From United Nations Economic
Commission for Africa
Economic Report on Africa 2006
Capital Flows and Development Financing in Africa
Front
Matter
Continuing the economic recovery since the mid-1990s, African countries generally
recorded strong growth in 2005, a major turnaround after decades of economic
stagnation. However, growth remains uneven across countries, and in
many countries, fast growth has not been accompanied by substantial gains in
employment or poverty reduction. The African continent thus continues to face
challenges of achieving and sustaining higher growth rates as well as translating
growth into employment and poverty reduction.
Overview
African countries continue to face a perennial shortage of resources to finance
public and private investment, which constrains their ability to accelerate growth.
The chronic resource gap arises from imbalances between exports and imports, between
resource inflows and debt payments, and between domestic savings and domestic
investment (figure 1). Resource shortages limit the ability of governments on the
continent to undertake public expenditure in infrastructure and social services needed
to boost domestic demand, encourage private sector activity, and sustain high levels of
economic growth.
Chapter 1
1
Recent Economic Trends in Africa and Prospects for 2006
1.1 Introduction
1.2 The global economy was largely favourable in 2005
1.3 Overall growth performance in Africa remained strong
1.4 Macroeconomic balances continue to improve
1.5 Despite high growth performance, important development challenges remain
1.6 Growth prospects for 2006 are positive
1.7 Conclusion and policy recommendations
References
Chapter 2
2
Capital
flows to Africa and their impact on growth
2.1 Introduction
2.2 Trends in capital flows to Africa
2.3 Determinants of capital flows to Africa
2.4 Impact of capital flows on African growth and economic development
2.5 Conclusion
References
Appendix A: Tables
Appendix B: Debt Relief under HIPC and MDRI
The main outflow from most countries is debt service (figure 2.3). Between 1984 and
1986, debt service payments were higher than the inflows of ODA, FDI, remittances
and portfolio investment combined. Other outflows consist of profit repatriation
from FDI, which accounted for approximately one third of debt service payments in
2003, but has been increasing rapidly since the beginning of the 1990s. In addition
to these officially registered flows, there is capital flight, which is estimated to amount
to between $3 and $13 billion per year.
These aggregate figures obscure significant cross-country differences within Africa.
Although ODA is the most important inflow for most African countries, FDI has
been more important between 1980 and 2003 for several countries, namely Angola,
Equatorial Guinea, Nigeria, Seychelles and South Africa. For North African countries,
as well as Lesotho and Swaziland, workers’ remittances are the most important
inflows.
Chapter 3
3
Capital
Flows and Factor Markets
3.1 Introduction
3.2 Foreign direct investment (FDI) and domestic labour
markets
3.3 FDI and domestic investment
3.4 Official development assistance and domestic factor
markets
3.5 Remittances also play an important role in investment
and job creation
3.6 Case studies: FDI, domestic investment and job
creation in Ethiopia and Ghana
3.7 Conclusion and policy recommendations
References
Chapter 4
4
Capital
Flows and Economic Transformation
4.1 Introduction
4.2 Africa needs structural transformation: what can
capital flows do?
4.3 Key constraints to structural transformation in Africa
4.4 Experiences of capital flows and economic
transformation in Africa
4.5 Conclusion and policy recommendations
References
Capital flows are neither a necessary nor a sufficient condition to trigger economic
transformation. Lack of economic transformation in Africa is due to a combination
of shortcomings in policy, institutions and physical and human infrastructure. Overcoming
these constraints is important for economic transformation, which is critical
for attaining sustainable growth and reducing Africa’s vulnerability to shocks. The
analysis of the links between capital flows and economic transformation in Africa
indicates that:
• Capital flows to Africa during the last four decades have not been accompanied
by economic transformation. In countries such as Mauritius and Tunisia,
with relatively greater degrees of economic transformation, structural change
was not due to capital flows but rather to a combination of sound policies and
reforms that attracted domestic and foreign investment into sectors that were
more conducive to export promotion and economic diversification;
• For most of the time, ODA has been the most important source of capital
inflows to Africa. However, ODA flows to Africa have been largely channelled
to primary education and other services with very little flow to infrastructure.
