is the lagged dependent variable coefficient; approximation in this case is 1.8.
- Mechanisms: declines in real interest rates and improved credit to private sector associate with higher private investment; real GDP growth is a key determinant, consistent with a virtuous cycle.

### VIII. Application to Benin — counterfactual consolidation scenario and macro-fiscal implications
- Assumed shock applied:
  - Decrease in public investment by 2 percent of GDP over 2 years (from 2017 to 2018).
  - Associated increase in private investment by 2.25 percent of GDP over 5 years (from 2017 to 2021), based on estimated short-run and cumulative responses.
- Projected impacts (projections as of November 2019; comparison "Before applying the change" vs "After applying the change"):
  - Primary Deficit:
    - Before applying the change (2021): -0.7
    - After applying the change (2021): 0.8
  - Public Debt (percent of GDP):
    - Before applying the change (2021): 37.8
    - After applying the change (2021): 36.0
  - Real GDP Growth:
    - Before applying the change (2021): 6.7
    - After applying the change (2021): 7.0
- Additional quantified macro outcomes implied by the scenario:
  - A decrease in public investment by 1 percent of GDP associated with an increase in private investment by 0.45 percent of GDP (or a 2 percent public investment drop over 2 years with a 2.25 percent private investment improvement over 5 years) would entail:
    - (i) a reduction in the primary deficit to GDP ratio by 1.5 percent;
    - (ii) a diminution of the public debt to GDP ratio by 1.8 percent;
    - (iii) an increase in real GDP growth by 0.24 percent.

### IX. Policies implemented in successful transitions — typology and lessons
- Analytical framework: Hausman, Rodrik and Velasco (2005) typology — policies that lower cost of financing investment versus policies that increase total/private returns, and those addressing government failures versus market failures.
- High-level summary: a mix of policies across episodes, with recurring importance of:
  - Improving the business environment to boost private returns.
  - Improving access to finance to lower investment costs.
  - Policies to support agriculture and prevent deindustrialization.

- Six key lessons when private investment rebounded after public investment drops:
  1. Improve the Quality of Infrastructure
     - Vital systems: transportation, communication, sewage, water, electric systems.
     - Application to Benin: address electricity, transportation, communication; improve capital expenditure efficiency (Benin investment efficiency score 0.5 in 2015 vs 0.65 WAEMU and 0.64 SSA); use PPPs if fiscal risks are assessed and PPPs reflected properly in fiscal accounts.
  2. Implement Reforms of the Regulatory and Governance Framework
     - Simplify business procedures; strengthen judiciary and audit bodies to improve appropriability.
     - Application to Benin: bottom 20 percent on business environment (2017-18 WEF); two private investment facilitation bills under discussion; CPI score 40/100 in 2018; recommendation to strengthen audit institutions and follow-up on findings.
  3. Foster Health and Resilience of Bank and Nonbank Sectors
     - Banking reforms, NPL resolution, nonbank development (pension funds, mutual funds) deepen markets and lower financing costs.
     - Application to Benin: banking sector shallow with low profitability, sovereign exposure, high NPLs; recommendation to address NPLs, loan concentration, promote financial inclusion and develop non-banking institutions (FCPs, SICAVs).
  4. Promote Actively Financial Market Development
     - Opening domestic financial sector to foreign investors can diversify investor base and raise governance and technology.
     - Application to Benin: attract foreign investors to deepen WAEMU government securities market; implement integrated market supervision and a single Central Securities Depositor.
  5. Nurture High Potential Activities
     - Raise agricultural productivity and support manufacturing with competitive wages, quality infrastructure, and functioning financial system.
     - Application to Benin: promote cashew, pineapple, cotton; focus on land tenure, irrigation, extension services, high-value crops, fertilizer, storage, environmental protection; manufacturing share declined from 21 percent in 1999 to 14 percent in 2018 (preliminary).
  6. Use Tax Incentives Sparingly
     - Tax incentives cannot overcome major bottlenecks; guidance on “good” tax incentives: (i) targeted towards exporting firms; (ii) not limited to large investments; (iii) temporary; (iv) cost-based rather than profit-based.

