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Structural Adjustment in Sub-Saharan Africa

Author(s):
International Monetary Fund. External Relations Dept.
Published Date:
January 1989
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The policy issues and challenges for the 1990s

Since the early 1980s, a number of Sub-Saharan African countries have undertaken adjustment programs aimed at reducing economic distortions and financial imbalances, in the face of mounting domestic and external pressures. The programs have sought to achieve over the medium term a sustainable rate of economic growth consonant with relative price stability and a viable external sector position. These efforts have recently gained momentum, and significant economic progress has been made by those countries that persevered with their adjustment programs. The International Monetary Fund, in close collaboration with the World Bank, has directly supported these efforts by providing advice and technical and financial assistance, as well as by acting as a catalyst for international resource flows.

The African continent faces a formidable challenge in the 1990s in its objective of improving the living standards and quality of life of its population. The recent progress made by certain countries in dealing with some of their most pressing difficulties has brought to the fore the more intransigent and deep-rooted structural problems that will need to be tackled in the decade ahead. Furthermore, adjustment efforts need to be undertaken by a number of other countries. Accordingly, for the region as a whole, it will be necessary to (1) strengthen the adjustment process to reach the roots of the structural problems; (2) sustain the adjustment efforts; and (3) increase the number of countries pursuing structural reform programs.

Growth and adjustment

While economic growth is a central objective, its sustainability depends on the maintenance of domestic and external financial stability. Thus, the increased emphasis being placed on structural policies in no way diminishes the importance of appropriate demand management policies. If there were excess demand pressures, reflected in high domestic inflation, savings and investment would be discouraged, leading to a drop in the growth of output. In addition, such demand pressures would be manifested in persistent external imbalances, which in turn would contribute to an overvaluation of the currency and shortages of foreign exchange. The ensuing price distortions and restrictions on imports of critical intermediate and capital goods would undermine export and import- competing industries, to the detriment of economic growth. Hence, adjustment cannot be purely structural or financial, nor should it involve a trade-off between growth and financial stability—one needs to strike the right balance between the two. The basic complementarity and interdependence of the two are at the root of the close cooperation between the staffs of the Fund and the World Bank in assisting the authorities of member countries to design growth-oriented adjustment programs.

The design of adjustment programs has to pay adequate attention to maximizing the social benefits and minimizing the costs of adjustment over a reasonable period. Too often, attention is focused on the short-term costs of an adjustment program, while the alternative costs of not adjusting are not taken into account. Without a properly designed adjustment program, a country confronting major economic and financial problems will rapidly exhaust its foreign exchange reserves, making it impossible to finance essential imports, thus depressing the prospects for economic growth. Moreover, the emergence of parallel market activities and the intensification of inflationary pressures will contribute to an erosion of purchasing power, which will seriously hurt the poorer segments of the population. The pursuit of an appropriate adjustment program prevents the problems created by the lack of adjustment and establishes the basis for sustained improvements in social welfare. Furthermore, to an increasing extent, such adjustment programs have been addressing directly the short-term social costs of adjustment, through the implementation of job placement programs, as well as consistent health, education, and food security strategies.

Background: the 1980s

The decade of the 1980s can be characterized as one during which there has been a growing recognition of the need for reform in Sub-Saharan Africa. Nonetheless, the progress made during 1980–84 was limited, as adjustment efforts were sporadic and insufficient, the terms of trade deteriorated further, international interest rates were high, world demand for Africa’s exports remained weak, and drought conditions seriously hurt economic activity.

There were substantial changes—both positive and negative—in the economic environment during 1985–88. On the positive side, 1985 saw an end to the drought in Sub-Saharan Africa, a fall in international interest rates, some recovery in economic activity in industrialized countries, and a drop in the import prices of petroleum products. The combination of all these factors led to an average annual growth of real GDP in Sub-Saharan Africa (excluding the petroleum exporting countries and South Africa) of 3.2 percent during this period, implying a modest increase in real per capita income. On the negative side, Sub-Saharan Africa experienced a drop of about 20 percent in its terms of trade in 1986–88. In part because of this, during 1985–88 there was an increase in the fiscal deficit as a ratio of GDP, while the expansion of money and quasi-money averaged 28 percent annually. As a result, the external current account deficit widened, and the ratio of external debt to GDP rose, albeit at a slower pace than in previous years, to some 70 percent. Reflecting the slowdown in indebtedness and the movements in international interest rates, the debt service ratio declined from an average of 25 percent in 1984 to 21 percent of the value of exports of goods and services.

