TWN Info Service on Finance and Development (July10/02)
13 July 2010
Third World Network

The financial crisis and challenges facing Africa
Published in SUNS #6962 dated 9 July 2010

Geneva, 8 Jul (Kanaga Raja) -- The global financial and economic crisis has had a negative impact on African economies, and the main challenge facing these countries now is how to position themselves for post-crisis recovery as well as ensure that policy responses to the crisis do not lead to medium- and long-term problems of debt sustainability.

An effective response to this challenge requires that African countries build robust regional markets, unleash the potential of local business and entrepreneurs for development, and build resilience to shocks. It also requires support by Africa's development partners.

These are the main conclusions of a note prepared by the Secretariat of the UN Conference on Trade and Development (UNCTAD) for the fiftieth executive session of the Trade and Development Board that has focused on Africa.

The executive session of the Board is being held on Thursday, with the first half being devoted to activities undertaken by UNCTAD in support of Africa, followed by a panel session in the afternoon on "Financial Crisis, Macroeconomic Policy and the Challenge of Development in Africa."

Speaking in the morning session, Egypt, on behalf of the African Group, underscored the importance of consolidating the role of UNCTAD in providing advisory services and technical assistance to African countries.

In particular, the African Group highlighted the issues of global concern, on top of which come the current trends and developments in the international trading system, climate change, food security, development impact of investment, and Economic Partnership Agreements (EPAs), the use of ICT (information and communication technologies) for development, and the development impact of intellectual property rights.

It also called upon UNCTAD to continue to provide assistance to African countries in the process of accession to the World Trade Organization.

Pointing to the issues of policy space, building of productive capacities, economic diversification, the debt burden and commodities, the African Group said "when discussing the African priorities, we cannot over-emphasize the relevance of such issues to our discussion."

Another area of particular concern relates to the contribution of migrant remittances to development. The global economic and financial crisis has led to a drop in Foreign Direct Investment (FDI) flows and lack of fulfillment of Official Development Assistance (ODA) commitments, thereby presenting limitations on the sources of income available to African economies, said the Group.

The Group called upon UNCTAD to pay particular attention to providing policy advice on the ways and means of employing migrant remittances as one of the sources of financing development in complementarity to ODA.

It said that the global financial and economic crisis has unraveled the fallacies of a self-governing market economy, and has highlighted more than ever the need for a more active role to be played by the State to retain balance and guard against shocks. "In this domain, two key words are pertinent to the African continent, namely, policy space and economic diversification," said Egypt.

Cuba, on behalf of the Group of 77 and China, said that fundamental systemic reform has to take place if the international community is to overcome its blind and misguided faith in the infallible powers of self-adjustment of the global economic system. "The invisible hand of the markets must be guided by the very visible will of the developmental State."

It further said that the effects on the ground and on the real economy, and the consequent crisis in the accomplishment of the Millennium Development Goals (MDGs), has underscored that while the Goals are valuable as tools for development policy, the approach that has been anchored on poverty reduction must be overcome. "Put bluntly, an approach based mainly on poverty eradication focuses on achieving an acceptable level of poverty. We must be more ambitious than that and focus our efforts on achieving a minimum level of acceptable prosperity."

The Group believed that what is needed at the global level is to anchor new development approaches on an international economic system which places development at the centre.

Referring to three new P's - of political solidarity, policy space and productive capacity - the Group said that these should be considered as core principles of a new approach to development which takes into account the lessons of recent years and indeed of the development challenges which continue to persist.

It stressed that political solidarity must be mobilized to provide Africa with the resources and support to follow nationally owned and formulated development policies. This should be translated into providing Africa with sufficient policy space to use the various policy tools available. In turn, the continent must be assisted in developing productive capacity to actively and meaningfully participate in the global trading system.

In order to accomplis this, the Group of 77 and China said that there is need to focus UNCTAD's technical assistance to Africa into those areas which will help to steer the region towards new and more successful development strategies as determined by African countries.

In addition to UNCTAD's current work on the mobilization of domestic resources and equitable distribution of income, the Group said that this could be done by expanding technical cooperation activities which amongst others help African countries develop pro-active trade policies; strengthen technology transfer and the diffusion of knowledge and know-how to African countries, and this included helping African countries to fully and adequately deal with the development dimension of the evolving intellectual property system; assist African countries to realize developmental gains from increased investment flows and enterprise development, and enhancing international competitiveness through productive capacity building; help African countries to strengthen their manufacturing and agricultural sectors; and assist African countries to fully exploit the developmental impact of the commodities sector.

Bangladesh, speaking on behalf of the Asian Group, said that the lingering effects of the recent global financial and economic crisis took a heavy toll on economic activity in Africa, retarding progress towards achieving the continent's developmental goals.

With economic growth declining, the numbers of unemployed as well as poverty rates have risen, particularly among the vulnerable groups. In many countries, the crisis has jeopardized progress towards meeting the MDGs and the objectives of the African Union and its NEPAD (New Partnership for Africa's Development) programme, said Bangladesh.