### X. Conclusion — three main messages consistent with Benin’s Government Action Plan
- Improve the business environment to boost private returns:
  - Prioritize quality of physical infrastructure before public investment consolidation; advance deep regulatory and governance reforms; use tax incentives cautiously.
- Facilitate access to finance to lower the cost of investment:
  - Financial development was key in successful transitions and unlocked financing for the private sector.
- Conduct policies to support agriculture and avoid deindustrialization:
  - Raise productivity and quality in cotton and other crops and create a competitive environment to attract manufacturing investment.

_Italic: Source: wpiea2021286-print-pdf - 1. Evolution of debt and public investment; Annex IV (Econometric Estimate of the Public versus Private Investment Coefficient)._

### 1. Evolution of debt and public investment _______________________________________4

### 1. Evolution of debt and public investment _______________________________________4

### I. Introduction — key observations
- Many SSA countries engaged in a public investment scaling-up program during the last decade with the aim of closing infrastructure gaps.
- Examples cited:
  - Rwanda: public investments contributed to gross capital formation through government-funded construction and large-scale purchases of machines, devices, and tools.
  - Benin: announced in 2014 a major increase in public investment focused on energy and transportation infrastructure.
  - Senegal: strong growth since 2014 supported by significant public investment in a new airport, railway and highways.
- Investment scaling-up has resulted in a sharp increase in public debt.
- About half of SSA countries that witnessed a debt increase since 2013 recorded higher public investment spending during 2013–18 relative to 2008–12.
- Three main policy messages from the analysis of successful transitions:
  - Improvement of the business environment to boost private returns is key.
  - Better access to finance to lower the cost of investment is important.
  - Implementation of policies to support agriculture and avoid deindustrialization is efficient.

### II. Figure and trends (SSA)
- Figure 1 (descriptive): plots Gross fixed capital formation, constant prices and General government gross debt, percent of GDP (RHS) over 2008–2017 for SSA (source: AFR REO database).

### III. Challenge and aim
- Medium-term challenge: maintain or elevate growth while scaling down public investment.
- Given modest progress in revenue mobilization, fiscal consolidation will require sharp rationalization of public spending.
- Greater participation of the private sector is essential to sustain or generate high growth.
- Paper focus: episodes where contraction of public investment is offset by increase in private investment (transition from public to private investment-led growth).

---

### II. The context of Benin — facts and figures
- Growth and investment scaling-up:
  - 2016: growth about 4 percent.
  - 2017: real GDP growth 5.7.
  - 2018: real GDP growth 6.7.
- Public investment envelope and schedule:
  - Government adopted a public investment envelope of CFAF 1,400 billion to be spent over three years.
  - Investment started in 2017 at CFAF 500 billion and was expected to decrease to CFAF 450 billion in 2019.
- Financing strategy and debt outcomes:
  - Over 2015-17 authorities increasingly relied on domestic and regional financial markets to finance public investment projects at non-concessional terms.
  - Domestic public debt tripled from 7.8 percent of GDP in 2014 to 23.7 percent of GDP in 2017.
  - Total public debt:
    - 22.3 percent of GDP in 2014;
    - 30.9 percent of GDP in 2015;
    - 41.2 percent of GDP in 2019.
- Authorities committed to a fiscal consolidation plan to reverse rising public debt.

---

### III. Literature review on expansionary fiscal consolidation — relevance and distinction
- Expansionary fiscal consolidation literature (Giavazzi and Pagano; Alesina and Perotti; Alesina and Ardagna; others) shows fiscal consolidation can be growth-friendly under certain conditions.
- Mechanisms:
  - “Expectation view”: confidence effect when fiscal tightening removes need for larger future adjustment.
  - “Labor market view”: reducing public spending (wages, unemployment benefits) may lower unit labor costs.
  - Eliminating rents can reduce corruption and improve private sector incentives.
- Distinction from current paper:
  - Expansionary fiscal consolidation deals with contraction of total budget (spending and revenue) and GDP growth.
  - Present paper focuses specifically on public investment-driven consolidation episodes and whether reduction in public investment is offset by private investment increases.

