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ECONOMIC COMMISSION FOR AFRICA Ad-hoc Expert Group Meeting on the Domestic
Mobilization of Financial Resources for
, Africa's Development: Retrospect and Prospect Addis Ababa, 24-27 March 1996
DOMESTIC FINANCIAL RESOURCE MOBILIZATION FOR AFRICA'S DEVELOPMENT
EXECUTIVE SUMMARY AND ISSUES TOR DISCUSSION Prepared by:
Socio-economic Research and Planning Division, UN-ECA
96-474
I. Ifttroductioji
Africa's economic performance over the last two decades has been less than satisfactory compared to its own historical record, or relative to other developing countries, and measured against the rate of population growth. The rate growth of real GDP in the 1960s was 5.4 per cent per annum, resulting in a yearly per capita income increase of 2.$ per cent. In the 1970s,
^comparable figures were 4.3 per cent and L4 per cent respectively,- During the decade of
the 80s the annual growth rate averaged 1,8 per cent in consequence of which per capita incomedeclined by 1.2 per cent yearly. During the first half of the 1990s GDP growth averaged 1.7
per cent and per capita income declmed at the rate of 1.3 per cent per annum.
Africa needs to reverse its declining fortunes and relocate its economy on a growth trajectory if the welfare of me people is to improve. For this purpose, it has to undertake extensive administrative reform and implement imaginative and innovative policies to drastically upgrade efficiency of resource use, create an enabling environment both for domestic and
external entrepreneurs and increase its productive capacity through investment.African governments have expressed commitment and made heroic attempts in the past
to regenerate and transform their economies collectively and individually. The Lagos Plan of
Recovery and Development (UNSPAFERB) are multilateral commitments supplementing
domestic undertakings to resuscitate and further energise the sagging economies.Despite the enormous difficulty of the last two decades and half, the people and government have maintained their savings habit and the volume of investment. Domestic efforts to increase the volume of investment as one means of reviving the economies have been well supported by the international donor community. Since the early 70s, external resources have
The purpose of this paper is to summarize the contents of the background paper, review
the capability of the African economies to meet the challenges of providing for their growth and
development and raising pertinent bsijss tor discussion. . , II. Statement of the ProblemWith considerable upgrading of efficiency, an aggregate GDP growth rate of 8 per cent
per annum in Africa with all its country specific variations could double the per capita income
over the next decade and hall Attainment of this rate of growth is estimated to require an
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additional investment of about US$45 billion per annum in 1990 prices above the present level of US$115 billion and raise the level of investment of US$160 billion. This would double the investment rate from the current 21 per cent of GDP.
Most and perhaps all of this additional funding must be mobilized from domestic sources.
External resource inflows are unlikely to maintain their historical level let alone finance additional investment at least for two reasons. The first is aid fatigue in donor countries, and unfavourable image on the part of many African countries. The donor communities' perception of value for money in Africa is very low indeed. The heavy debt burden and the difficulties of servicing along with demands for rescheduling and write-offs have exacerbated the negative image. The second factor contributing to declining external resource inflow is the global competition that seems to be "crowding-out" Africa. These conditions, augmented by calls for deficit reduction in the major donor countries are likely to further limit the volume of external resource inflows for the future.
Consequently, African countries would have to assume the responsibility of financing the additional investment required to service their economies. Reducing inefficiency, creating an environment conducive to the retention of savings within the country and reversing capital flight and, above all, encouraging savings through appropriate policies as well as creating the necessary institutional mechanisms for its intensive mobilization would provide the necessary resources to finance the additional expenditure.
The challenges facing African experts in resource mobilization is the charting of ways and means of optimizing the availability of investable resources, and educating the policy makers on the policy options available to them.
HI. Methodology
The background paper does three things: (a) it surveys theoretical and empirical evidence on the determinants of savings, (b) it discusses trends in public and private savings and (c) it reviews the principal methods of financial intermediation in Africa. Each section is 'followed by issues that heed to be discussed and resolved and for a better understanding the
essential elements raised in the body of the paper. ; IV. Determinants of Savings in Africa
Attempts to understand the determinants of savings in the African context must differentiate between the behavioral aspects as well as identify the nature and degree of their impacts on the sources of saving. The literature identifies incomes, interest rates, prices,
demography (age structure, size of households, location (rural and urban) political stability and
the external environments as the major determinants of savings. The saving units are segmented into public (governments), business and households. This section covers aggregate saving.
Review of the literature on African empirical exercises and in other developing countries elicit the following conclusions. Income (however defined) is the most important determinant.
