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Now that the Third International Conference on Financing for Development (FfD) has concluded in Addis Ababa, Ethiopia, in July 2015, policymakers are getting ready for the next United Nations General Assembly in New York in September 2015, which should result in a global agreement on the post-2015 Sustainable Development Goals (SDGs). The third and final meeting of this critical year for the development agenda will be in December in Paris, France, with the United Nations Conference on Climate Change (COP 21). As policymakers are setting the global development agenda, it is important that the rapid pace they have set be matched by economists. This is important as the results of their research can guide policies and, perhaps more importantly, help improve their effectiveness. The following seven questions aim at informing researchers about some of the current issues in the Financing for Development program.

Question 1. Financing for Development: What is at stake?

Shortly before the Addis Ababa Financing for Development meeting, IMF Managing Director Christine Lagarde announced a number of measures to assist developing countries in their pursuit of the post-2015 Sustainable Development Goals. The IMF pledged to (i) expand access to all of its concessional facilities by 50 percent; (ii) apply a zero interest rate for low-income countries struggling with natural disasters and conflict; and (iii) scale-up its support for raising domestic revenue potential and pay greater attention to equity and inclusion.

The measures taken by the IMF are part of a broader effort to formulate, finance, and implement a new agenda for sustainable development, which aims at “overcoming poverty and protecting the planet” (AfDB, ADB, EBRD, EIB, IADB, IMF, and World Bank 2015). The proposed 17 Sustainable Development Goals (SDGs) and 169 targets seek to address a broad range of challenges, including climate change, employment, infrastructure, and inequality that will require an unprecedented surge in financing and investment.

In a report entitled “From Billions to Trillions,” referring to the needed resource flows, which surpass existing development flows, seven multilateral development institutions, including the IMF, have called for a paradigm shift to come up with a wide-ranging financing framework to channel domestic and external finance from both public and private sources, toward the SDGs. The challenge will be two-fold. Policymakers will need to efficiently deploy $135 billion of official development assistance (ODA) currently available. In addition, they will have to find ways to attract and use effectively $1 trillion of non-ODA resource flows for development, which include philanthropy, remittances, South-South flows and other official assistance, and foreign direct investment.

Given the wide scope of the SDGs, which require environmental and infrastructure investments and the diversity of financing flows, such a framework is of concern to both developed and developing economies. However, Africa is among the regions with the most pressing needs. In anticipation of the SDGs, Africa has already established a common position on the Post-2015 Development Agenda, based on six pillars, with the aim to speak with one voice and facilitate the discussion toward a global consensus on the SDGs. The first five pillars cover a number of specific priorities. For instance, Pillar One focuses on structural economic transformation and inclusive growth while Pillar Two highlights science, technology, and innovation. These objectives face major financing gaps as domestic resources are not sufficient to cover the costs associated with the SDGs. This is why Pillar Six, finance and partnerships, is so important and must be linked with the first five pillars.

Question 2. How large are financing flows to Africa?

External financial flows to sub-Saharan Africa (defined as the sum of gross private capital flows, official development assistance (ODA), and remittances to the region) have not only grown rapidly since 1990, but their composition has also changed significantly. The volume of external flows to the region increased from $20 billion in 1990 to more than $120 billion in 2012. Most of this increase in external flows to sub-Saharan Africa can be attributed to the increase in private capital flows and the growth of remittances, especially since 2005.

In 1990, the composition of external flows to sub-Saharan Africa was about 62 percent ODA, 31 percent gross inflows from the private sector, and about 7 percent remittances. However, by 2012, ODA accounted for about 22 percent of external flows to Africa, a share comparable to that of remittances (24 percent) and less than half the share of gross private capital flows (54 percent). Also notably, in 1990, foreign direct investment (FDI) flows were greater than ODA flows in only two countries (Liberia and Nigeria) in sub-Saharan Africa excluding South Africa, but 22 years later, 17 countries received more FDI than ODA in 2012—suggesting that sub-Saharan African countries are increasingly becoming less aid dependent (see Figure 1).

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Sub-Saharan Africa: Number of Countries Where FDI is Greater than ODA

(1990–2012)

Citation: IMF Research Bulletin 2015, 003; 10.5089/9781513592428.026.A003

Sources: IMF, World Bank, and authors calculations.

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Question 3. How do countries differ: Who gets what?

A closer look at the data indicates therefore that, clearly ODA is not dead, though its role is changing. For instance, middle-income countries (MICs) are experiencing the sharpest decline in ODA as a share of total external flows to the region, while aid flows account for more than half of external flows in fragile as well as low-income countries (LICs) and resource-poor landlocked countries.

Much has changed in external financial flows to sub-Saharan Africa since 1990. Total external flows grew more than six times during this period, from $20 billion in 1990 to more than $120 billion in 2012. ODA, which accounted for just under two-thirds of total flows in 1990, is now much lower and comparable to remittance flows. Private capital flows are now the single-largest source of external financing for the region, with more than half of the total flows.

