When the global economic crisis struck, sub-Saharan Africa had just enjoyed a decade of rapid economic growth. In the three years before the crash, output had jumped to 6% a year, from an average of 5% over the preceding years.
A benign mix of high commodity prices, a buoyant global economy and improved macro-economic policies fuelled the continent’s growth. For example, median inflation in 2005 was half the level of that in 1995. Official development aid was overshadowed by increased external capital – including remittances, which rose to $20 billion a year, and private capital flows, which by 2007 had reached $47 billion.
Before the crisis, private capital flows to Africa were rising faster than anywhere else, helping finance infrastructure and other development projects. Admittedly, this jump in investment came from a low base, underscoring the potential to scale up flows.
But the continent presented a compelling investment opportunity as well. For the 954 Africa-based, publicly traded companies, the average annual return on equity was 65%-70% – higher than in comparable firms in China, India, Vietnam and Indonesia, according to economists Paul Collier and Jean-Louis Warnholz.
Improved economic policies, increased external resources and the region’s vast investment potential fed a virtuous cycle, stoking economic growth and poverty reduction which, in turn, spurred further reforms, attracting even more private capital. In a symbol of how the region’s access to external finance diversified away from aid and foreign direct investment in the heyday before the global crisis, Ghana in 2007 floated a $300 million sovereign bond to widespread investor acclaim.
When the global crisis hit, many feared that the virtuous economic growth cycle in Africa was broken for good.
Though no fault of African governments, consumers or bankers, external capital flows dried up while payoffs to economic reforms failed to materialize. Yet most African policymakers continued to follow prudent economic policies – contradicting the doom-mongers who feared reform inertia or heterodox policies would sweep the continent.
Countries with fiscal space – thanks to prudent economic policies in the past – such as Zambia and Tanzania ran modest fiscal deficits to cushion their population from the worst of the global recession. Countries without fiscal space, such as Ghana, reduced their deficits despite the global downturn.
POLICY ORTHODOXY
Despite the cutback in external resources, many African governments continued to invest, particularly in infrastructure. South Africa continued an ambitious infrastructure programme, partly related to hosting the football World Cup. Tanzania increased the share of its budget going to investment in roads and water in 2009 while Nigeria boosted spending on growth bottlenecks by 2.5% of non-oil GDP.
Since external aid resources were limited, much of these increases were financed from domestic resources. Of the $45 billion the continent spent on infrastructure, two-thirds were financed by the African taxpayer and infrastructure user.
Now that the worst of the global crisis appears to be over, and economic growth in Africa has resumed – growth this year is expected to be about 5% – it is time to kick-start the virtuous cycle.
While external capital flows have resumed, they are nowhere near the levels needed to meet the continent’s development challenges, especially the infrastructure deficit of $31 billion a year. Today’s capital flows are not reflective of the potential returns to investment in Africa: the business environment is continually improving, a fact that is likely to further boost investment.
In the World Bank’s latest annual country policy and institutional assessment (CPIA), the number of African governments embarking on reforms exceeded the laggards by two to one. Rwanda and Mozambique, for example, have been steadily increasing their CPIA score over the past five years. Rwanda, in addition, was ranked as world’s top reformer in last year’s World Bank’s flagship Doing Business indicators, and in the top 10 (along with Zambia) this year.
So how can we restore the virtuous growth cycle in Africa?
Foreign aid holds the key. Africa receives about $44 billion in official development assistance each year. This aid is typically viewed in terms of which development projects it can finance: schools, clinics, rural roads, and the like.
But what if we asked the question differently: how can we use this aid – or a portion of it – to leverage other public and private resources to Africa? For instance, the Bujagali Hydropower project in Uganda is a $750 million project, $115 million of which is financed by the World Bank’s International Development Association. This contribution comes in the form of a partial risk guarantee that has successfully induced commercial lenders to participate in the project.
Aid donors must revisit development principles: aid effectiveness should increasingly be judged by the extent to which it mobilizes private sector investment. If successful, resurgent private capital, improved macro-economic policies and the high-return profile of investments in the continent will launch sub-Saharan Africa’s growth cycle once again – and make the continent a choice investment destination in years to come.
Shanta Devarajan is the chief economist of the World Bank’s Africa region.