The higher the level of income the more is saved. An interesting evidence emerging for econometric models using data for the 60s, 70s and 80s shows the consistent decline in the marginal propensity (MPS) to save. The exercises using pooled data of the decade of the 60s, the MPS was quite high and in many instances greater than unity, implying considerable saving potential. During the 70s and particularly the 80s, the MPS fell, reflecting the declining saving potential due to the declining income. The impact of interest rate is mixed, although the weight of evidence suggests at best no effect and is more probably negatively related to savings. This follows from the effect of interest rate on income which is the primary determinant. High interest rate militates against investment, lowering income and saving. Inflation and inflationary expectations have no discernable impact on total saving but on the form the saving is held. In an inflationary economy, savers prefer real assets and limit their cash holdings to what is required for transaction purposes. The evidence on the impact of the rate of growth of population, although not conclusive, tends to be negative. Demographics also affect savings;
people younger than 15 and old than 65 tend to save less. Declining death rate and increasing fertility increases the proportion of dependents, leading to increased consumption^ Rural
communities are believed to save more than the urban based population driven mostly by
precautionary motive due to the greater uncertainty of their income. Political instability has positive impact on savings, since people are uncertain about their future income, but has a considerably detrimental impact on its retention within the country. Actual and perceived political instability along with inappropriate policy environment encourages and drives capital flight. International economic relations have both positive and negative effect on domestic savings. Increased demand for exportables and/or high prices increase savings via income while external resource inflows tend to substitute for domestic savings rather than supplementing.V. Saving Trends in Africa
The evidence on gross national and domestic saving during the last two decades points to the deteriorating savings capacities in African countries. Gross national savings declined from 19 per cent during the 1975-79 period to 16 per cent over the 1980-85 years and to 13 per cent between 1986 and 90. Gross domestic saving declined from 21 per cent to 18 per cent to 17 per cent respectively.
VI. Financial Intermediation and Savings Mobilization
Financial institutions offer an economy a means for mobilization of resources. Currently,
the formal African financial institutions are overwhelmingly dominated by commercial banks -
both indigenous and foreign. Governments have established development finance institutions to provide credit on long-term basis. In some countries, rural and community banks have been established to mobilize resources from the small.savers and to also provide them with loans.However, the capacity of the financial institutions to grow and their real capacity to mobilize deposits and to lend are very linn*ted in the context of their present structure and its size. Consequently informal financial institutions dominate the mobilization and allocation of
resources.
In terms ofgeographic coverage and bank branch density, as an indicator of the nearness of financial institutions to households are very inadequate, limiting the services they can provide
to\teie population as a whole, particularly in the rural areas.
The contributions of the non-bank formal financial institutions are either non-existent in
many countries or are at the rudimentary slate where they exist. Insurance companies are limited
both functionally and geographically and in many cases serve as local agents for well established foreign companies who act as their reinsurers.
Stock exchanges have failed to exploit their potential, forcing companies to rely on retained earnings and bank credit. The avenue for venture capital does hot exist outside.
Pension funds are limited to the small numbers of employees of the private and the public sectors and excluding the self-employed in many countries, and are invested for the most in government
securities. ; ,:
There has been attempts to reach the small savers through specialized financial institutions such as peoples' banks, community banks, rural banks and the post office banks but tlieir success
is quiet limited. ;
VII. Role of Financial and Other Policies For the Mobilization of Savings
The role of financial and other policies on savings should target the saving units in the economy - the public sector, and the private sector (households and business).
lU Public saving^ in Africa has been very low and in most cases negative* relying on
domestic as well as external credit and assistance to cover the gap between avenue and expenditure. Government deficit arid the financing of the deficit by borrowing from domestic financial institutions has been held partly responsible for the poor performance of African economies although this is hotly disputed. It is often claimed that government expenditure policy rather than "crowding-out" the private sector has "crowding-in" effect.Clearly, governments should increase tneir savings by increasing revenue and ^decreasing current expenditure and improve the efficiency of resource use. Revenue maximization focuses on the tax policy and its efficient administration while the drive to efficiency requires its "right- sizing". "/"":, ■' ■ '. ■■ ' ' ■ ■ -."'._.. .'-.--.
*"" An obvious Instrument to increase government revenue is the tax policy. Increasing taxes are likely to have negative impact on private sector saving by reducing disposable income and the after-tax profit. An alternative source for government revenue are incomes of parastatals.
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What would the impact of divestiture of profitable public enterprises on government savings?
There has been notable achievements in reducing government expenditure but how this reduction was achieved and its impact on development has been questioned. The SAP imposed reduction in both the tax rate (and particularly taxes on external trade) and expenditure has had detrimental impact on its capacity to deliver essential services since governments were forced to cut back on their investment on social and economic infrastructure and supplies. The contraction of the state is claimed.by many to constrain the government's capacity to provide the most basic of services and push the economy into depression, reduced employment and income and therefore
the saving capacity of the population.
