Well-developed financial markets and institutions facilitate the exchange of goods and services, the mobilization of resources, and their efficient allocation to profitable invest-ment projects, and diversification of risk. There is a strong positive correlation between development of the financial sector and economic growth (Levine 1997; Gelbard and Leite 1999; Rousseau and Sylla 2001).
While there is evidence of significant financial development in Africa throughout the 1990s (Gelbard and Pereira Leite 1999), important limitations remain. Commercial banks concentrate lending at the short end of the term structure, other nonbank sources of finance are underdeveloped, and capital markets have low capitalization and liquid-ity. The relatively high average spread between lending and deposit rates and the high rate of nonperforming loans are also indicators of a weak market structure. Finally, the array of financial products is very limited in most countries, with medium- and long-term financing rarely available.
Empirical evidence confirms that financial integration and development facilitate eco-nomic integration at both regional and worldwide levels (Rousseau and Sylla 2001), and some regional economic communities now recognize the limitations of a country-focused approach to financial development, especially for capital markets.7Integration (by harmonizing policies and regulatory and legislative frameworks and promoting cross-border investments) will facilitate the formation of adequate financial demand and supply; will enhance competition, and thereby efficiency and productivity; and will facil-itate the flow of information. Regional financial integration is also expected to strengthen links with financial systems and capital markets in more developed countries.
Though financial and monetary integration are separate processes, they are linked. The degree of financial market integration affects the transmission of monetary (and other) shocks and monetary policy across countries in a monetary union (Buch 1998; De Bondt 2000; Dornbusch, Favero, and Giavazzi 1998). With low financial integration a common monetary policy will have different effects in different countries. Similarly, lack of financial integration, because of the differences it generates in propagation mechanisms, implies divergent responses to communitywide shocks, increasing the costs of participation in a monetary union. Therefore, there is a clear case for financial integration to match monetary integration.
The discussion of capital markets and stock exchanges, financial institutions, and invest-ment, focuses on the five regional economic communities that have formally established convergence criteria, plus the Southern African Development Community (SADC) and the Arab Maghreb Union (UMA),to provide a more geographically comprehensive picture.
Capital markets and stock exchanges. Capital market development across Africa is aimed primarily at domestic resource mobilization, but also at increasing cross-border investments and foreign direct investment.
Financial integration and development facilitate economic integration at both regional and worldwide levels
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Stock markets in Sub-Saharan Africa are relatively small, with low market capital-ization. Few companies are listed. With the exception of Nigeria and South Africa, most stock markets have fewer than 100 listed companies—and some have as few as 5. A further weakness shared by markets in several countries is low liquidity, as evi-denced by limited turnover mainly due to limited floatation of shares and high trans-action costs.
South Africa, Morocco, and Egypt stand out in market capitalization, at more than
$244 billion combined in 2000, or 88% of the total in Africa (World Bank 2001).
South Africa’s market capitalization jumped from 122% of GDP in 1990 to 200% in 2000 (figure 6.2), while Morocco’s went from 4% to 39% and Egypt’s from 4% to 37%.
In most Sub-Saharan African countries capitalization remains below 40%—and not much higher than 10% in some countries. By comparison, between 1990 and 2000 market capitalization grew from 2% to 58% in Argentina, from 86% to 182% in the United Kingdom, and from 53% to 154% in the United States.
Stock exchanges exist in all the regional economic communities. SADC has the greatest number of national exchanges, with the most active being the Johannesburg Stock Exchange, which also serves as a subregional hub. Cross-border investments are very high in SADC, particularly among members of the Southern African Customs Union. There are three stock exchanges in ECOWAS: the Nigerian Stock Exchange, the Ghana Stock Exchange, and a regional exchange for UEMOA in Abidjan.
Market capitalization of selected stock markets in Africa, 1990 and 2000 (% of GDP)
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In COMESA the Cairo and Nairobi Stock Exchanges play leading roles. UMA has growing exchanges in Morocco and Tunisia. CEMAC has the Douala Stock Exchange, and there are plans for a regional exchange.
Many capital markets that had been dormant for years have been picking up signifi-cantly in recent years, and several new markets have emerged. Privatization, part of struc-tural reform in almost all African countries, has stimulated capital market development when backed by appropriate policies, as in Nigeria. In some countries (Botswana, Côte d’Ivoire, Kenya, Mauritius, Nigeria, South Africa) market efficiency, as evidenced by the degree to which prices efficiently incorporate information on companies and the envi-ronment, appears to be approaching that achieved in emerging Asian and Latin American economies (Magnusson and Wydick 2002). These equity markets have facil-itated cross-border investments—though investments remain constrained by currency inconvertibility, weak payment systems, and variations in listing procedures.