---

### IV. Selection of successful investment transition episodes — definition, results, and robustness

H3: Definition — baseline criteria for a “successful transition”
- Baseline definition (three conditions):
  1. Public investment declines by, at least, 2 percent of GDP over the first two years of the transition.
  2. Such a decline is compensated by an increase in the private investment ratio over the five years.
  3. The average real GDP growth during the transition period should be superior to the average growth rate recorded during the 2 years prior to the successful transition.
- Note: “Transition” refers to the 5 years period through which the drop in public investment is compensated by an increase in private investment.
- Rationale: a two percent of GDP decline in public investment over two years corresponds to 1 percent of GDP per year and lies in the second bottom decile of the distribution of public investment adjustments in the global sample (1987–2017).

H3: Selection results
- Data: World Economic Outlook database; sample of 162 countries; period 1987–2017.
- Baseline selection yields nine episodes of successful transition. Episodes are geographically spread (Asia, Africa, Middle East) and occur across decades (one in the 1980s, two in the 1990s, rest since the 2000s).

H3: Robustness checks
- Alternative scenarios: four additional selections using modified criteria (examples include using 3 years instead of 2 for the consolidation window).
- Main outcome: the nine episodes identified in the baseline hold under alternative criteria, though alternative criteria may include additional episodes.

H3: Comparison with Benin
- Benin’s average ratio of private investment over GDP estimated at about 18 percent between 2015-17.
- Except for China, Benin’s private investment ratio is similar or superior to ratios recorded in selected countries during the period preceding their transitions.
- However, Benin’s ratio of private investment to GDP declined during the following period, while countries with successful episodes recorded significant increases in private investment (examples: Bahrain, Botswana, Kosovo, Ethiopia).
- Transitions were persistent: countries maintained private investment significantly superior to pre-transition levels 5 years after the episodes.

H3: Examples from an alternative selection (Table 3: 2 percent, 3 years, 5 years)
- Selected episodes with key metrics (Change in Public Investment in percent of GDP; Change in Private Investment in percent of GDP; Change in Total Investment in percent of GDP; Change in real GDP growth):
  - Bahrain 2003-05: -3.4; 7.7; 4.2; 4.0
  - China 2004-06: -4.7; 7.2; 2.5; 2.0
  - Ethiopia 2013-15: -2.6; 5.6; 3.0; 0.4
  - India 1995-97: -2.6; 3.4; 0.8; 1.1
  - Jordan 1990-92: -2.5; 5.0; 2.4; 9.0
  - Kosovo 2005-07: -4.5; 5.9; 1.3; 0.4
  - New-Zealand 1991-93: -2.1; 2.9; 0.8; 1.6
  - Rwanda 2000-02: -4.9; 7.3; 2.3; 2.1
  - Thailand 1987-89: -2.3; 6.5; 4.2; 5.9
  - United Kingdom 1986-88: -3.9; 6.5; 2.6; 0.3
  - Uzbekistan 2003-05: -2.4; 6.0; 3.6; 3.0

H3: Estimation of Benin’s potential gains from a successful transition (GMM application)
- Econometric setup: Generalized Method of Moments (GMM) to estimate public versus private investment coefficients in cases of fiscal consolidation that are successful (details in Annex IV).
- Applied counterfactual: a decrease in public investment by 1 percent of GDP associated with an increase in private investment by 0.45 percent of GDP (or equivalently: drop in public investment by 2 percent of GDP in 2 years with an improvement in private investment by 2.25 percent of GDP in 5 years) implies:
  - Reduction in primary deficit to GDP ratio by 1.5 percent.
  - Diminution in public debt to GDP ratio by 1.8 percent.
  - Increase in real GDP growth by 0.24 percent (see table A.4.2 in Annex IV).
- Interpretation: a transition from public to private sector-led growth would improve Benin’s main macroeconomic indicators under the estimated parameters.

---

### V. Policies implemented in successful transitions — typology and lessons

H3: Analytical framework for policy classification
- Framework: Hausman, Rodrik and Velasco (2005) typology.
- Main distinctions:
  - Policies that lower the cost of financing investment versus policies that increase returns (total and private) to investment.
  - Policies addressing government failures (e.g., doing business reforms; economic stability; governance improvement) versus policies addressing market failures (e.g., creation of clusters to develop sophisticated economic activities).
- The framework is used to identify and classify policies that fostered private investment rebounds following public investment contractions.

