According to a new UNCTAD report, if the pernicious cycle of low growth and aid dependence experienced by sub-Saharan Africa is to be broken, donors must commit themselves now to a big push on external aid.

by Chakravarthi Raghavan

Geneva, 27 July 2000 -- If donors are serious about breaking the pernicious cycle of low growth and aid dependence in Sub-Saharan Africa (SSA), they must commit themselves now to a big push on external aid, the UN Conference on Trade and Development said Thursday in a new report: ‘Capital Flows and Growth in Africa’.

Prof. Korkut Boratov, an UNCTAD economist said that a clear balance-sheet, taking account of terms of trade losses, shows that after 20 years of pre- and post-adjustment policies, and opening up of the domestic economies to the international economy, SSA has lost almost 50% in relative prices (terms of trade losses). “These countries have now to export 50% more to import the same quantity of goods - capital equipment, consumer goods and inputs,” he said.

“A rethinking of international and domestic policy approaches is now called for, based on a realistic assessment of the resource needs of SSA, recognizing the short-comings of pre- and post-adjustment policies, and addressing directly the structural constraints and institutional hiatus that pervade the region,” UNCTAD said. Despite many years of intensive and widespread adjustment, barely any African country has successfully completed its adjustment programme and set off on a sustained growth process.

“Not only have there been serious shortcomings in the design and implementation of policies, but also adjustment has generally been under-financed. A judicious combination of a big push in external official financing and a reorientation of domestic policies on the basis of the lessons drawn from the experience of the past three decades appears to be the only viable way of securing rapid and sustained growth in the region, and eventually eliminating its dependence on aid.”

A doubling of aid flows for SSA to $20 billion a year would amount to no more than an increase of five US cents to every $100 of consumer spending in the OECD countries, Mr. Richard Kozul-Wright, an UNCTAD staff economist pointed out at a press briefing. “These are not big numbers,” he said.

The only feasible way to end aid dependence of Africa is to launch a massive aid programme and to sustain rapid growth for a sufficiently long period so as to allow domestic savings and external private flows to gradually replace official flows, the report said.

An aid package on a sufficient scale could lead to rapidly rising incomes, pulling up savings and attracting private flows, Kozul-Wright said. Reliance on ODA would fall and rising consumption could reduce poverty.

The simulations done at UNCTAD suggest that on the most optimistic scenario, after a decade of six percent growth in the region, there would be lower current account deficits and a smaller external financing requirement, while a higher proportion of external financing would be met by private inflows. Official aid would be lower in absolute terms.

The two economists said that reliance on private capital flows rather than official aid was no solution. Data and experience showed that Foreign Direct Investment (FDI) lagged growth and did not lead growth.  And despite being on the margins of global capital markets, due to the thin domestic financial markets in SSA, even small shifts in flows can be very disruptive.

The report brings out that in SSA, net capital inflows registered a moderate increase in the 1980s, compared to the 1970s, and fell somewhat in 1990s. But this picture is strongly influenced by Nigeria, the largest economy in the region. If Nigeria is excluded, total net capital inflows (official and private) were lower in 1990s than in 1970s, though recovering slightly from the depressed levels of 1980s.

In the same period, North Africa witnessed a dramatic decline in capital inflows as a proportion of GNP during the 1980s, compared to the 1970s, and the trend continued in the 1990s, largely due to a decline in private inflows.

In terms of net transfers (total flows minus interest payments and profit remittances), there was a similar declining trend. In SSA it was lower in the 1980s than in 1970s, and this continued in the 1990s - despite a fall in interest payments on external debt.

Almost 40% of net capital inflows into SSA (including Nigeria) in 1990s were transferred back to creditor countries as interest payments and profit remittances. For North Africa the turn around was even more dramatic: after a sharp drop in the 1980s, it turned negative in 1990s, implying a net transfer of resources from the region.

Overall in Africa, while ODA grants have risen over the past three decades, multilateral and bilateral lending has either fallen or stagnated. Official inflows have accounted for an increasing proportion of total capital inflows.

In per capita terms there has been a pronounced downward trend in both total and official capital inflows—from a level of $20 per head in mid-1970s, total net inflows in SSA more than doubled to reach $43 per head in 1983, then started falling, and at an accelerated pace in 1990s. At end of the decade it was less than $30 per head.