Some regional economic communities have designed capital market initiatives at the regional level. UEMOA has had a regional capital market serving all member coun-tries since 1998. CEMAC decided to establish a regional capital market in December 2000. In ECOWAS an agreement between the Lagos Stock Exchange and the Ghana Stock Exchange introduces cooperation in such areas as staff training, surveillance pro-cedures, self-regulation, and communication of information, with the intention of merging the two markets in 2004. In SADC the Johannesburg Stock Exchange is heav-ily involved in cross-border investment. SADC is also contemplating harmonizing list-ing and other tradlist-ing requirements with those of the Johannesburg Stock Exchange.
COMESA has no regional capital market, but two of its members, Kenya and Uganda, are involved in an interesting regional initiative under EAC. The EAC countries adopted a regional approach to capital market integration in 1997, incorporated in the 1999 EAC Treaty. The initiative includes harmonizing capital market policies and reg-ulatory frameworks, promoting cross-border listing and trading of securities, and developing a regional rating system (World Bank 2002).
EAC’s experience shows that while several steps to strengthen capital markets call for action at the national level, there is also wide scope for action at the regional level.
Above all, harmonizing legal and regulatory frameworks is very useful. However, even more than full harmonization (possibly not sustainable over time) the more relevant and pragmatic objective appears to be mutual recognition, so that compliance with the regulatory regime in one country constitutes compliance in another country.
Harmonization of reporting and disclosure requirements and liberalization of finan-cial services can also be achieved at a regional level.
A key factor in the creation of viable capital markets is the existence of sufficiently large demand and supply of securities. Regional cooperation can help establish links with other markets to achieve critical levels of demand and supply, launch awareness cam-paigns among investors and potential issuers on the costs and benefits of stock market Many capital markets
that had been dormant for years have been picking up significantly in recent years
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trading, coordinate capital market development with regional strategies for private sec-tor involvement, and promote cross-border listing.
Finally, the creation of regional markets might not be feasible in some regional economic communities where individual countries wish to retain their own stock exchange. In that case virtual regional markets, based on automated common trading systems and central depository systems, might be feasible (World Bank 2002).
The development of other capital markets is generally lagging far behind that of stock markets. In particular, debt markets are dominated by short-maturity government secu-rities. These represent the principal investment of commercial banks. Corporate bond markets are also very thin. To some extent this is due to the absence of a credit rating industry, as well as to the more general problem of weakness in the private sector.
Financial institutions. To advance economic integration, regional economic communi-ties have established institutions to support regional financial cooperation. Regional development banks operate in CEMAC, COMESA, EAC, ECOWAS, UEMOA, and UMA. These institutions provide finance to facilitate trade, to undertake projects at the national or regional levels, and to assist poorer members in each region. In SADC the South African Development Bank has taken on responsibility for serving the inter-ests of all community members. UMA is in the process of establishing a foreign invest-ment bank for Maghreb countries.
The COMESA Clearing House was established in 1984 to lessen the effect of foreign exchange scarcity on intraregional trade. With the reduction of exchange rate controls and the liberalization of current accounts since then, the clearinghouse requires restruc-turing. New priority areas are transferring clearing functions to commercial banks, transforming the clearinghouse into a regional SWIFT centre and hub for electronic money transfer among regional commercial banks, and putting the new clearinghouse in charge of providing regional export guarantees against political risk.
An insurance and reinsurance company (ZEP-RE) also promotes regional economic integration in COMESA. Opened in 1991, its shareholders are the 14 COMESA member states and the Eastern and Southern Africa Trade and Development Bank (PTA Bank), a development bank providing finance for trade and investment projects at the national and regional level through credit, credit guarantees, and minority equity participation in joint ventures. It also aims to supplement the activities of national development agencies of member states by arranging joint financing operations and using such agencies as conduits for financing specific projects. Priority sectors for PTA Bank are manufacturing, agribusiness, tourism, mining, infrastructure, and energy.
PTA Bank derives a significant proportion of its funding from relations with inter-national banks, export credit agencies, and other business partners. It has also raised funds using commercial paper, bonds, and other capital market instruments. Since its restructuring in 2001, PTA Bank has intensified its resource mobilization activities,
Virtual regional markets, based on automated common trading systems and central depository systems, might be feasible
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as evidenced by the signing of a master guarantee agreement with the U.S. Export-Import Bank and the Islamic Development Bank, among others.
In ECOWAS financial cooperation is reflected in the establishment of several regional banks, beginning with the formation of the ECOWAS Fund for Cooperation, Compensation, and Development in 1975 to provide finance for compensation of rev-enue losses from trade liberalization and for the development of less advanced areas in the region. Now the ECOWAS Bank for Investment and Development, it has two sub-sidiaries: the ECOWAS Regional Development Fund, which focuses on the public sec-tor, and the ECOWAS Regional Investment Bank, which focuses on the private sector.
The UEMOA countries also established a compensation and solidarity fund. Finally, the ECOWAS Bank Group (Ecobank) is yet another successful model of regional financial cooperation. Ecobank is the parent holding company of subsidiaries in 12 countries of West and Central Africa. It provides commercial banking and other finan-cial services to individuals and to private and public sector organizations. The ECOWAS Regional Development Fund is its major stakeholder.