VIII. Issues for Discussion
Although the major determinants of saving are summarized above, it is obvious that more research is needed, to substantiate the existing evidence, understand the transmission mechanism and inform and advise policy makers on ways of optimizing resource mobilization. The impact and the degree to which the variable identified above .do.-not enjoy universal consensus. For different reasons, many disagree with the above findings and many dispute the relevance and Following financial liberalization, practically all African countries have increased the rate of interest and are making attempts to maintain it at a positive level, This policy stance has been
interest rates have no effect on total saving but influence the form the saving is held in. High interest rates change the portfolio of savers but do not increase
(b) high interest rate reduce the volume of investment'by increasing the opportunity cost thereby reducing Income; and saving;
(c) " high interest rates are inflationary since they increase the cost of production; and (d) high interest rate, relative to the rest of the world erode the capacity of the domestic economic agents to compete successfully both in the home and global
determinants of savings are likely to raise issues which need to be discussed. Although the errect of income on saving is not disputable, there are nevertheless questions on the identification of income (absolute, permanent, relative, life-time) and its measurement.
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The effect of the demographic structuring of a nation on saving is also controversial.
Based on the life cycle hypothesis of Modigliani and associates, saving correlates negatively with dependents i.e. the below 15 and above 60. In the African context, particularly in the rural setting, income and consumption are communal rather than individual based and therefore high dependency is hypothesized to have small, if any effect, on savings. The assumption that the between 15 and 60 cohorts atre income earners is also disputable in the African context where unemployment is very high. Africa has a large young population for now, but it is by no means self evident that its savings rate will necessarily rise as the population grows older and accords more closely with the higher savings profile. At the opposite end of the spectrum, there are people who of course claim a positive relationship between population increase and saving rationalizing on account of the size of the market and large number of producers.
With respect to foreign capital inflow, the issue seems to be more complicated than is suggested in the literature. While the negative effect of foreign assistance may suggest decreasing dependence to increase domestic saving, this is likely to have a negative impact on the growth of African economies facing foreign exchange constraints. The issue here is what needs to be done to increase domestic savings while at the same time not abandoning foreign assistance.
Available estimates of capital flight (both human and financial), although difficult to measure with high degree of confidence, are nevertheless high. These are resources that are desperately needed for Africa's development. What do governments need to do to reverse the flow and minimize the outflow.
Issues for discussion:
B. Savings Trends in Africa
(a) The most obvious problem facing analyst is the quality and availability of data. Currently savings are estimated indirectly by deducting the current account deficit from gross investment. This is an unsatisfactory measure and governments need to upgrade the quality and availability of national accounts data (income, expenditure, investment to improve analysis).
(b) The decline in gross domestic saving is in line with the fall in the earnings of the people confirming income among the major determinant of savings.
The reversal of the present trend is dynamically linked to a strong and sustained recovery. What needs to be done to locate the African economies on growth trajectory.
(c) Gross national saving is less than gross domestic saving indicating that foreign savings have been negative. What needs to be done to reverse this
trend. ■■'.
C. EnmMM&immmLm Savings Mobilization
Should central banks ^it their role to simple regulation and control of financial institutions or ex^nd their activities to the development realms.
(a) What should be the nature of reforms in the financial institutions and
particularly the commercial banking structures and operations.
(b) What needs to be done to increase the saving mobilization capacity of Development Finance Institutions such as development banks whose records are very poor, since in most cases they rely on public funds and
serve as conduit for external credit.
(c) Should new types of financial institutions be considered to cater for the needs of the majority of the non-banking private sector and build up the
banking habit of the people.
(d) What policies should be considered for the formal institutionalization of
savings mobilization and credit disbursement in sectors that the existing
financial institutions cannot be expected to serve.(e) Should linkages be created between the formal and informal financial
institutions? If so what and how?
(f) mat experience in Africa and elsewhere of specialized institutions and
other formal institutions in urban areas such as stock exchange, mutual funds, insurance companies, pension funds, etc are useful in the search for
appropriate forms of resource mobilization.
(g) Could government take advantage of their privatization need and drive to
create and foster the development of stock markets? If so, how should this be approached and what modalities should be pursued?
(h) VVhat experience in Africa and elsewhere, of less formal institutions in urban and rural areas provide the basis for viable instruments and
mechanisms for resource mobilization.
(i) To what extent does the liberalization of interest rates structure contribute
to the formahzation of the rural financial markets.
Rple of Financial and nther Policies on Savings Mobilization
(a) What policy should governments pursue in their revenue and expenditure
paradigm to enhance the saving investment capacity of the private sector
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while at the same time not incapacitating its capability to provide essential ,/ economic and social services?
(b) Does government financing of its deficit crowd out the private sector.
(c), What are the impacts of high interest rates on government, household and
private savings.
(d) Should the government increase taxes to reduce its deficit. What are the
impacts on;household and business savings.
(e) What areas of tax rationalization and improvements in tax collection are open to African governments? .What for instance are the relative means of income based taxes and consumption based tax (e.g. VAT)?