Africa continued to play a marginal role in world trade in 2009 with about a 3.4% share of global merchandise trade and an insignificant share in trade and services. Commodities continue to be the major exports. The reliance on a narrow range of commodities as well as a narrow range of markets, makes African export earnings extremely vulnerable to volatility in these markets, it further said.

Africa continues to face challenges in financing development, as the global economic crisis decreased both internal and external resources. In terms of domestic resource mobilization, the ratio of gross domestic savings to GDP dropped from 25% in 2008 to 19.3% in 2009, while the ratio of tax revenues to GDP decreased by 21% and 10% in Sub-Saharan Africa and North Africa, respectively.

Despite the HIPC (Heavily Indebted Poor Countries) initiative, the economic crisis increased the debt of African countries, as the average debt-to-GDP ratio rose from 22.4% in 2008 to 25.4% in 2009, said the Asian Group, adding that the debt service to export ratio also increased to 16.2% from 15.9% in the same period. If this increased debt ratio becomes a trend, Africa may be in danger of slipping back to the unsustainable high debt levels it recorded before the HIPC initiative, cautioned the Asian Group.

The global financial crisis has reinforced Africa's weakness vis-a-vis the world financial architecture where it is not a party to most decision-making regarding rules governing global financial flows.

The Asian Group underlined the need for adequate policy space for developing countries in managing their own economies. "We feel that it is an appropriate time for us to rethink the entire development paradigm, acknowledge the lessons learned, revamp the international organizations to cater to the needs of the developing countries, if we are sincere in our commitments to development," said the Asian Group.

In its note titled "The financial crisis, macroeconomic policy and the challenge of development in Africa", UNCTAD said that the global financial and economic crisis triggered by the decline of house prices in the United States in the second half of 2007 poses significant challenges for African countries and policy-makers. It has led to a significant reduction in growth rates and is slowly reversing the progress in economic performance made by the region since 2000.

"The crisis is also jeopardizing efforts by African countries to meet the Millennium Development Goals (MDGs) by the 2015 target date."

Before the current crisis, says the note, the conventional wisdom was that countries experiencing economic turmoil should adopt austerity measures in the form of restrictive monetary and fiscal policies to maintain macroeconomic stability. The result has been that macroeconomic policies in Africa tend to be pro-cyclical, rather than counter-cyclical as in developed countries, with dire consequences for growth and poverty reduction efforts.

"The current crisis has exposed the limitations of this approach to macroeconomic policy and renewed interest in the use of fiscal and monetary policies for economic stabilization. It has also raised questions about the role of capital account liberalization in developing countries."

Unlike in previous crises, notes UNCTAD, some African countries responded decisively to the current economic turmoil through counter-cyclical monetary, fiscal and financial policies. They also adopted measures at the regional level such as the establishment of a financing facility by the African Development Bank and the setting up of the Committee of Ten Ministers of Finance and Central Bank Governors to monitor the crisis and suggest ways to cushion its impact in the region. These national and regional actions have helped in limiting the adverse effects of the crisis in the region.

The challenge facing African countries now is how to position themselves for post-crisis recovery as well as ensure that policy responses to the crisis do not lead to medium- and long-term problems of debt sustainability. In this regard, there is the need for African countries to rebuild their economies and lay the foundation for revival of strong and robust economic growth. There is also the need to strengthen social safety nets as well as reduce vulnerability to shocks.

According to UNCTAD, African countries experience significant fluctuations in economic growth. This is due to various reasons, including their dependence on primary commodity exports with volatile prices, instability of both private and official capital flows, and vulnerability to climate change. In principle, counter-cyclical macroeconomic policies could be used to cushion the effects of these shocks on output.

However, macroeconomic policies in Africa have historically been pro-cyclical. For example, fiscal policy tends to be expansionary during booms and tight during downturns, thereby amplifying and exacerbating the adverse effects of shocks on output.

The note says that until the onset of the current financial and economic crisis, the conventional wisdom was that the primary objective of monetary policy should be the maintenance of low and stable inflation. Given this mind-set, central banks in the region were more concerned about the impact of their policy actions on inflation than the implications for output. Consequently, they are often hesitant to follow expansionary monetary policy during downturns for fear that it would create inflation and undermine macroeconomic stability.

Furthermore, in the 1980s and 1990s, African countries that participated in the Enhanced Structural Adjustment Facility (ESAF) of the IMF were required to adopt restrictive monetary policies in response to economic turmoil with severe economic and social costs. These conditions effectively limit the ability of African countries to conduct counter-cyclical monetary policies and contribute to macroeconomic instability in the region.

Regarding fiscal policy, one of the main reasons for its pro-cyclicality in Africa is the fact that financing (supply of credit) to African countries is pro-cyclical. During economic downturns, African countries either cannot obtain credit or can do so only at very high interest rates, making it difficult to run deficits. Consequently, the typical fiscal response of African countries during economic crises has been to cut government spending, with potentially adverse consequences for macroeconomic stability and growth.