In real terms the decline has been even more pronounced: real per capita inflows at end of the 1990s was less than half of those in 1970s and early 1980s.

An UNCTAD study shows that while multilateral and bilateral lending tends to be a catalyst for private capital inflows, this does not hold good between grants and private flows.

Also, private capital inflows show a strong response to lagged growth rate, but not to contemporaneous growth. They tend to lag behind rather than lead growth.

Evidence of the past decade, UNCTAD says, shows that a rising share of capital inflows of developing countries, including emerging markets, has been channelled to offsetting financial transactions, and that association between capital inflows and financing of the resource gap (the current account deficit) has grown weaker.

As a result of increased liberalization of the capital account and greater integration into global financial markets, increased capital outflows through acquisition of assets abroad by residents has become a widespread phenomenon in the developing world, particularly emerging markets. During the past decade, a number of African countries have also liberalized outward capital flows, facilitating acquisition of assets abroad. Such outflows could also take place under controlled capital account regimes, when such controls are ineffective and incentives for capital flight are strong.

For 16 African countries taken together, capital outflows have absorbed a greater proportion of capital inflows in recent years. For every dollar of net inflow, there was an outflow of 9 cents in the 1980s, and this rose to more than 23 cents in the 1990s.

[The 16 countries analyzed are Cameroon, Cote d’Ivoire, Egypt, Ethiopia, Ghana, Kenya, Madagascar, Mauritius, Morocco, Nigeria, Senegal, Sudan, Tunisia, Uganda, Tanzania and Zimbabwe.]

For emerging markets, the corresponding figures were 24 and 31 cents respectively.

Eleven of the 16 African countries experienced rising capital outflows as a proportion of inflows. The exceptions were Cameroon, Kenya, Morocco, Sudan and Zimbabwe. The last two are among countries with tighter controls on capital flows.

Co-existence of outflows and inflows is a widespread phenomenon in the industrialized world, a natural outcome of global financial integration. A similar situation can be expected to prevail in developing countries as their incomes and wealth increase and dependence for growth on foreign capital declines.  But these conditions do not yet hold for Africa. And in SSA, there is an important asymmetry between asset holders abroad and international debtors, making it even more difficult to manage external payments.

In Africa, net capital outflows by residents, together with international reserve accumulation, have thus absorbed an increasing proportion of net capital inflows in recent years, and a declining proportion of such inflows has been allocated to real resource transfers from abroad in the form of current account financing.

For the 16 African countries, the proportion of total inflows absorbed by offsetting financial transactions rose from less than 10% in the 1980s to more than 40% in the 1990s. That is, in the 1990s, less than 60 cents of each dollar mobilised from abroad has been allocated to real resource transfers.

Much of the capital inflows, particularly grants, are tied to imports, and the terms under which they are made available to users are not always linked to market conditions.

Evidence in Africa, as in emerging markets, shows that liberalization of short-term capital movements bring very little in the way of net flows of capital, while provoking significant instability.

In the past few years net short-term inflows into the region as a whole have tended to exceed net short-term outflows, with the region appearing to enjoy a positive balance.

“However, if the experience of countries with better fundamentals, institutions and markets is any guide, such flows are unlikely to provide a reliable basis for bridging the external resource gap.”

The UNCTAD Trade and Development Report 1999, showed that with few exceptions trade deficits have been increasing faster than income in developing countries during the past decade. And in most countries, the trend is one of widening trade deficits with falling and stagnant growth rates. Most SSA countries fall in this category.

Three factors have generally been responsible for the deterioration of the relationship between trade deficits and economic growth in developing countries during the past decade: terms of trade deterioration, rapid trade liberalization that is not matched by increased market access in industrialized countries, and exchange rate instability and misalignments associated with greater capital account openness and increased volatility of private capital flows.

The deterioration in African terms of trade has meant that despite rapidly rising export volumes in the 1990s, the purchasing power of the exports remained significantly below levels attained in early 1980s. This resulted in either a compression of import volumes or increase in trade deficits.

