7 A Policy Framework for Resource Mobilization: An African Perspective

Claire Liuksila
Published Date:
December 1995
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Delphin G. Rwegasira

The formulation of an appropriate policy framework for effective resource mobilization in Africa must begin with an assessment of the role that the financial sector has played in the region’s economy, and the shortcomings that it may have faced in mobilizing the necessary resources for investment. In the contemporary African context, efficient functioning of the financial sector takes on added significance for at least three reasons. First, if the region is to emerge from the economic crisis of the last decade and a half, the financial sector must contribute to the recovery through the enhancement of the savings-investment process. Second, the widespread economic liberalization programs that have swept across Africa put greater reliance on the private sector, which clearly requires efficient institutions to meet its financing requirements. And third, increasing competitiveness in the global economy requires that the financial system be efficient and flexible enough to support the region’s external economic relations.

If the financial system is to meet these challenges and assume a greater role in the development process, reform measures are required to reduce financial repression and restore confidence in the institutions of the formal financial sector, so as to encourage both savers and investors to use them fully. Effective measures are also needed to tackle the financial distress that characterizes the sector in many countries. Such reform measures should, however, be tailored to the region’s needs and specificities. They must take into account the rigidities as well as the market segmentation and fragmentation that characterize financial markets in the continent.

A number of studies, including a recent one by the African Development Bank, have traced the specific characteristics of the financial sector in Africa, and formulated appropriate policies to strengthen it. These studies have shown that while steps should be taken to reduce financial repression, they should, however, be applied in a pragmatic and prudent manner; also, measures are needed to ensure that other complementary conditions for successful reform—such as strengthened and effective regulatory frameworks—are present, as well as focusing on the proper sequencing of macroeconomic and financial sector reforms.

This paper discusses key policy steps required for effective resource mobilization and gives a brief overview of current conditions with regard to savings, resource mobilization, and investment in Africa. Also discussed are some factors that account for the low levels of savings and investment, as well as poor levels of resource mobilization that are observed in many countries. Based on this analysis and a brief evaluation of the results of financial sector reform, the paper outlines the key elements of a policy framework required for effective resource mobilization. Also highlighted is the important role of external resources in meeting the domestic savings-investment gap, and in allowing for the efficient use of domestic resources.

Overview of Savings, Resource Mobilization, and Investment

Savings and investment ratios in Africa (as percentages of GDP) have traditionally been low compared with other developing regions, and have declined further in the last fifteen years as a result of the region’s economic crisis. Indeed, the failure of these ratios to rebound in response to stabilization and reform programs is often taken as a shortcoming of these programs.

During 1965-94, the savings ratio for the region as a whole deteriorated considerably. Starting in the immediate post-independence period (1965-73) at an average of 18.1 percent (and 16.2 percent for sub-Saharan Africa), and after showing an improvement in the latter half of the 1970s, the savings ratio has shown a continuous decline, reaching in 1990-94 an average of 15 percent for the region as a whole, and 12.7 percent for sub-Saharan Africa. The investment ratio also shows a similar trend: starting at an average of 17.5 percent in 1965-73, and after increasing to 23.9 percent during 1973-80, it declined during 1990-94 to an average of 18.9 percent for the region as a whole, and 15.3 percent for sub-Saharan Africa. The low savings and investment rates compare unfavorably with other developing countries.

As expected, the deterioration in savings and investment ratios for a large number of countries is closely associated with a stagnant or declining performance of the formal financial sector. Standard indicators of financial deepening, such as the ratio of money and quasi-money to GDP, the ratio of deposit money to the money supply (M2), and the ratio of the banking system’s claim on the private sector in relation to national income, largely indicate a decline or stagnation for most countries. The findings are generally uniform across all the sub-regions of the continent. For countries belonging to the franc zone of West Africa, for example, the ratio of the banking system’s claim on the private sector in relation to GDP declined over 1980-92; for countries in the central African franc zone, the ratios have been largely stable with an increase in a few countries; in the non-CFA region of the Economic Community of West Africa, the evidence is mixed, although in The Gambia and Nigeria, there have been large falls; and for countries in the Common Market of Eastern and Southern Africa, while the ratios themselves are low, there has been no tendency for these to increase.

Financial sector reforms have been undertaken in many countries, often in relation to structural adjustment programs. Reform measures have often included actions to remove interest ceilings on deposit and lending rates, lower reserve ratios, and lift quantitative restrictions on the allocation of credit. In addition, attempts have been made to improve the efficiency of credit allocation by allowing greater competition in the financial sector. Studies undertaken to assess the impact of financial liberalization have concluded that (i) financial liberalization in many countries has resulted in moves toward positive or less negative interest rates; (ii) higher rates have not increased overall savings rates, although in a few countries, they have, with other policy measures, significantly increased financial savings; and (iii) higher interest rates, by increasing the costs of credit to investors, may have contributed to lower capital formation. The conclusion appears to be that recent financial liberalization measures have not yet significantly strengthened the savings-investment dynamic, although they may have contributed to increasing the volume of financial savings in some countries.

Factors Behind Low Savings, Resource Mobilization, and Investment Rates

To understand the causes for low savings and investment rates in Africa, as well as the limited resource mobilization capacity of the formal financial sector, a number of factors stand out. These pertain to income and its distribution; macroeconomic stability; financial repression; the low returns to investment; institutional underdevelopment; and declining volumes of external capital inflows.

There is a consensus that the level of savings is largely determined by the level of income; and, in the case of Africa, studies have shown that the elasticity of savings with respect to the real interest rate is very low or zero. This low level is explained by the low and declining levels of income that have characterized the region in the last fifteen years.