These aggregate economic and financial indicators do not fully reflect the positive effects of the adjustment efforts undertaken by a number of Sub-Saharan African countries for two key reasons. First, the diversity of shocks, such as droughts and movements in the terms of trade, tends to obscure the positive effects of the reforms. Second, the reforms were not consistently and effectively pursued by a sufficiently large number of Sub-Saharan African countries. Various studies have shown that there is a close correlation between program implementation, the achievement of adjustment objectives, and improvement in economic conditions (see “Adjustment Programs in Africa,” by Justin Zulu and Saleh M. Nsouli, Finance and Development, March 1984; and “Africa’s Adjustment and Growth,” by Charles Humphreys and William Jaeger, Finance and Development, June 1989).

Adjustment in the 1990s

The prospects for Sub-Saharan African countries in the 1990s depend critically on the adjustment efforts undertaken by these countries, and on the evolution of the international economic and financial environment. The policies of industrial countries to achieve sustained growth with low inflation, reduce interest rates, and adopt a more open trading system will be particularly important. On the assumption that there are no severe commodity shocks, Sub-Saharan African countries pursue appropriate adjustment policies, and the international economic environment improves, it is projected that during 1989–92 real GDP in Sub-Saharan Africa could grow at an average annual rate of close to 4 percent, involving a rise of real per capita income of about 1 percent per year. The rate of inflation could be reduced from almost 22 percent in 1988 to some 11 percent in 1992. The external current account deficit, excluding official transfers, could be narrowed from 9.4 percent of GDP in 1988 to about 8 percent in 1992. Finally, external debt would virtually stabilize at about 70 percent of GDP, while the debt service ratio would level at approximately 21 percent.

Although the thrust of policies outlined below is relevant for a number of African countries, each adjustment program has to be designed in a way that would address the specific problems of each country. Indeed, while the objectives and instruments are common to most countries, the design of programs involves the setting of specific quantitative targets and the selection of the proper mix of instruments, as well as the determination of the degree to which each instrument will be used.

A combination of structural and demand management measures will be required to foster private sector economic activity and strengthen public resource management. The main objectives will be to improve the effective use of existing capacity, thereby increasing productivity, and to stimulate the expansion of productive capacity through a mobilization of domestic savings and external resources. The diversification of the economies will be essential to reduce their vulnerability to internal and external shocks.

The structural policies in most countries will need to include exchange rate action, reform of the exchange and trade system, liberalization of domestic pricing and marketing policies, financial sector reform, restructuring of public enterprises, reductions in labor market rigidities, strengthening of public investment programming, restructuring of the tax system and public expenditure, and improvements in interest rate policy. To complement the structural policies, balanced fiscal and monetary policies will need to be implemented. The above quantitative projections for Sub-Saharan Africa assume that the fiscal deficit would be narrowed from 6.5 percent of GDP in 1988 to 3.3 percent in 1992, and that the rate of monetary expansion would be reduced from 23 percent to 15 percent.

External sector policies will need to be strengthened to reduce economic distortions and promote external competitiveness. While many African countries have adjusted their exchange rates and adopted more flexible exchange systems, there remains in a number of countries a considerable degree of overvaluation and rigidity, adversely affecting export-oriented and import-competing industries. Partly because of the limited progress made in moving toward more realistic and flexible exchange rates, the pace of reduction of exchange and trade restrictions has been slow. The removal of such restrictions is an important element for ensuring adequate supplies of capital equipment, intermediate goods, and other essential imports. Furthermore, the reduction of restrictions on capital flows will encourage foreign investment. Concomitantly, progress will need to be made in improving domestic incentives by introducing greater flexibility in agricultural producer prices, reducing the scope of price controls, and liberalizing domestic marketing arrangements. The combination of these policies will not only improve economic efficiency but will also foster economic diversification.

Considerable efforts have been made to restructure the large and inefficient public enterprise sector in Sub-Saharan African countries by reforming certain enterprises and privatizing or liquidating others. Progress, however, has generally been slow. Improvements in the profitability and productivity of enterprises being restructured have been limited, as the restructuring programs have often proved ambitious. Privatization has suffered from the lack of sufficient resources by private investors, stemming in part from inefficiencies in financial intermediation, uncertainties about the viability of enterprises, and excessive administrative controls on employment and pricing policies. The limitations on the access of individuals to adequate domestic financial resources have also hindered the liquidation process.