The reality, however, is that changes in both the scale and composition of external capital flows have not benefited all sub-Saharan African countries equally:

• Fragile countries and LICs, not surprisingly, are regional laggards in terms of access to both external and domestic finance.

• Even resource-rich countries, which are able to attract large volumes of private capital flows, fare relatively poorly when external financing flows are scaled to the size of their economies. In addition, these countries, although they raise more domestic government revenues than other countries, do so mostly because they benefit from fiscal revenues linked to volatile commodity prices.

• Francophone countries both in the West African Economic and Monetary Union (WAEMU) and the Central African Economic and Monetary Community (CEMAC) are not able to attract the same level of private capital flows as other sub-Saharan African countries.

• Remittances are high for MICs.

• When external financing is contrasted with domestic financing, it seems that sub-Saharan African countries do not appear to have a natural hedge to the risks of reversal of external financial flows.

In sum, the claim of the demise of aid is still premature; the growth of private capital flows has benefited few countries; remittances have become significantly more important for some countries; and the rise of external flows means that sub-Saharan African countries will have to manage the volatility associated with such flows.

Question 4. Why is there a focus on financing infrastructure?

There is a consensus among African policymakers that the continent’s economic growth and transformation is significantly constrained by its limited infrastructure. Inadequate infrastructure—including unreliable energy, an ineffective urban-rural road network, and inefficient ports—is one of the largest impediments to Africa’s international competitiveness.

Infrastructure is not only one of the areas where Africa is lagging the most behind other regions (together with health and primary education) but it is also one area where the divide between African countries is the largest. The infrastructure deficit is particularly high for sub-Saharan low-income countries even when compared to that of other low-income countries (see Yepes, Pierce, and Foster 2008 and reproduced in Foster and Briceño-Garmendia 2009, 1–2).

Improving infrastructure can benefit the continent through a number of channels, including better performance in the agriculture sector and increased regional and global trade. Increasing investment in rural infrastructure such as irrigation, roads, and energy can help reduce Africa’s dependence on rain-fed agriculture, improve access to markets for agricultural produce, and increase resilience to climate change. Through better and more affordable information, communication, and technology (ICT) infrastructure, farmers can register their land and have access to credit, use land and water more efficiently, obtain weather, crop, and market information, and trade food and animals.

Better information, communication, and technology infrastructure cuts across sectors by allowing the rapid and free flow of information. Similarly, more reliable electricity provision can significantly reduce the cost of doing business for all sectors, including the manufacturing sector. Well connected infrastructure networks can benefit a broad range of sectors by enabling entrepreneurs to get their goods and services to markets in a secure and timely manner by facilitating the movement of workers. They can also help increase intra-regional trade (which is the lowest globally) and participation in regional and global value chains,

In part, thanks to the above benefits, improving infrastructure can increase per capita annual growth by up to one percentage point (see Boopen 2006, Calderón 2008, Estache and Wodon 2011, Briceño-Garmendia and Domínguez-Torres 2011). To put things in perspective, the latest World Bank forecast for the region puts real GDP growth at 4 percent in 2015 (World Bank 2015). However, accounting for the continent’s 2.6 percent population growth results in a per capita income growth of only 1.4 percent.

African policymakers are well aware of the potential for infrastructure to support the continent’s accelerated integration and growth, technological transformation, trade and development. The continent’s long-term vision as articulated in Agenda 2063 is that, in about 50 years, African infrastructure will include high-speed railway networks, roads, shipping lines, sea and air transport, as well as well-developed information, communication, and technology infrastructure and a digital economy. The vision plans for a Pan African High Speed Rail network that will connect all the major cities of the continent, with adjacent highways and pipelines for gas, oil, water, as well as ICT broadband cables, and other infrastructure. Infrastructure will be a catalyst for manufacturing, skills development, technology, research and development, integration and intra-African trade, investments, and tourism. Building a world-class infrastructure together with trade facilitation should see intra-African trade growing from less than 12 percent currently to about 50 percent by 2045 and the African share of global trade rising from 2 percent to 12 percent (see African Union 2014).

Building African infrastructure will, however, require substantial financing. A World Bank comprehensive study estimates that sub-Saharan Africa’s infrastructure needs are around $93 billion a year (See Foster and Briceño-Garmendia 2009).

Question 5. What are the external sources of financing for infrastructure?

Traditional partners include official development financing (ODF) sources from aid donors and multilateral development banks such as the World Bank and the African Development Bank, as well as the private sector. A recent study of external financing of traditional partners as well as private sector participation in infrastructure (PPI) highlights three significant trends (See Gutman, Sy, and Chattopadhyay 2015):

• All major sources of external financing have appreciably increased their annual commitments. From $5 billion in 2003, commitments have risen to almost $30 billion per year in 2012.