Common to financial cooperation efforts in ECOWAS and COMESA is the attempt to encourage private participation, especially through communitywide financial asso-ciations, including women’s groups.
In UMA the Maghreb Bank for Investment and External Trade, headquartered in Tunis with a declared capital of $500 million, $150 million of it paid up, aims at contributing to integration by financing agricultural and industrial projects in which UMA members have a common interest. It also aims to mobilize investments for other bankable proj-ects and to promote trade and related payment arrangements. The bank intends to bor-row from international financial markets as well as those in UMA member states and to accept deposits of freely convertible currencies. The bank is overviewed by its general assembly, composed of all of its shareholders or their proxies. It is administered by a board of directors, with two representatives from each of the five member states.
Investment. A stable macroeconomic environment attracts and encourages investment—
essential for development. Privatization is also expected to attract foreign investment to Africa. Investments between African countries are contributing to macroeconomic stability and closer integration. For example, South Africa has invested in various African countries’ telecommunications, energy, mining, manufacturing, agriculture, and breweries. Kenya has investments in Tanzania. And Royal Air Maroc holds a 51%
share in Air Sénégal International, established in November 2000.
Foreign direct investment in Africa grew 1.2% a year between 1994 and 1999. Foreign direct investment represents about 2.8% of GDP in ECOWAS, 2.0% in COMESA, 1.9% in UEMOA, 1.8% in CEN-SAD and SADC, 1.4% in IGAD, 1.0% in ECCAS, and 0.9% in UMA. For Africa as a whole foreign direct investment averaged about 1.5% of GDP.
Investments between African countries are contributing to macroeconomic stability and closer integration
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During 1994–99 SADC and CEN-SAD each attracted about 21% of foreign direct investment in Africa. Other major recipients of foreign direct investment were COMESA (16%), ECOWAS (12%), and UMA (5%). SADC is an attractive invest-ment destination because of its mining and minerals potential and the macroeconomic stability in most of its member countries. South Africa is SADC’s most attractive des-tination for foreign direct investment, with considerable spillover effects on the rest of the community. In CEN-SAD foreign direct investment focuses on petroleum.
Between 1994 and 2000 Africa’s 10 largest recipients of foreign direct investment were Nigeria, South Africa, Egypt, Angola, Tunisia, Côte d’Ivoire, Lesotho, Sudan, Uganda, and Zambia (table 6.6).
Still, Africa’s share of global foreign direct investment remains limited, hovering just above 1% in the mid- to late 1990s and falling below 1% in 2000 (UNCTAD 2001).
By comparison, Latin America and the Caribbean received 10% of global foreign direct investment in 1995 and 11% in 1999. This raises the issue of what regional integration can do to make African countries a more attractive spot for foreign direct investment.
On theoretical grounds there are reasons to believe that the correlation between regional integration and foreign direct investment is positive. First, if the volume of incoming foreign direct investment is constrained by the small size of national mar-kets, integration will create the necessary condition for greater investments from abroad. The resultant surge of inward foreign direct investment might not be evenly distributed among member states, but concentrated in areas with the strongest loca-tional advantages. Second, liberalization of trade among regional economic commu-nity members will force outsiders to take action to remain competitive. One option is
Africa’s share of global foreign direct
investment remains limited, falling below 1% in 2000
Table 6.6
Foreign direct investment inflow to 10 largest recipients in Africa, 1994–2000 (US$ millions)
Average per Average capita (US$
Country 1994 1995 1996 1997 1998 1999 2000 1994–2000 thousands)
Nigeria 1,959 1,079 1,593 1,539 1,051 1,005 1,082 1,330 11
South Africa 374 1,248 816 3,811 550 1,503 961 1,323 32
Egypt 1,256 598 636 891 1,076 1,065 1,235 965 16
Angola 170 472 181 412 1,114 2,471 1,698 931 77
Tunisia 432 264 238 339 650 350 752 432 47
Côte d’Ivoire 78 212 269 425 380 324 106 255 17
Lesotho 19 275 288 268 265 163 118 199 99
Sudan –5 0 0 98 371 371 392 175 6
Uganda 88 121 121 175 210 222 220 165 8
Zambia 56 97 117 207 198 163 200 148 15
Source: Compiled by Economic Commission for Africa from World Bank Africa Database 2002.
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to increase investment in the regional economic community. Third, regional integra-tion can generate dynamic effects such as faster growth in participating countries, mak-ing the region more attractive to foreign investors.
Empirical evidence is also available for several regional economic communities on the pos-itive impact of regional integration on foreign direct investment, including NAFTA, MERCOSUR, and the European Union (Blomström and Kokko 1997; World Bank 2000). Thus by strengthening intraregional market links and promoting trade integration, regional economic communities can create the preconditions for increasing the volume of foreign direct investment to Africa.