The increase in trade deficits was not reflected as much in current account balances. As a result of increased payment difficulties, many countries have accumulated arrears on interest payments, thus adding to external debt rather than current account deficits. For SSA as a whole, arrears on interest payments on long term debt accumulated from 1989 to 1998 amounted to $13 billion or 14% of total current account deficit.  Also, grants in IMF Balance-Of-Payment (BOP) accounting are treated as current account transactions rather than capital inflows. With grants being a large part of total official inflows, this helped to show a fall in current account deficits.

But this did not imply an increase in real resource transfers from abroad - since aggregate official financing, including grants, have tended to decline.

Africa needs to register a sustained six percent growth rate a year - to help reduce aid dependence by allowing levels of domestic savings to be raised and by attracting greater inflow of private capital. For such a growth rate, an investment rate of about 28% of GDP is needed.

SSA has an investment rate of about 18% of which 13% is accounted for by domestic savings, with the gap financed by net capital flows from abroad.

Additional capital inflows are needed to raise investment. And initially, this has to come from official sources, but this dependence would gradually fall over time as domestic savings and private capital flows rise.

Debt reduction as well as fresh money could play an important role in the provision of resources needed to raise investment and growth, particularly for low-income countries.

Empirical evidence about behaviour of private capital inflows into developing countries show that private flows tend to respond strongly to economic growth (and not the other way round).

In a simulation exercise of capital inflows and growth, UNCTAD says these involve a number of policy challenges.

Firstly, it is important to ensure that a larger proportion of foreign capital inflows is used for imports needed to operate and add to productive capacity, rather than financing capital outflows or build excess reserves to safeguard against discontinuation or reversal of capital flows. A commitment by the international community to a steady provision of adequate external financing would itself reduce the need to accumulate reserves.

Secondly, effective utilization of capital inflows to raise accumulation and growth will not be possible without an appropriate management of the capital account, particularly without regulation and control of short-term capital flows.

Thirdly, aid should be effectively used to accelerate capital accumulation and growth, and ease the BOP constraint. Success depends on establishing a virtuous circle between investment, exports and savings.

The failure in Africa to initiate such a process is often blamed on policy mistakes, and this also appears to be the main reason for “aid fatigue” in donors.

However, as several studies have shown, additional aid provided since early 1980s has barely compensated for resource losses due to declining terms of trade, let alone means for rapid and sustained growth.

In the post-independence period in SSA, various structural and institutional shortcomings inherited from colonial times made the task of sustaining growth and development difficult.

But policy errors also played a role.

Industrialization was pursued without adequate attention to agricultural productivity and growth and industrial competitiveness.

And policy errors during the more recent adjustment period were no less serious. Structural adjustment programmes sought to leave accumulation and growth to market forces without adequate attention to shortcomings in markets, institutions and infrastructure. While the State withdrew from economic activity in a number of areas, viable alternatives based on private initiative have not emerged because of such shortcomings.

And rapid economic growth does not automatically translate into increase in proportion of national income saved. Average savings rates in some of the middle-income countries of Latin America failed to show a significant increase from late 1960s to late 1970s, despite a relatively rapid growth of per capita income. But many late industrializers in East Asia, notably Korea and Taiwan, managed to raise their savings rates. This was due to the role of government in promoting savings and accelerating capital accumulation.

On the oft-cited examples of Ghana and Korea having started more or less on the same basis, but with Korea having faster and sustained growth, Prof Boratov, noted that apart from other internal policies, there was a sustained and large external financing for Korea from the US, albeit politically motivated. Aid to Africa was not sustained over a period of time, and whatever was provided had an unequal distribution. Aid to Korea was linked to growth, and not by attaching it to policy instruments as now.

But there can be no universal blueprint, and policies have to be tailored to the specific structural and economic needs of a country, Mr. Kozul-Wright added. Policy agendas have oscillated between too little market and too little State.

In addition to a new push on aid, debt relief and market access would bolster growth prospects across the continent. An aid package of sufficient scale could lead to rapidly rising incomes - pulling up savings and attracting private flows. Reliance on ODA would fall and rising consumption could reduce poverty.

In the most optimistic scenario of UNCTAD simulations, after a decade of 6% growth in the region, there would be lower current account deficits and a smaller external financing requirement. A higher proportion of the last could also be met by private inflows, and in absolute terms official aid would be lower.-SUNS4718

The above article first appeared in the South-North Development Monitor (SUNS) of which Chakravarthi Raghavan is the Chief Editor.

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