National Council of Applied Economic Research
Opinion: Udaibir Das.
In her 2009 book Dead Aid, Zambian economist Dambisa Moyo probes why Africa trails in economic prosperity compared to other emerging nations. Global narratives often overlook the need for creative, transformative and continent-specific changes.
One such area is Africa’s financial sector. As a pivotal player in Africa’s development, the sector, unfortunately, has been unable to realise its economic potential fully. This shortcoming has contributed significantly to the macroeconomic instability and debt crises many African nations grapple with today.
Over the past two decades, research has consistently indicated a positive correlation between financial development and economic growth. However, the pace of macro-financial evolution in Africa has been disappointingly slow.
Factors such as financial frictions, structural rigidities and institutional underdevelopment, coupled with unsuitable financial system structures, have put a stranglehold on Africa’s credit dynamics and macro-financial stability.
The hope
International efforts are underway to alleviate Africa’s debt, support the United Nations’ sustainable development goals and provide climate finance for Africa’s transition needs. Given the incapacity of the public sector to carry alone the burden of poverty alleviation and growth, serious efforts are afoot to bring in private finance for investments and social spending. With the African Union joining the G20 this year – being granted the same status as the European Union – the expectations of a global African partnership are high.
If the influx of public and private capital into Africa is partially correct, the African development landscape will become more crowded, straining balance sheets and financial systems as a result. The new flow of resources will bring along a host of macro-financial interactions to manage including implications for Africa’s ‘current account’ of the balance of payments. Africa stands to be scrutinised further through the lens of global finance and private finance expectations.
While the digitalisation of finance advances and the potential introduction of central bank digital currency might aid finance in Africa, it is not enough. We must distinguish between the financial system’s ability to provide transaction services (where digital modes help) and its capacity to intermediate funds from savers to borrowers and assume credit risk (where a well-functioning financial system is needed). Africa needs both, but it certainly needs more capacity in the latter for sustainable growth.
The doubt
Is Africa’s financial sector prepared for a more prominent role in its growth and stabilisation? Can it handle new global financial flows and their attendant risks and tribulations? The annual Absa Africa Financial Markets Index, produced by OMFIF, provides hope. The survey highlights three crucial trends: improved market infrastructure, increased environmental, social and governance initiatives and rapid growth in digital technologies and market integration. However, economies with underdeveloped financial markets have a high money-to-gross-domestic-product ratio, indicating a lack of attractive economic alternatives.
At the same time, the report warns of foreign exchange inadequacies, external sector management weaknesses and external shocks to the financial system, such as geo-economic and geopolitical fragmentation. Rising interest rates in advanced economies have led to exchange rate depreciation, capital outflows as well as weaker foreign exchange reserves across Africa.
The priority
Africa must take immediate steps to demonstrate its commitment to overhauling its financial system. The plan should enhance its ability to manage exogenous risks and explicitly address, thus far, the neglected endogenous risks that are often the case of financial instability and derail economic development. It must also clearly state that inept governance of new resources, including financial misconduct or regulatory violation, will not be tolerated.
Crafting Africa’s financial sector future
To effectively address the specific challenges faced by Africa, a strategy tailored to its specific circumstances is essential. This strategy must be deeply rooted in Africa’s realities rather than being a mere adaptation of international experiences, which may no longer be a viable approach.
Africa’s financial sector is a continent of contrasts. While vast regions still lack access to essential financial services, others are ripe for a commercial and market-oriented financial system. Some areas might benefit from a ‘utility’ style financial sector, while others might thrive on a system grounded in risk and return theory. For instance, very basic banking and payment services may suffice for Africa’s fragile states and conflict-ridden countries.
With its diversity and varied financial behaviors of its households, businesses and governments, Africa demands an innovative approach. While the specifics of this approach warrant further discussion, the following issues could serve as a springboard for crafting a tailored financial sector strategy, shaping Africa’s financial future.
For one, the continent’s economic systems are not homogeneous. We need to define and better differentiate between countries with an emerging financial sector, countries where a financial sector exists but is nascent and countries with a rudimentary financial sector. It may be necessary to revise and adjust the financial sector frameworks to these broad classifications.
Beyond these categories, another consideration to note is that Africa harbours the youngest population in the world. Its demographic structure means there are different expectations of what money and credit are about and historical reasons why large swathes of the population have been left behind. Thus, it is essential to understand the demand side of financial credit and services as well as the behaviour of Africa’s households and small- and medium-sized enterprises.
It is also crucial to have an agreed criterion on three matters of policy debates. First is how to measure financial development progress best, second, the causality between financial depth and growth and third, the suitability of a banking-based versus a market-based financial system for what parts of Africa.
To add, the strategy will benefit from mapping the financial system to identify vulnerabilities and how the demand and supply side of finance work. In practice, this would mean using available data to develop a proof-of-concept sectoral map, noting financial linkages between banks, corporates, households and the government. It would thus be possible to explore regional approaches to some of the micro aspects of the financial sector that could facilitate intermediation and credit. These could be regional platforms on data, information, financial taxation, regulation and knowledge exchange and scenario building to understand precisely where Africa’s financial sector trails.
As we strive to overcome the financial sector challenges in Africa, it is crucial to understand that building an effective financial system is akin to running a marathon, not a sprint. There may be stumbles and falls along the way, but the accurate measure of success lies not in the speed of progress but in the endurance to keep moving forward.
The key to this endurance is a financial system that is meticulously tailored to meet Africa’s specific needs. A robust and well-designed financial sector becomes paramount as Africa gears up to harness international resources and foreign investments.
The international community has a significant role to play in this journey. It must rally behind Africa, extending not just financial resources but also technical support. Encouraging Africa to build and fortify its financial systems before new resources flow into the continent is a critical step toward sustainable development. Without it, the influx of resources could become a breeding ground for failure and disappointment. Therefore, as we move forward, let us ensure that Africa builds a financial sector that is ready to weather the storms and equally capable to partner in Africa’s growth and prosperity.
Udaibir Das is a Non-Resident Fellow at the National Council of Applied Economic Research, a Senior Non-Resident Adviser at the Bank of England, a Distinguished Fellow at the Observer Research Foundation America and a Distinguished Visiting Faculty at the Kautilya School for Public Policy. He is the former Assistant Director and Adviser of the International Monetary Fund’s Monetary and Capital Markets department. He held various positions at the Bank for International Settlements, the World Bank and central banks.