ODA, in its current structure, has had limited impact on economic transformation.
Higher flexibility in donor policy to ensure a more balanced and
productive allocation of ODA flows among various sectors would enhance
the effects of ODA on economic transformation;
• FDI to SSA is mainly directed to extractive sectors, especially oil and minerals.
Such FDI will not induce economic transformation unless revenues from
oil and minerals are adequately used to develop infrastructure and institutions
and to spur investment in other sectors;
• Portfolio flows to Africa are unlikely to affect economic transformation as
they are quite small in volume and go to countries with more diversified
economies and active capital markets; and
• Research indicates that remittances have been largely driven by the motive to
support family consumption and have had little impact on economic transformation.
Chapter 5
5 Economic
Policy, Institutional Environment and Capital Flows
5.1 Introduction
5.2 A sound macroeconomic environment is essential for
attracting capital flows
5.3 The gains from economic reforms for capital flows have
been small
5.4 Capital inflows have posed challenges for
macroeconomic policy management
5.5 African countries need to further consolidate
macroeconomic stability
5.6 The institutional environment for increasing capital
flows to Africa
5.7 Conclusion
References
Chapter 6
6 Absorption
Capacity and Management of Capital Flows
6.1 Introduction
6.2 Financial Development and Absorptive Capacity
6.3 Managing capital flows
6.4 Policy Recommendations
References
Copyright © Economic
Commission for Africa
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Policy Recommendations
The debates on capital flows and development financing should focus on policies
and strategies aimed at increasing the volume of capital flows, enhancing absorption
capacity – including policies to improve the efficiency of the financial system –, tilting
the balance in favour of long-term capital, increasing the impact of foreign capital
on diversification and transformation, raising the employment effects and the overall
growth impact of foreign capital. The following policies should figure prominently on
the national development policy agenda:
Improving the institutional and regulatory environment to promote financial
deepening
The ability of African countries to absorb and take full advantage of capital flows
depends on the depth and efficiency of their financial systems. To increase financial
deepening, the financial reforms initiated over the past three decades need to be
complemented by more vigorous reforms of the regulatory and legal environment, to
remove distortions and increase efficiency in the financial system. These reforms must
focus on increasing competition in the banking system, the range of savings instruments
and the returns on savings, and on encouraging development of alternative
tiers of banking institutions that are more equipped to operate at a smaller scale in the
rural and informal sectors. The development of a liquid bond market is also essential
to deepening of the financial system.
Promoting regional financial integration
Regional financial integration allows African countries to overcome constraints associated
with the small size of their domestic markets. Integration allows those that
do not have national capital markets to take advantage of regional markets to raise
funds for investment. Regional financial integration will also enable the continent as a
whole to attract more foreign capital. Therefore, African governments need to support
and demonstrate effective commitment to new and existing initiatives for regional
integration of trade and finance.
Encouraging investment-oriented remittances
Workers’ remittances play an important role in increasing access to basic needs for the
recipient households. However, given the observed increasing volume of remittances,
it is necessary to design strategies to direct these funds into investment to minimize
the inflationary effects of a potential remittance-led consumption boom, but also and
most importantly to maximize the effects on economic growth through capital accumulation.
Financial institutions need to play an important role in designing investment
instruments to attract remittances. This alleviates information asymmetries
faced by non-resident investors, which tend to discourage long-term investment. Discussions
between banks and Africans in the Diaspora may generate suggestions for
new and creative means of channeling remittances into long-term investment. African
governments also need to design schemes that explicitly target remittances, such as
facilitating access to land for non-residents, either through purchases or fixed-term
leasing arrangements.
Establishing systematic monitoring of capital flows to minimize instability
One of the objectives of financial policy is to prevent financial fragility especially by
shielding the financial system and the real sector from the adverse effects of volatility
of capital flows. Each African country needs to design mechanisms for monitoring
the risk of instability and to establish the appropriate policy responses to impending
instability. In other words, each country must identify a number of warning indicators
to gauge the risk of instability and establish the appropriate measures to prevent
instability. Policies for regulating capital flows must be conceived as an integral part of
the national economic policy framework aimed at achieving macroeconomic stability
and improving resource allocation throughout the economy.
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