H3: Summary findings on policies (high-level)
- Table 4 (in the source) summarizes policies implemented during each episode and shows a mix of exogenous policies in effect across episodes.
- Three policy areas repeatedly identified as crucial in the successful transitions:
  - Improvement of the business environment to boost private returns.
  - Better access to finance to lower the cost of investment.
  - Policies to support agriculture and prevent deindustrialization.

H3: Policy implication for Benin
- Given Benin’s experience (high public investment scaling-up, rising public debt, then decline in private investment), applying lessons from successful episodes suggests prioritizing:
  - Business environment reforms to increase private returns.
  - Measures to improve access to finance and lower investment costs.
  - Sectoral policies (notably for agriculture) to avoid premature deindustrialization while sustaining productive private investment.

*Italic: Source: wpiea2021286-print-pdf - 1. Evolution of debt and public investment _______________________________________4*

### 1. Policies that increase total returns

### 1. Policies that increase total returns

### 1.1 Policies that address government failures
- 1.1.1 Infrastructure
  - Infrastructure improvement plans often precede successful transitions from public to private investment. Critical systems: transportation, communication, sewage, water, and electric systems.
  - International examples: China (early 2000s) improving interior provinces and urban environment; Ethiopia (early 2010s) investment in power generation, telecom, transportation including Ethio-Djibouti railways; Rwanda Transport Sector Project (early 2000s); Botswana investments across transport, water and sanitation, power, and mobile telephony.
  - Application to Benin:
    - Inadequate supply of infrastructure—particularly access to electricity—is cited as one of the most problematic factors for doing business in Benin.
    - Benin scored 0.5 in investment efficiency in 2015 versus 0.65 for WAEMU countries and 0.64 for SSA countries (IMF, 2020).
    - About 60 percent of the Government Action Plan projects are expected to be financed by the private sector, mainly in the forms of PPPs (IMF, 2017b).
    - Recommendation: Improve efficiency of capital expenditure and, if PPPs are properly reflected in fiscal accounts and fiscal risks assessed, use PPPs to improve infrastructure access and quality without jeopardizing public finance sustainability.

- 1.1.2 Education
  - (Marked in source with X entries; content not expanded in supplied excerpt.)

- 1.1.3 Health
  - (Marked in source with X entries; content not expanded in supplied excerpt.)

### 1.2 Policies that address market failures
- 1.2.1 Sectoral policies that develop new activities
  - (Marked in source with X entries; content not expanded in supplied excerpt.)

- 1.2.2 Sectoral policies that develop existing activities
  - (Marked in source with X entries; content not expanded in supplied excerpt.)

### 2. Policies that improve private appropriation of total returns

- 2.1 Policies that address government failures
  - 2.1.1 Regulatory framework, property rights, governance reforms
    - Regulatory and governance reforms that simplify business procedures and improve public sector transparency (notably judiciary and audit bodies) tend to encourage private investment by reducing time/cost to set up and operate businesses and by improving appropriability of profits.
    - International examples: Ethiopia Industrial Park Development Corporation (2014) to remove bureaucratic bottlenecks; Bahrain reforms (2003) easing access to capital for SMEs and simplifying business setup; Bahrain established an independent Public Audit Office in 2002; Rwanda strengthened Office of the Auditor General in 2001.
    - Application to Benin:
      - 2017-18 WEF Global Competitiveness Report places Benin in the bottom 20 percent of countries on business environment.
      - Two private investment facilitation bills discussed in Parliament: one revising the code of investment; one on promotion and development of micro, small and medium enterprises.
      - Benin scored 40 points out of 100 on Transparency International’s 2018 Corruption Perception Index (an improvement versus 2016 and 2017).
      - Recommendation: Further strengthen internal and external audit institutions and follow-up on findings and recommendations to foster transparency and reduce risk of low appropriability.

  - 2.1.2 Decrease in taxes on capital
    - (Marked with X entries; content not expanded in supplied excerpt.)

  - 2.1.3 Economic stability
    - (Marked with X entries; content not expanded in supplied excerpt.)