Sub-Saharan Africa 1 1980–92(Change in percent, unless otherwise specified)
Projections
198019821984198619881989199019911992
Real gross domestic product2.01.503.93.33.64.14.04.0
Real gross domestic product per capita–1.3–1.3–2.50.80.20.51.00.70.7
Inflation25.919.822.922.921.917.413.311.910.8
Money and quasi-money20.420.428.532.423.018.516.115.815.3
Central government budget (in percent of GDP)–8.4–8.1–5.6–6.2–6.5–6.4–5.7–4.1–3.3
External current account (in percent of GDP)
Excluding official transfers–12.2–12.0–7.8–7.4–9.4–9.3–8.9–8.4–7.9
Including official transfers–9.0–8.6–4.2–3.4–5.1–4.9–4.8–4.4–4.0
Balance of payments (in billions of US dollars)–2.6–3.4–3.0–3.1–5.6–4.9–4.9–4.3–4.7
Terms of trade–8.0–3.410.0–9.40–2.5–1.7–0.20
External debt (in percent of GDP)40.052.260.467.369.170.671.270.368.9
Debt service ratio (in percent of exports of goods and services)16.122.624.724.920.720.822.921.821.5
Source: IMF, World Economic Outlook Data Base.

There is thus an urgent need to reassess the strategies for the reform of the public enterprise sector. In particular, more careful attention will need to be paid to developing the institutional infrastructure to support the reform process. This includes establishing appropriate credit facilities to enable entrepreneurs to purchase and successfully manage those public enterprises identified for privatization, improving pricing and marketing policies, and streamlining the legal and administrative framework within which enterprises operate.

A more active policy to reduce rigidities in the labor market and in wage determination will assume an increasingly important role in Sub-Saharan Africa in order to promote both employment and economic expansion, particularly as the size of the skilled labor force increases and as the trend toward public sector employment is reversed. A number of African countries have employment laws that limit the flexibility of enterprises in adapting the size of their labor force to changes in market conditions. These laws tend to discourage private investors from expanding their productive capacity and employing a greater number of individuals, because of the potential problems associated with the need for reductions in their labor force in the event of a drop in demand for their products. Thus, while such laws protect present employees, they militate against a healthy expansion in employment over the longer run. Furthermore, a number of African countries have institutional mechanisms leading to a relatively high and rigid wage structure, thereby reducing the competitiveness of many industries.

Financial and fiscal measures

The enhancement of financial intermediation will be critical to promoting domestic savings, attracting foreign capital, and channeling scarce resources into productive investment. Today, a number of Sub-Saharan African countries are suffering from inadequate banking systems, with severe liquidity problems resulting from inappropriate management, insufficient supervision, and excessive administrative interference. Many African countries have initiated banking reforms, but these and other countries will need to adopt more comprehensive reform programs for their banking systems. Concomitantly, a more flexible, market-oriented interest rate policy will contribute to enhancing financial intermediation, improving resource mobilization, and increasing the efficiency of credit allocation. Thus, the use of such an instrument of monetary policy will not only affect aggregate demand, but will also have a structural dimension.

The decade of the 1980s has witnessed substantial improvements in public investment programming. The elaboration of public investment programs in the context of coherent macroeconomic policies, as well as the establishment of appropriate criteria for project selection, has considerably improved the efficiency of public investment. Private investment, however, has not received adequate attention. In the overall design of future investment programs, it will, therefore, be important to take full account of the role of the private sector in domestic capital formation and to direct investment to projects that can support and facilitate private productive activities. Further work is also needed in studying the long-term effects of investment programs on recurrent costs, economic growth, export-oriented and import-competing activities, domestic production, and the debt-servicing obligations of each country.

While fiscal policy is generally viewed as a financial instrument, increasing attention has recently been paid, and will need to be paid, to the structural nature of fiscal adjustment. This will ensure that it is durable and that the structural effects are consistent with the medium- and long-term growth objectives of the country. On the revenue side, greater attention needs to be given to the incidence of specific measures. The objective will be to select revenue measures that improve the distribution of the tax burden and enhance the elasticity of the tax system. The former will help improve incentives, while the latter will contribute to the durability of growth of the revenue base of the country. An important challenge will be to find a way to gradually tax the rapidly growing informal sector in many African countries. On the expenditure side, it will be essential to reduce the proportion of public consumption, including the wage bill, in government expenditure, while expanding that devoted to recurrent outlays, basic services, and capital formation.

The above structural measures will have an immediate bearing on the medium-term prospects. There are, however, four critical issues that affect Africa’s long-term development, and concerted efforts will be needed to overcome these obstacles:

• population growth rates in Sub-Saharan Africa are among the highest in the world and tend to put substantial pressure on scarce available resources;

• the degradation of the environment, particularly that of arable land, has intensified, and desertification is increasing at an alarming rate;

• increased attention needs to be given to improving human and institutional capacities through the promotion of better quality and more extensive education and health care; and

• domestic markets remain small. The widening of African markets through regional economic integration would contribute importantly to the development of domestic industries.

