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Financing Africa: Deepening local financial systems

23.04.2017Excerpt from Financer l’Afrique Densifier les systèmes financiers locaux

Financial development indicators (IMF, AfDB, World Bank and OECD) indicate that African financial systems are generally less developed compared to other regions of the world. It should be recalled that, in the aftermath of independence, most African countries inherited rudimentary financial systems. This state persisted until the 1990s in a number of countries. The savings rate remained very low despite the start of the growth period from the early 2000s.

According to the African Economic Outlook report (AfDB, OECD and UNDP, 2014), external financing flows to Africa were in the order of USD$ 200 billion in 2014, 4 times the level in 2002. They accounted for 9% of GDP compared with only 6% in 2000. However, aid still accounts for close to 50% of these flows for the 27 poorest countries. Notably in all Sub-Saharan countries, the ratio of taxes collected as a percentage of GDP increased from 18% in 2000-2002 to 21% in 2011-2013, the increase mainly driven by commodity-exporting countries. This amount corresponds to about 50% of official development assistance in 2013 (Africa Progress Panel, 2013). The mobilization of domestic revenues through tax collection remains insufficient, as a result most African states are still dependent on the international donor community to finance country budgets.

There is evidence that development aid resources are used more to finance consumption needs and other types of spending that do not necessarily stimulate investment. More recently, Ndikumana et al. (2015) indicated that only domestic resources (savings and credit to the private sector) and, to a small extent, foreign direct investment, have a significant effect on domestic investment and economic growth in Africa. This is a major achievement that should appeal to the continent's policy makers. It is in line with the very abundant economic literature, which shows that domestic savings are the real driving force of investment.

In addition, historical evidence shows that countries that have modernized their financial systems have seen their economies grow faster while attracting foreign direct investment - Venice (as early as the Middle Ages), the Netherlands and Great Britain in the 17th century), Japan, France and Germany (19th century), etc. For their part, the United States underwent a transformation of their economy thanks to the reforms initiated by Alexander Hamilton. This drove the modernization of the American financial system between 1789 and 1795. It brought the United States from a bankrupt country (after the American War of Independence), with an embryonic financial system, to a credible country that repaid its debts and which, as a result of these reforms, was endowed with a more efficient financial system. Thus, the United States had all the elements of a modern financial system before the nineteenth century. These conditions allowed the US economy to start a good growth process in real terms over a long period. Throughout each period, it appears that the development of a modern financial system precedes the acceleration of growth, followed by progressive economic development over a long period.

On the whole, African countries need to realize a Kondratieff, i.e a long cycle of economic growth mainly supported by phases of innovation. Consequently, they should primarily promote the deepening of their financial systems. Otherwise, the vagaries of nature and the international state of affairs will always dictate the financing of the continent's economic agenda. 

In spite of a dominant informal sector, total insurance industry assets are estimated at around US$ 300 billion, over US$ 400 billion for pension funds, over US$ 121 billion for Sovereign wealth funds, the asset management industry stands at US$ 634 billion, and so on. These figures certainly make people dizzy, but remember that enormous disparities exist between countries. Southern Africa, North Africa and Nigeria are the main financial reservoirs of the continent. It is therefore urgent to pursue the integration / economic and financial cooperation agenda. Progress margins are enormous for other countries in view of the low level of financial inclusion.

Domestic savings are the most reliable source of financing to support the investments needed to transform economies over the long term. As a result, deepening of local financial systems is crucial for economic development. This requires commitment and innovation.

The Financer l'Afrique: Densifier les systèmes financiers locaux book highlights that contrary to what is usually stated, Africa has, on the whole, the financial resources necessary to finance its economic transformation agenda. The continent is a net creditor vis-à-vis the rest of the world. 

It provides a detailed analysis of the main actors of long-term domestic investors in Africa, the amount of resources currently available and most importantly recent reforms and policies to be implemented to increase institutional demand in Africa. As an economy develops, it is only natural that savings accumulate in various financial institutions, such as banks, insurance companies, pension funds, etc. The book draws attention to different approaches to deepening domestic financial systems and optimizing the use of local savings to stimulate the pre-conditions for sustainable endogenous growth.

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