- 2.2 Policies that address market failures
  - 2.2.1 Information externalities
    - (Heading present; detailed content not included in supplied excerpt.)

B. POLICIES THAT REDUCE THE COST OF INVESTMENT

### 1. Better access to and cost of domestic finance
- 1.1 Creation of new financial markets
  - (Marked with X entries; content not expanded in supplied excerpt.)

- 1.2 Deepening of existing markets
  - (Marked with X entries; content not expanded in supplied excerpt.)

- 1.4 Better transmission of monetary policy
  - (Marked with X entries; content not expanded in supplied excerpt.)

- 1.5 Microfinance
  - (Marked with X entries; content not expanded in supplied excerpt.)

### 2. Better access to and cost of international finance
- 2.1 Liberalisation of capital flows
  - (Marked with X entry; content not expanded in supplied excerpt.)

B. Main Lessons — Six key lessons from cases analyzed when private investment rebounded after public investment drops
- Lesson 1: Improve the Quality of Infrastructure
  - High-cost but vital: transportation, communication, sewage, water, electric systems—significantly affect returns to private investment.
  - Application to Benin: Improve electric systems, transportation, communication; raise efficiency of capital expenditure (Benin score 0.5 in 2015 vs 0.65 WAEMU and 0.64 SSA). Use PPPs with proper fiscal accounting and risk assessment.

- Lesson 2: Implement Reforms of the Regulatory and Governance Framework
  - Simplify business procedures, improve transparency, strengthen judiciary and audit bodies to encourage private investment and protect profit appropriability.
  - Application to Benin: Address burdensome procedures, advance bills revising investment code and MSME promotion, strengthen audit institutions; Benin scored 40/100 on Transparency International’s 2018 CPI.

- Lesson 3: Foster Health and Resilience of Bank and Nonbank Sectors
  - Banking reforms, corporate governance, and NPL resolution lower financing costs and facilitate innovation. Development of non-banking sector (pension funds, financial advisory groups, money brokers) deepens markets, increases liquidity, and mutualizes risks.
  - International examples: China recapitalization and oversight reforms; Bahrain diversification of financial players; Rwanda financial inclusion innovations (mobile money transfers, agent banking, microinsurance, micro-leasing).
  - Application to Benin:
    - Banking sector is shallow and under-developed with low profitability, exposure to the sovereign, and high NPLs limiting banks’ ability to finance private projects.
    - Recommendation: In coordination with regional supervisors, address high NPLs, loan concentration, low profitability; promote financial inclusion; develop non-banking institutions (mutual funds FCPs and unit trusts SICAVs) to foster market liquidity and diversify investor base in the regional government securities market.

- Lesson 4: Promote Actively Financial Market Development
  - Opening domestic financial sector to foreign investors can diversify investor base and raise governance, technology, and management practices.
  - Application to Benin: Attracting foreign investors could deepen WAEMU government securities market; implement integrated market supervision and a single Central Securities Depositor.

- Lesson 5: Nurture High Potential Activities
  - Raise productivity and climb the quality ladder in agriculture; support manufacturing with competitive wages, quality infrastructure, and well-functioning financial system to absorb technology and create jobs.
  - International examples: Thailand rice recovery (1987); Ethiopia mechanization strategy and export-oriented manufacturing with industrial parks and clusters; China focus on manufacturing and export-oriented production.
  - Application to Benin:
    - Authorities promote cashew nuts, pineapple, and develop cotton sector.
    - Policy focus areas: land tenure security, irrigation, extension services, development of high-value crops, expansion of good quality fertilizer, better storage in warehouses, protection against erosion and environmental problems.
    - Manufacturing share decreased from 21 percent in 1999 to 14 percent in 2018 (preliminary data). Recommendation: Investigate causes of deindustrialization and implement policies to counteract this trend, including developing food processing and textile linkages to cotton.

- Lesson 6: Use Tax Incentives Sparingly
  - Targeted tax incentives have been used by some countries (China, Jordan) but cannot overcome major bottlenecks like poor infrastructure, weak governance, and underdeveloped financial systems.
  - Application to Benin: Use tax incentives with caution and ensure they are well designed given potentially large budgetary costs.
  - Guidance on “good” tax incentives (from source): generally (i) targeted towards exporting firms; (ii) not limited to large investments; (iii) temporary; and (iv) cost-based rather than profit-based (see IMF, 2015b).