Policy-based financial assistance

In recent years the international community has provided substantial resources, including debt relief, to support growth- oriented adjustment programs in Sub-Saharan Africa. To continue to support structural reforms, policy-based financial assistance appropriate to each country’s circumstances, in addition to project assistance, will be critical in the coming decade. A number of considerations need to be taken into account in reviewing the role of policy-based external financing.

First, in view of the nature of structural reforms, there will be a need for increasing resources. For example, the liberalization of exchange and trade restrictions, which is critical to the promotion of private sector investment and economic activity, will put considerable pressure on scarce foreign exchange reserves.

Second, structural reforms require a sustained effort over a number of years. If such efforts are to be successful, the authorities will need to evaluate and plan the implementation of reforms in light of the external financing available over the medium term.

Third, the adherence to a timetable for the disbursement of external financial commitments and the simplification of the often complex administrative requirements for disbursement are essential for the effective implementation of reform measures. In a number of cases, the implementation of adjustment programs has suffered because of delays in the receipt of external financial assistance, owing, in certain instances, to the intricate administrative requirements.

Fourth, given the already high debt service ratios of many African countries, financial assistance to support structural adjustment programs will have to be extended on the most concessional terms possible. The concessional terms applied on official debt relief following the recommendations of the Toronto summit (of leaders of major industrial countries in June 1988) go some way toward providing the type of assistance that is needed in these countries. The initiative proposed by President Mitterrand in May 1989 to forgive French official debt to 35 least developed and most indebted countries should help considerably to reduce the financial imbalances confronting them. In addition, the Brady initiative (of the US Treasury Secretary) should help ease the debt burden of the countries with substantial commercial debts.

Fifth, increased emphasis will need to be placed on the coordination of external financial assistance, so that it is channeled within a comprehensive framework. The medium- term policy framework paper, prepared in cooperation with the World Bank in the context of the Fund’s structural adjustment facility and enhanced structural adjustment facility, can play a critical role in identifying the financing needs of a country and providing a framework for coordinating such flows (see box).

Long-term process

The efforts envisaged for the 1990s will only succeed if adjustment is viewed as a continuous and sustainable long-term process. Many countries confronted with a major economic and financial crisis are initially prepared to undertake strong adjustment programs. The successful implementation of these programs causes the crisis to become less apparent, even though fundamental disequilibria remain. With a reduction in the apparent economic and financial tensions in the country, the momentum for adjustment diminishes. Indeed, there is a tendency to relax the adjustment effort until the crisis resurfaces, and the effort needs to be resumed.

These on-again, off-again adjustment efforts have led to a cyclical pattern, whereby the progress made during certain periods is subsequently eroded. In such circumstances, the overall progress that a country can make is very limited. The severity of the problem is illustrated by the fact that of the 35 Sub-Saharan African countries undertaking Fund-supported adjustment programs in the last ten years, less than a third have pursued their adjustment efforts in a relatively sustained manner. Multiyear external financial commitments in support of well-designed, medium-term structural adjustment programs could encourage Sub-Saharan African countries to sustain their efforts to promote growth-oriented adjustment.

The role of the Fund in African adjustment

The International Monetary Fund has been involved closely with the African countries in their efforts to adjust. Two facilities, the structural adjustment facility (SAF) and the enhanced structural adjustment facility (ESAF), were established to help low- income countries with protracted external payments problems undertake adjustment programs designed specifically to strengthen their balance of payments and promote economic growth over the medium term. To enhance the Fund’s support to member countries, the compensatory and contingency financing facility (CCFF) was established in August 1988, integrating a contingency financing mechanism into the existing compensatory financing facility.

Under the SAF and ESAF, a policy framework paper (PFP) is developed by the member country in close collaboration with the staffs of the Fund and the World Bank. The PFP provides the broad outline for a three-year macroeconomic and structural adjustment strategy within which annual programs are developed. The PFP in fact acts as a catalyst to assist a country to (1) develop a medium-term strategy, and (2) mobilize external financial resources from other multilateral and bilateral sources in support of the strategy. The total resources that may be made available under the SAF and ESAF amount to SDR 8.7 billion, at an annual interest rate of about 0.5 percent, with a maturity period of five and a half to ten years.

By end-June 1989, 25 of the 34 eligible Sub-Saharan African countries had arrangements approved under the SAF or the ESAF. Total commitments through June 30 under these arrangements amounted to SDR 1.9 billion, equivalent to 69 percent of total commitments to all countries. In addition, commitments under stand-by and extended arrangements for seven African countries amounted to SDR 1.2 billion as of end-June 1989.

Saleh M. Nsouli

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