Africa, growth sustainability question

Dirk Willem TeVelde
Sub-Saharan Africa grew at a rate of 5 percent in 2013, and is expected to grow by 6 percent this year. Impressive data, but unless this growth is accompanied by deeper economic transformation, the continent will face challenges in sustaining it for much longer. If the proceeds of the natural resources boom are not invested and allocated towards skills enhancement, technological development, infrastructure, productivity and diversification, the effects on incomes will be short-lived.

The financial sector must support this transformation. There has been success in Africa both in implementing new financial regulation and attracting new sources of private capital flows. For example, there were US$5bn in sovereign bond receipts in 2013 alone. But major challenges remain to ensure the proceeds are allocated efficiently towards infrastructure programmes.

So what could be done to help sustain Africa’s growth through financial sector development? The DFID-ESRC Growth Research Programme and ODI have recently asked some of the brightest academic thinkers and practitioners on the continent and beyond, to provide their views, and the results provide insight to the challenges faced. Here are four key challenges for those in control of African economies in 2014:

1. Find the right size, depth and pace of financial sector development whilst preventing banking crises. According to the governor of the Bank of Ghana, the financial sector is like a “double edged sword”, and requires robust financial policies and regulatory frameworks to work.

My colleague Professor Stephany Griffith-Jones believes “we cannot carry on assuming that more finance is necessarily better, lessons we have already painfully learned in the West”. Rapid increases and very high levels of private sector credit can destabilise economies anywhere.

Nonetheless, financial sector development is still very low in African countries, meaning that the industry is not yet a drag on growth. That said, any rapid increases should be watched. Private sector credit in Ghana was 14 percent of GDP in 2010, 18 percent on average in sub-Saharan Africa, and 30 percent in Kenya. This contrasts with many developed countries, where it exceeds 100 percent, with bloated financial sectors providing part of the problem.

2. Inclusive finance: Ensure regulation that does not exclude ‘the missing middle’. Financial sector support to the real (i.e. productive) sector of the economy remains weak in many African countries, with corporate lending at the short end. There is a lack of adequate competition that has led to inefficient pricing of financial assets.

The high costs of finance can impede investment and innovation, limiting the possibility of economic transformation. Furthermore, there is much less attention to providing credit to the small and medium scale business sector, sometimes called the ‘missing middle’. The financial sector is also often dominated by large, international banks providing credit to either the government or large multinationals, but SMEs frequently get left out in the cold. Efforts to increase financial sector development have not always helped — the Nigerian banking reforms of 2004, for example, led to an increase in private sector credit but did little to help the availability of long term credit for real sector development or for small businesses. This all shows that there is a real need for inclusive finance for sustained growth.

Perhaps African countries can learn from the ASEAN case where development banks helped to provide inclusive finance and growth.
3. Reduce interest rate spreads. A high interest rate spread – the gap between the central bank rates and the lending rate – is also a major problem for many sub-Saharan countries. A high spread means higher costs of credit, in turn stifling investment.

This is particularly evident in Ghanaian banking, where lack of competition, efficiency and a high interest rate spread are obvious.
Despite the recent financial sector reforms, the spread, instead of narrowing, has been either stagnant or growing. More countries could perhaps learn from the Kenyan example, where financial sector efficiency has increased. Additional solutions such as improving the collateral process, credit information and other targeted interventions could help further.

4. Develop financial mechanisms that can channel long-term finance.
A strategic financial sector is important for allocating long-term savings to long-term development needs. Infrastructure financing needs in Africa amount to nearly us$100bn a year. Increases in sovereign bond receipts and domestic resources mobilisation are promising but not yet enough. — This Is Africa.