Although the total volume of savings is clearly determined by income levels, the economic crisis of the last decade and a half and the macroeconomic instability it generated largely account for the low rates of financial savings and investment. Unstable economic conditions have caused a significant proportion of total savings to leak out of the official financial system into other forms of assets.

In addition to such factors, long-term financial repression explains the low rate of financial savings and the limited intermediation capacity of the official financial sector. Low or highly negative administered deposit rates, for example, tend to drive savings into other financial and nonfinancial assets, particularly under inflationary conditions. And negative interest rates, along with official credit allocation, result in credit rationing, and in many instances contribute to the crowding out of the private sector, in favor of the public sector.

Another factor that has limited financial intermediation is the low return to investments. The amount of loans that a financial system makes available for investment is not necessarily constrained by prior savings. The ability of the banking system to create credit and finance investments is often as important. The amount of resources available for investment is thus a function of the demand for such loans, as well as the ability of the banking system to assess investment risk satisfactorily and maintain its financial integrity. In many African countries, the demand for investment funds has been adversely affected by macroeconomic instability, deteriorating infrastructure, external debt overhang, and declines in external resource flows. Paradoxically, in some countries, the continued low demand for investment has resulted in what some authors have called the excessive liquidity syndrome, with commercial banks in some countries holding liquidity far in excess of reserve and related requirements.

Poor financial intermediation and the inadequacy of resource mobilization efforts is also explained by weaknesses and shortcomings inherent to the financial institutions themselves. Commercial banks and development finance institutions often have high intermediation costs and cumbersome procedures, and prefer to serve well-established clients. Few countries have been able to expand the formal financial sector to cover rural areas or to establish relations with the informal sector. There are thus few examples in Africa, unlike the many examples in Asia, where resources from the formal financial sector are channeled through the informal sector to meet financing needs of small-scale producers and traders.

Another important development that has adversely affected domestic resource mobilization is the considerable decline in real external capital flows in the 1980s. The increasing financial burden that external debt servicing has imposed on many countries has had the same, effect. These developments have contributed both to the severe import compression experienced by several countries, and then to the slowdown in domestic and foreign investment.

Policy Framework for Effective Resource Mobilization

The low rates of savings and investment in Africa and the difficulties that formal financial institutions have faced in promoting savings, investment, and growth have clear implications for the design of appropriate policy frameworks for effective resource mobilization. It needs to be emphasized that substantial increases in the volume of total savings are unlikely in the short run; these will only be achieved once policies for accelerating and strengthening income growth bear measurable results. Short-term policies should therefore concentrate on measures to mobilize existing resources from savers and to channel efficiently such resources to investors. This requires that returns on medium- and long-term financial savings be made positive, partly through the adoption of market-related interest rate structures.

Market-oriented measures would also reduce the size of the savings leakage by reducing the parallel market for foreign exchange, integrating the underground economy and the informal credit market with the formal economy, and discouraging capital flight. Studies of financial sector performance in African countries have shown, however, that increases in real interest rates, while necessary, are not the only effective policy instrument available. Other important instruments include those related to promoting macroeconomic and exchange rate stability as well as overseeing the overall soundness of the financial sector.

While financial liberalization must be part of a policy package to improve domestic resource mobilization, policymakers will need to monitor closely the rise in interest rates following the adoption of such measures. For as numerous African countries’ experience attests, while increases in real interest rates may have positive effects on financial savings, their adverse impact, through increasing the cost of credit and reducing the expected yields on investment, is also significant. The net effect of increases in the real interest rate on investment could thus be negative, particularly if the rates become highly positive. Further, sharply increased rates have resulted in bank losses, as debtors faced difficulties in servicing their loans. These trends could thus make the financial system more fragile and subject to financial distress. Increases in interest rates should thus not be allowed to overshoot, and their short- and medium-term impacts should be carefully monitored.

The Savings-Investment Gap and the Role of External Resources

While the need to mobilize additional domestic resources to promote higher levels of investment must be a central focus of any growth strategy, efforts should also be made to bridge the unavoidable savings-investment gap through mobilizing external resources. The extent of external resources required is related to the very low savings rates that prevail in many African countries today. Total net financial flows to Africa, consisting overwhelmingly of official transfers, have averaged $24.7 billion over 1988-92—well below the requirement to sustain a minimal per capita growth rate of one percent per annum. The volume of direct foreign investment has also been disappointingly low, averaging $2 billion for the whole continent during this period. Further efforts are therefore required to increase the flow of both official and private external resources. African countries will need to strengthen policies for promoting domestic savings and investment, and will also need stronger support from the donor community. Governments will need to establish policies (and institutions) to attract a much higher volume of private foreign investment than has been the case to date. This implies, among other things, that African countries should continue their current reform efforts and deepen the reforms in specific directions conducive to private foreign investment.


This paper has emphasized the importance of an efficient financial sector, both to mobilize domestic resources and to channel these to productive uses. So far, the results of recent financial reform measures have demonstrated that standard indicators of financial intermediation have yet to show signs of significant improvement. And, although in some countries financial liberalization measures have led to improvements in the mobilization of financial savings, the overall savings and investment dynamic has yet to be revitalized.

The experience with financial reform points to the importance of adopting measures that fully take into account the specific characteristics of African economies. Reforms also need to address the serious shortcomings of financial institutions. In addition, it is clear that if financial sector reforms are to succeed, they should be closely coordinated and sequenced with broader macroeconomic reform measures. Efforts to mobilize domestic resources are important for achieving more satisfactory growth rates; these, however, will need to be complemented by efforts to enhance the flow of both official and private external resources.

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