VI. Conclusion — three main messages consistent with Benin’s Government Action Plan
- Improve the business environment to boost private returns:
  - Focus on improving quality of physical infrastructure before public investment consolidation and advancing deep regulatory and governance reforms.
  - Use tax incentives cautiously and design them carefully given budgetary costs.
- Facilitate access to finance to lower the cost of investment:
  - Financial development was key in successful transitions and unlocked financing sources for the private sector.
- Conduct policies to support agriculture and avoid deindustrialization:
  - Raise productivity and quality in cotton and other crops (particularly for Benin) and create a competitive environment to attract manufacturing investment.

*Source: wpiea2021286-print-pdf - 1. Policies that increase total returns*

### References

### Annex IV. Econometric Estimate of the Public versus Private Investment Coefficient

### Empirical framework
- Objective: estimate the amplitude of the private investment response to public investment in cases where (i) there is fiscal consolidation and (ii) it is successful.
- Baseline regression: ratio of private investment to GDP (Yit) on lagged Yit, and observable controls Xit including:
  - real GDP growth,
  - real interest rates,
  - government (public) investment as a percentage of GDP,
  - domestic credit to private sector as a percentage of GDP,
  - domestic credit to public sector as a percentage of GDP.
- Dynamic panel specification:
  - Yit = sum_{j=1..p} ρj Yit−j + Xit′ β + δi + εit  (equation (1))
  - First-differenced to remove fixed effects: ΔYit = sum_{j=1..p} ρj ΔYit−j + ΔXit′ β + Δεit  (equation (2))
- Estimation method: Generalized Method of Moments (GMM) using deeper lags of the dependent variable as instruments for differenced lags, following Arellano–Bond (1991), Arellano–Bover (1995), and Blundell–Bond (1998).
- Interaction term: constructed as PUBLIC INVESTMENT * D1, where D1 = 1 for successful episodes and 0 otherwise, to capture the public investment coefficient in successful fiscal consolidation episodes.

### Data
- Sample: 162 countries, period 1987-2017.
- Sources:
  - Real GDP growth, private and government investment: WEO database.
  - Domestic credit to public and private sectors: World Development Indicators (WDI).
  - Real interest rates: Financial Soundness Indicators (FSI).
- Panel: unbalanced, 2244 observations.

### Empirical results — key estimates and diagnostics
- Lagged private investment coefficient (PRIVATE INVESTMENT (-1)):
  - EQ1: 0.642514 (p-value (0.0004)**)
  - EQ2: 0.646283 (p-value (0.0002)**)
  - EQ3: 0.649748 (p-value (0.0013)**)
  - EQ4: 0.652387 (p-value (0.0010)**)
- PUBLIC INVESTMENT coefficient:
  - EQ1: -0.279417 (p-value (0.0025)**)
  - EQ2: -0.320778 (p-value (0.0006)**)
  - EQ3: -0.423437 (p-value (0.0045)**)
  - EQ4: -0.400297 (p-value (0.0049)**)
- Interaction term PUBLIC INVESTMENT*D1 (effect during successful episodes):
  - EQ1: -0.153355 (p-value (0.0519)**)
  - EQ2: -0.140980 (p-value (0.0373)**)
  - EQ3: -0.155394 (p-value (0.0548)**)
  - EQ4: -0.082602 (p-value (0.0403)*)
- Other control variables (selected):
  - REAL INTEREST RATES: negative and significant in specifications reported.
  - DOMESTIC CREDIT TO PRIVATE SECTOR: positive and significant (e.g., 0.095450, p-value (0.0022)**).
  - REAL GDP: positive and significant across specifications (e.g., 0.110087, p-value (0.0004)**).
  - DOMESTIC CREDIT TO PUBLIC SECTOR: small positive and significant in some specifications (e.g., 0.015789, p-value (0.0003)**).
- GMM diagnostics:
  - J-statistic and Prob(J-statistic) indicate instrument validity (examples):
    - EQ1: J-statistic 107.87, Prob(J-statistic) 0.4583
    - EQ2: J-statistic 104.50, Prob(J-statistic) 0.5503
    - EQ3: J-statistic 102.06, Prob(J-statistic) 0.5356
    - EQ4: J-statistic 107.76, Prob(J-statistic) 0.4071
  - AR(1) p-values: 0.0000 (rejection expected)
  - AR(2) p-values: 0.1647, 0.1648, 0.1577, 0.1572 (no rejection of no second-order serial correlation)

