Backgrounder: Domestic resource mobilization

IV. Specific issues

A. Domestic savings

12. Africa, the ratio of gross domestic savings to GDP is still below the average of middle-income economies and the average of the fast-growing economies in East Asia (Economic Commission for Africa, 2012b). The key challenges relate to the removal of savings barriers, the strengthening of the main drivers of savings, the effective mobilization of revenues from natural resources without hampering investment, and the creation of a fair and efficient system of taxation. With Africa's domestic revenue reaching $520 billion in 2012, against less than $50 billion in foreign aid received, the potential for increased domestic revenue mobilization is enormous, especially considering the current low levels of taxation.

B. Financial markets

13. While banking is at the heart of Africa's formal financial systems, it faces many problems, including scale, large interest margins (lending and borrowing rates), high overhead costs and a low penetration rate. The latter is a key issue as limited access to the banking system by ordinary people and too few bank deposits inevitably lead to a dearth of credit to extend. Inefficiencies in the banking sector arising from a lack of competitive pressure on existing banks has led to extremely expensive banking services, characterized by huge banking spreads, overheads and profits. This is compounded by weak regulatory structures that do not support robust risk management systems.

14. Stock market capitalization in Africa rose from $300 billion in 1996 to $1.2 trillion in 2007, but secondary financial markets on the continent remain largely underdeveloped, with scarcely one in three African countries having an organized capital market. In 2012, 9 of the 17 countries for which recent disaggregated data is available had market capitalization ranging from 6 to 30 per cent of GDP; 6 had between 30 to 70 per cent; while Zimbabwe and South Africa had 109 per cent and 159 per cent respectively. With the exception of South Africa and some North African exchanges, African exchanges are considered "frontier markets", typically characterized by low capitalization and liquidity levels. Issues of capacity (human, technological and institutional) are persistent, and management of risk and regulation are still issues that limit portfolio inflows.

C. Contractual savings

15. Being typically long term by nature, pension funds can provide reliable financing for long-term development projects that would normally face difficulty attracting suitable investment. The insurance sector has similar potential, with the added benefit of providing an income safety net for businesses and individuals. However, these options are not without challenges: relatively high mortality rates in many African countries not only tend to reduce the take-up of life insurance policies, but also make the pricing of such products more difficult and less attractive for consumers. In this regard, the small number of consumers in most countries means that the pooling and diversification of risks becomes more difficult. Low savings rates, a general lack of awareness and financial literacy, and inadequate consumer protection also limit growth in these sectors. All these factors are compounded by a lack of effective investment guidelines as well as limited capacity to implement investment strategies. Moreover, as with most investments, there are prudential, investor and performance risks associated with investing certain assets in capital markets. Owing to these risks, most African countries have restrictions on how and where funds can be invested, which ultimately limits investment returns.

D. Public financial management

16. It could also be argued that failures in public financial management contribute to inadequate domestic resource mobilization. Sound public financial management is characterized by aggregate fiscal discipline; resource allocation and use based on strategic priorities; and efficiency and effectiveness of programme and service delivery. Although steps have been taken to improve public financial management, many African countries still struggle to tackle endemic weaknesses such as unauthorized expenditures, committing unavailable funds to projects, poor reporting and accounting practices, and long delays in auditing and preparing annual national accounts. These weaknesses have led to poor budget performances, fiscal imbalances and the exacerbation of national deficit levels. Resolving fiscal fundamentals alone may not necessarily enhance domestic resource mobilization if national public financial management is lacking. African countries will need to engage in fiscal reforms that contribute to, among other things, the maintenance of budgetary discipline; the equity of public resource use; the efficiency of revenue mobilization; and general fiscal transparency (Economic Commission for Africa, 2002).

E. Sovereign wealth funds

17. A sovereign wealth fund is a non-traditional form of savings that can be used to fund development projects or for future generations. More than 10 African countries already have sovereign wealth funds, including Algeria, Angola, Equatorial Guinea, Gabon, Ghana, Libya, Nigeria, the Sudan and Sao Tome and Principe. The establishment of such funds should be given particular priority in countries with plentiful natural resources and in middle-income countries, with a view to harnessing surpluses from such resources and economic activity, and effectively converting them into viable development projects. Countries that have successfully established sovereign wealth funds should be encouraged to share best practices with other countries. However, it is important not to deprive the current generation of Africans from benefiting from such funds, particularly where existing public service provision is inadequate.

F. Remittances

18. Remittances are an important source of foreign exchange and they enable countries to import vital goods and pay off external debt. Remittance flows to Africa quadrupled between 1990 and 2010, reaching nearly $40 billion in 2010 and some $62 billion by 2012 (Economic Commission for Africa and African Union Commission, 2014). At a cost of 12.4 per cent per transaction, Africa is the most expensive continent to send money to. If this could be reduced to 5 per cent – the target set by the Group of 8 and the Group of 20 – it could save $4 billion a year (World Bank and European Commission, 2013). Governments need to provide incentives to lower the cost of sending money to Africa and shift remittance expenditure from consumption to productive investments, as seen in Senegal, the Philippines and Bangladesh.

G. Diaspora bonds

19. In 2008, Ethiopia was the first country in Africa to introduce diaspora bonds. Called "Millennium Corporate Bonds", they were issued by the Ethiopian electric power authority to finance national projects. Although the bonds were not as successful as had been hoped, the Ethiopian Government tried again in 2011, with a second bond issuance, to secure financing for the Grand Renaissance Dam project. Efforts were made to improve the marketing campaign vis-à-vis diaspora Ethiopians and to date $400 million has been raised, although much of this has come from within the country. Drawing from Ethiopia's experience, it is clear that there are important conditions that countries considering issuing bonds must consider if the process is to be effective and cost efficient. Governments must, first, ensure that the bonds are marketable and will appeal to the diaspora; second, be able to identify and locate nationals living abroad; third, establish an entity that will attract and maintain ties with the diaspora; fourth, improve financial literacy among members of the diaspora to help them to become active investors; and lastly, demonstrate good governance, transparency and political stability.

H. Public-private partnerships

20. Public-private partnerships have been widely used in both developed and developing countries since the 1970s. In essence, public-private partnerships are risk-sharing mechanisms or relationships in which a legal contract assigns public service delivery responsibilities to a private entity. Public-private partnership investment in developing countries across different sectors – water, energy, telecommunications and transport – grew from about $30 billion in 1995 to $140 billion by 2009. Despite the huge potential of such partnerships, the implementation of public-private partnership investments in Africa is hampered by a number of factors, including:

a. Small markets and un-creditworthy players (in public services delivery)

b. Large investment relative to the expected revenue, and front loaded cost

c. Unliberalized African public entities, tight government regulation and low-tariff requirements

d. Difficulties managing the various risks, including legal, regulatory and government risks, project and technical risks, and taxation and economic risks.

I. Illicit financial flows

21. Illicit financial flows impact all facets of the economy in affected countries. Such flows have been a huge drain on Africa's resources, preventing access to these funds for productive investments and undermining the economic governance of the continent. African Governments will need to address the issue of illicit financial flows as part of their efforts to mobilize both domestic and external resources.