Policy conditions imposed by international financial institutions also restrict government spending, forces African governments to impart a pro-cyclical bias to fiscal policy, and amplify economic fluctuations.

Another factor contributing to fiscal policy pro-cyclicality in Africa is the existence of fiscal rules designed to achieve debt sustainability or meet convergence criteria established by regional economic groups. These rules often take the form of limits on government borrowing, spending or debt accumulation that give governments less room to conduct discretionary fiscal policy.

As a result of the current crisis, says UNCTAD, economists, policy-makers and international financial institutions are slowly changing their views on the role of macroeconomic policy and now recognize the need for discretionary policies to reduce economic fluctuations and support the development efforts of developing countries.

"However, it is important to stress that the effective use of macroeconomic policies for stabilization in Africa requires reduction of policy conditions attached to lending by international financial institutions. It also requires building strong institutions of accountability as well as improving access to credit, particularly during downturns. African countries can also create fiscal space for counter-cyclical policy responses in the future by managing revenue from commodity booms more effectively."

The UNCTAD paper highlights some important policy lessons from the current crisis for Africa as well as for the international community.

In the 1980s and 1990s, many countries in Africa adopted sweeping economic reforms that reduced the role of the State in the economy. This was rationalized on the grounds that the public sector was inefficient compared to the private sector and that markets were self-regulating and could ensure that output growth was close to potential.

"The current crisis has shown that these assertions have serious limitations and that the State has an important role to play in economic development. In particular, it has shown that, although the market mechanism provides a vital framework for economic activities, governments must provide appropriate oversight. Consequently, there is the need for policy-makers to find the right balance between state and markets for better development results."

Another lesson from the crisis is that monetary policy is not an end in itself. It is useful to the extent that it supports the development efforts of countries. In this regard, the focus of monetary policy should not be on inflation alone. It should also explicitly take into account growth and financial stability issues in order to minimize the impact of shocks to the economy. One way to accomplish this is to alter existing mandates of central banks to include growth and financial stability objectives.

According to UNCTAD, the crisis has also shed light on the need for African countries to have policy space to respond to adverse shocks. In particular, it has shown that an active fiscal policy is necessary to cushion the effects of shocks on output. In this regard, there is the need to reform the current international financial architecture, particularly the way in which international financial institutions support countries facing external payments problems and economic crises.

Furthermore, international financial institutions should consider reducing policy conditions attached to loan facilities so as to enhance the ability of developing countries to respond appropriately to shocks.

There is also the need for African countries to exercise prudence in the management of commodity revenues during booms to create room for counter-cyclical fiscal policy responses in the future. They should also build resilience to external shocks through the development of productive capacity. This can be accomplished through infrastructure development, providing targeted incentives to promote technology transfer by foreign investors, and improving manufacturing export competitiveness through improving the business environment.

Another lesson from the crisis is that developed countries are not immune to financial crises and disruptions arising from imperfections of the market economy. "In the past, the IMF focused its surveillance activities mostly on developing countries on the assumption that the systems in place in developed countries functioned well. This led to the neglect of systemic risks arising from the policy actions of developed countries. There is the need for the IMF to exercise its oversight responsibilities more effectively and in an even-handed manner."

"The need for a cautious approach to capital account liberalization is another key lesson from the current crisis. The timing and pace of such liberalization should depend on each country's degree of financial market development as well as strength and quality of regulatory institutions. Each country should also have the policy flexibility to impose capital market restrictions if and when capital flows threaten the stability of the domestic financial system and economy."

According to UNCTAD, African countries need to position themselves to take advantage of the recovery phase of the crisis and should consider adopting the following policy actions:

-- Build robust regional markets. The development of regional markets is necessary for African countries to exploit economies of scale, enhance export competitiveness and integrate effectively into the global economy. It is estimated that intra-African trade accounts for about 9% of Africa's trade while intra-African foreign direct investment (FDI) represents about 13% of inward FDI to Africa.

-- Unleash the potential of private entrepreneurs for development. The private sector has a role to play in the recovery process and every effort should be made by African governments to address barriers to private sector development. There is also the need for government intervention to boost public investments and increase access by entrepreneurs to reliable and cost-effective sources of finance. There is the need for African governments to scale up efforts to mobilize domestic resources as a sustainable basis for financing public investments needed to boost growth and engender development.

-- Build resilience to shocks. Policy-makers in the region should seize the opportunity of the crisis to build resilience to shocks through developing productive capacities, avoiding currency and maturity mismatches associated with borrowing, and managing revenue from commodity booms in a manner that creates room for conduct of counter-cyclical policies in the future.

Africa also needs assistance from its development partners to weather the global slowdown and revive post-crisis growth. The crisis has increased Africa's financing needs and it is estimated that the region would need $50 billion to achieve pre-crisis growth rates and $117 billion to attain the 7% average growth rate required to meet the MDGs.

"In this regard, an increase in official development assistance is necessary to reignite economic activities and enhance growth in the region. Such an increase in aid will be most effectively used if domestic ownership of the design and implementation of national development strategies is enhanced rather than constrained," says the UNCTAD paper. +