### Quantitative interpretation of the coefficients
- Short-run private investment response during successful transition episodes:
  - A decrease in public investment ratio by 1 percent of GDP is associated with an increase in private investment by 0.3 + 0.15 = 0.45 percent of GDP in the short run (sum of PUBLIC INVESTMENT coefficient and PUBLIC INVESTMENT*D1).
- Long-run approximation:
  - Long-term multiplier approximated by 1/(1-β) where β is the lagged dependent variable coefficient; the approximation in the present case is 1.8.

### Mechanisms and additional findings
- Declines in real interest rates and improvements in credit to the private sector are associated with higher private investment.
- Real GDP growth is a key determinant of private investment, consistent with prior literature (Greene and Villanueva (1991); Ghura and Goodwin (2010)).
- The results are consistent with a virtuous cycle: increased private investment contributes to real GDP growth, which in turn supports further private investment.

### Application to Benin — macro-fiscal implications of a successful consolidation scenario
- Assumed shock applied:
  - Decrease in public investment by 2 percent of GDP over 2 years (from 2017 to 2018).
  - Associated increase in private investment by 2.25 percent of GDP over 5 years (from 2017 to 2021), based on the estimated short-run and cumulative responses.
- Projected impacts (comparison "Before applying the change" vs "After applying the change", projections as of November 2019):
  - Primary Deficit:
    - Before applying the change (2021): -0.7
    - After applying the change (2021): 0.8
  - Public Debt (percent of GDP):
    - Before applying the change (2021): 37.8
    - After applying the change (2021): 36.0
  - Real GDP Growth:
    - Before applying the change (2021): 6.7
    - After applying the change (2021): 7.0
- Additional quantified macro outcomes implied by the scenario:
  - A decrease in public investment by 1 percent of GDP, associated with an increase in private investment by 0.45 percent of GDP (or a drop in public investment by 2 percent of GDP in 2 years with an improvement in private investment by 2.25 percent of GDP in 5 years), would entail:
    - (i) a reduction in the primary deficit to GDP ratio by 1.5 percent;
    - (ii) a diminution of the public debt to GDP ratio by 1.8 percent;
    - (iii) an increase in real GDP growth by 0.24 percent.

### Robustness and sensitivity (summary)
- Robustness analysis (Annex II) explores alternative episode definitions by varying:
  - size of public investment tightening,
  - length of the tightening,
  - period over which success (private investment compensation) is tested.
- Multiple scenarios reported (examples):
  - Scenario 1 (2 percent, 3 years, 5 years): lists countries with changes in public and private investment and changes in real GDP growth (e.g., Bahrain 2003-05: Change in Public Investment -3.4, Change in Private Investment 7.7, Change in Total Investment 4.2, Change in real GDP growth 4.0).
  - Scenario 2 (1.5 percent, 2 years, 2 years): lists alternative episodes and associated changes (e.g., Bahrain 2004-05: Change in Public Investment -1.8, Change in Private Investment 3.9, Change in Total Investment 2.1, Change in real GDP growth 2.1).
  - Scenario 3 and Scenario 4 present further alternative listings with numeric changes for identified episodes.
- Annex III reports ratios of private investment to GDP before, during, and after successful transitions for selected countries (examples):
  - Bahrain 2003-04: before 13.1, during 21.1, after 19.0
  - China 2004-05: before 17.9, during 23.6, after 28.2
  - Rwanda 2000-01: before 1.0, during 6.8, after 10.5

_Italic: IMF Staff Calculations (content unit: Annex IV and supporting annexes as provided)._

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_Source: https://www.imf.org/-/media/files/publications/wp/2021/english/wpiea2021286-print-pdf.pdf_