Backgrounder: Domestic resource mobilization

I. Introduction

1. Africa has experienced remarkable economic growth over the past decade. Sustaining such growth will require increased reliance on domestic resources in order to increase national ownership of public policy, ensure accountability to citizens and reduce the risk of volatility associated with external funding (North-South Institute, 2010). Awareness of the importance of domestic resources is not a new development: back in 2001, the framework document of the New Partnership for Africa's Development (NEPAD) emphasized the need for Africa to strengthen domestic resource mobilization, and this was reaffirmed at the global level in 2002 by the Monterrey Consensus on Financing for Development, which made improved domestic resource mobilization the first of its six leading actions and stressed the importance of establishing the necessary internal conditions for mobilizing domestic savings to sustain adequate levels of productive investment. Indeed, the need for Africa to explore different sources of financing to meet its development needs and transform its economies into middle-income countries has been reiterated at various forums over the past decade.

2. Enhanced domestic resource mobilization increases the ability of Governments to achieve long-term development objectives. Until now, however, African countries have had difficulty in mobilizing adequate domestic resources to meet their investment needs. Although there has been some progress in mobilizing domestic resources since the adoption of the NEPAD framework document and the Monterrey Consensus, the ratio of savings to gross domestic product (GDP) has fallen, from 24.3 per cent of GDP in 2008 to 16 per cent in 2011. Moreover, since 2008, the gross domestic savings rate has been consistently lower than the gross domestic investment rate. With current estimates of the financing gap standing at approximately 6 per cent of African GDP, it is clear that mobilizing sufficient, stable and predictable resources still remains a real concern for the continent.

II. Objectives

3. The overall objective of the present paper is to provide background material for the Ninth African Development Forum, the theme of which is "Innovative financing for Africa's transformation". The paper will discuss the key issues, opportunities and challenges regarding domestic resource mobilization in Africa, with a view to providing guidance on policy options and mechanisms for fully exploiting sources of finance for economic development. The present paper should be read in conjunction with the concept note, which takes a broader look at Africa's challenges in accessing and utilizing innovative sources of financing, and covers issues such as illicit financial flows, private equity, new forms of partnerships and climate financing.

4. The present paper is also intended to provide a critical perspective on the secondary factors that impact the policy discussion on domestic resource mobilization: governance (policies, laws and regulations); environmental sustainability and stewardship issues; and the knowledge base, including human and institutional capabilities. This will be followed by a section on cross-cutting issues. The paper will conclude by highlighting a number of options for improving domestic resource mobilization in Africa.

III. Broad issues

5. Research on the nature and scale of Africa's financing needs consistently demonstrates that financing remains a huge obstacle to achieving sustainable economic transformation. The estimates of the continent's financing needs are indeed staggering, with some $90 billion needed to plug the infrastructure gap; $30-$50 billion annually to meet the cost of climate adaptation; and $25 billion annually to achieve universal access to modern forms of energy. Within the next few years, the cost implications of the post-2015 development agenda will become clearer; nonetheless, it is already certain that they will be comparable to those of the Millennium Development Goals ($40-$60 billion per year).

6. Although taxes are the largest source of domestic revenue, tax collection as a share of GDP has increased only marginally over recent years, from 26.6 per cent in 2009 to 27.0 per cent in 2011, and many countries are still recording tax ratios of less than 10 per cent. As a result, African countries are increasingly turning to external borrowing to bridge the financing gap and fund domestic investment, despite the positive growth of foreign direct investment, remittances and official development assistance.

7. The bulk of existing research on development finance has focused on identifying the key challenges that Africa faces in mobilizing and retaining resources (both domestic and external) and potential policy solutions. These challenges include low savings rates, poor tax administration and a limited tax base, often dominated by practices that restrict the growth of intra-African trade and provide opportunities for large-scale commercial tax evasion. Despite the reforms adopted across Africa, there is still much to be done to expand and exploit the fiscal potential of the informal sector, amend tax laws to combat profit-shifting by multinational companies through transfer pricing, and tackle high capital flows to tax havens. Domestic resource mobilization in the form of private savings is mainly hampered by low income levels and a lack of access to financial services in rural areas.

8. There are also challenges stemming from poor public sector governance and planning. Although many African countries have made huge strides over the past decade to improve their macroeconomic management, the same cannot be said for public financial management. There is still a pervasive disconnect between public financial management and national budgets and planning, which makes it difficult for countries to identify funding gaps and channel existing funds into priority development areas. Official development assistance is often used to support the delivery of public services, which in turn exacerbates aid dependency and reinforces the culture of poor public financial management.

9. Furthermore, financial systems in many African countries are currently ill-equipped to mobilize capital in ways that help individuals and the private sector. In the early 2000s, a number of African countries undertook banking reforms to curb the widespread proliferation of unregulated banks, improve prudential requirements (and therefore improve risk management) and encourage competition to increase access to financial services. Despite such improvements, many banks are still wary of offering credit to small and medium enterprises (even if the enterprises are prepared to pay a premium), fail to provide services that are accessible to the large informal sector and rural communities, and are timid when it comes to funding large-scale infrastructure projects due to the low capacity to assess risk, poor management of cost recovery and lack of guarantees.

10. The development of capital markets has been slow and has failed to provide an efficient conduit for capital for a number of reasons, including: scale; low capacity; stifling regulatory frameworks; poor technological infrastructure; and legal frameworks that are incapable of providing sufficient protection to investors through contract enforcement.

11. Lastly, the pervasiveness of illicit financial flows should also be noted. It is estimated that such flows cost the continent about $854 billion between 1970 and 2008, and the problem is becoming more marked: between 2000 and 2008, Africa lost an average of $50 billion per year. The amount that Africa has lost to date could wipe out the continent's total outstanding external debt and still leave $600 billion for poverty reduction efforts (Economic Commission for Africa, 2012a).