• Official development financing investments, though not as dominant a source of infrastructure financing in sub-Saharan Africa as in the 1990s, has grown appreciably since 2007 and represents 35 percent of external financing.

• Private sector participation in infrastructure has been the largest financing source since 1999—accounting for more than 50 percent of all external financing. Its overall level has remained remarkably stable and unaffected by the recession in 2008.

In addition, official investments from China have increased from what was virtually insignificant to about 20 percent of these three main sources of external finance. The increase in Chinese financing is mirrored by the rise of other non-traditional partners. New and emerging partners (NEPs) in Africa are increasingly investing in the continent’s infrastructure. These countries include Brazil, China, India, Korea, Malaysia, Russia, and Turkey—the so-called NEP7 economies. These countries were involved in 239 infrastructure projects during 2000–2010, of which 41 percent were not linked to Chinese stakeholders. In particular, Brazil and Korea accounted for about 15.9 percent and 8.8 percent of the number of projects, while India and Korea were involved in 6.3 percent and 5.9 percent of total (see United Nations Office of the Special Adviser on Africa 2014).

Question 6. What do we know about budget financing for infrastructure?

Although data on government spending on infrastructure are not readily available, some recent estimates are. IMF (2014) estimates that national budget spending by sub-Saharan African countries reached about $59.4 billion or 72.9 percent of total funding for infrastructure in 2012. [IMF 2014 assumes that countries allocate 75 percent of total public investment to infrastructure. This assumption does not take into account infrastructure spending executed by public utilities and local governments.] These figures include official development financing of about $8 billion by international financial institutions (IFI) such as the World Bank and African Development Bank. Excluding IFI contributions from national government budget estimates, spending on infrastructure projects amounts to $51.4 billion (63 percent of total funding). Comparable estimates are also available from the Infrastructure Consortium for Africa (2014).

Domestic resources in sub-Saharan Africa have increased thanks to debt relief, increased revenue collection, gains from the commodity price boom, and, more generally, improved macroeconomic and institutional policies. The average tax-to-GDP ratio increased from 18 percent in 2000–2002 to 21 percent in 2011–2013. (In comparison, Ahmad (2014) notes that a rule of thumb for calculating the amount needed to meet the financing requirements for the 2014 MDGs was a tax-to-GDP ratio of around 18 percent, which would cover the provision of the MDGs, as well as operations and maintenance spending, and new investment in infrastructure.) This increase was equivalent to half of 2013 aid receipts (Africa Progress Panel 2014). However, increased tax mobilization has been driven by resource-rich countries and resource-related taxes. Tax mobilization remains low in spite of significant effort and recent reforms in non-resource-rich countries (Bhushan, Samy, and Medu 2013). For instance, the ratio of general government tax revenues to GDP in 2013 ranged from 2.8 percent in the Democratic Republic of the Congo to 25 percent in South Africa (one of the highest among all developing countries). Thus, in spite of good progress in raising fiscal revenues, African countries need to raise more domestic finance to meet their infrastructure gap.

Given the wide disparity among countries of tax-to-GDP ratio, many African governments still need to raise their fiscal revenues to meet the infrastructure gap. However, increasing tax mobilization over a certain threshold does not necessarily lead to adequate spending on infrastructure and revenue, and spending reforms may be needed. For instance, Ahmad (2014) notes that although Brazil’s tax-to-GDP ratio was relatively high at 24 percent in 2013, taxes are heavily earmarked, and, as a result, spending on infrastructure is just 1.5 percent of GDP (both public and private).

Question 7. What do we know about private financing for infrastructure?

African countries also need to complement fiscal revenues and diversify their source of domestic financing. African governments are increasingly accessing international capital markets. Before 2006, only South Africa had issued a foreign-currency denominated sovereign bond in sub-Saharan Africa. From 2006 to 2014, in all, 13 countries have issued a total of $15 billion in international sovereign bonds.

But are the aforementioned efforts sufficient to fill the continent’s infrastructure spending needs, which stand at about $93 billion per year with about 40 percent of spending needs associated with the power sector? Using their fiscal resources, African governments spend about $45 billion per year in infrastructure—about one-third of which is contributed by donors and the private sector. Two-thirds of the public sector money is used to operate and maintain existing infrastructure and one-third is used to finance new projects. This leaves a financing gap of $48 billion and begs the question of how to finance the difference. A more efficient use of existing infrastructure can reduce this gap by $17 billion by reducing inefficiencies through measures such as rehabilitating existing infrastructure, targeting better subsidies, and improving budget execution. Should inefficiencies be addressed, the remaining infrastructure funding gap would then be $31 billion a year, mostly in the power sector.

Given the relatively large size of the remaining infrastructure financing gap, efforts to mobilize domestic revenues should also focus on tapping the local institutional investor base, including pension funds, for infrastructure financing.