4~~~~~~~~~~~~~~~~~~~~~~~~~~~~~ Policy, Research, and External Affairs WORKING PAPERS Economics and Finance Technical Department Africa Regional Office The World Bank October 1991 WPS 764 African Financing Needs in the 1990s Jorge Culagovski Victor Gabor Maria Cristina Germany and Charles P. Humphreys Africa's external financing problem is much more than a struc- tural imbalance between imports and exports. Debt relief measures will be an important source of financing. The Polcy, Research. and l'xtemal Affairs ('ompli disinbuies PRI' Workung Papers to disseminate the fnd ings of v ork in progress and to eneourage the exchange of ideas among I3ank staff and all oLhers inicrested in development issues l'hese papers carr) the names of the auLhors, reflect only their views, and shoiuld h: ussed and cited accordingly The findings, inierpreLauLons, and conclusions are the authors' own 'I'he) should not be altnbuted to the A'orld B3ank, its Board of Directors, its man,georent, or any of its member eounines Policy, Research, and External Affairs Economics and Finance WPS 764 This paper- a product of thc Economics and Finance Division, Technical Department, Africa Regional Off1ice - w;s prcsecnted at the World Bank symposium on Africain Externazl Finance in ihe 1990s, held in September 1990 in Washingtoni, DC. A condensed version ol the paper will appear in the forthcoming symposium volume. Copies of the complete paper are available free from the World Bank, 1818 H Strect NW, Washington DC 20433. Please conitact MavitaGomez, room J3-282, extension 34349(87 pages, with figures and tables). October 1991. The gross forcign financing requirements for all ments in the last part of the 1990s result mnainly of Sub-Saharan Africat -- belore debt relief of from dhe continuallv wideninlg trade deficit. any kind or thc accumulation of newv arrears -- are projected to average about $28 billion a year Debt service obligations - before resched- (in nominal prices) between 1991 and 2000, or uling and before the accumulation of any addi- about $50 per capita annually. Thesc figures tional arrears -- comprise more than half of the comparc with estimatcd gross tinancing of $27- gross extcrnal financing requirements in the first $28 billion in 1988 and S24-$25 billion in 1982. half of the 1990s, but fall to about 40 percent by This is equivalent to only about 12 to 14 percent the end of the decade. Debt scrvice obligations of total capital flo\ws to the developing world in were equivalent to about three-fourths of the 1988. gross external financing requirements in 1988 but only about a third in 1982. The annual levels decline in mid-decade to about $26-$27 billion a year but rise to more The importance of dCbt service in total than $30 billion by 2000. This variation in dte requirements reveals that the extemal financing trend reflects combined movements in the problem in Africa is much more than a structural balance of trade in goods and services (excluding imbalance of imports and exports. Debt relief interest), debt service obligations, targets for measures will be an important source of finane- increase- in international reserves, and private ing. transfers. High levels in the early years are the result of heavy debt service obligations; the later For low-income countries, however, debt decline in these obligations helps reduce require- relief alone will not solve their financing prob- ments mid-decadc. Debt service obligations rise lem because their trade balance will continue to in 1991-93 on nonconcessional debt contracted deteriorate. But for most middle-income coun- in the last half of the 1980s but decline in 1994- tries where thc trade balance is positive. debt 97 and stabilize after that. The rising require- relief may have a much more decided impact. The i'RE Working P'aper Set es dissenrinaics the findlngs of A (irk under wa. in ihc Banlk's Pol icy, Rcscarch, and Exteemal AffairsComlplex. Anobjlecnlvcoftlheseri. s is to get th se flnding- outquickl , even if plesentations are lt ss than fullyrxoished. Tlrc Findings. inlerpretations, and concl.uions in these papers do not necesiaris represcnt official Bank pohct. Produced h\ the I'RE )svsernination CcnTIr Contents Oiew Economic change and evolution The last thirty years The crisis The reforms Extemal flows and the investment-savings gaD Saving, investment and efficiency of capital Need for investment Demand for investment Domestic sqvings and investment Efficiency of investment Impact of policy actions Estimated financing requirements Projected gross external capital requirements Projected financing sources Methodological summary Annex: The Framework and assumptions for the projections The projections framework Basic assumptions IDA-only countries Nigeria Selected IBRD borrowers Simplified algebraic description of the model Bibliography Text Tables 1 Growth of GDP, 1967-89 2 Evolution of key economic indicators for Sub-Saharan Africa, 1967-88 3 Evolution of key economic indicators for SPA countries, 1967-88 4 Investment and savings in Sub-Saharan Africa, 1966-88 5 Past and projected key economic indicators for Sub-Saharan Africa, 1985-88, 1995, 2000 6 Past and projected financing and debt relief for Sub-Saharan Africa, 1985-88, 1995, 2000 7 Prospective sources of financing for Sub-Saharan Africa, 1991-2000 Charts 1 Investment and growth in Sub-Saharan Africa, 1968-88 2 Investment and growth in Sub-Saharan Africa, 1980-88 3 Gross financing requirements of Sub-Saharan Africa, 1989-2000 (US$ billion) 4 Gross financing requirements of Sub-Saharan Africa, 1989-2000 (ratios to GDP) 5 Prospective financing by source in Sub-Saharan Africa, 1989-2000 Annex Tables 1 IDA-only countries: Key economic indicators, 1985-88, 1995, 2000 2 IDA-only countries: Financing and debt relief, 1985-88, 1995, 2000 3 Nigeria: Key economic indicators, 1985-88, 1995, 2000 4 Nigaria: Financing and debt relief, 1985-88, 19935, 2000 5 Selected IBRD borrowers: Key economic indicators, 1985-88, 1995, 2000 6 Selected IBRD borrowers: Financing and debt relief, 1985-88, 1995, 2000 Annex Charts 1 Sub-Saharan Africa: Terms of trade index, 1989-2000 2 IDA-only countries: Gross financing requirements (US$ billions), 1989-2000 3 IDA-only countries: Gross financing requirements (percent of GDP), 1989-2000 4 Nigeria: Gross financing requirements (US$ billions), 1989-2000 5 Nigeria: Gross financing requirements (percent of GDP), 1989-2000 6 Selected IBRD borrowers: Gross financing.' quirements (US$ billions), 1989-2000 7 Selected IBRD borrowers: Gross financing requirements (percent of GDP), 1989-2000 Overvew The purpose of this paper is to discuss the magnitude of exterr3l resources that Sub-Saharan Africa may require during the 1990s. There can be no firm projections because requirements are affected both by the growth and efficiency targets chosen and by a wide range of factors, both intemal and external to Sub-Saharan Africa, which often interact to reinforce or offset one another. However, the specific projections provided by this paper offer a point of departure for further discussions. To facilitate such discussions, this paper also provides a qualitative framework for considering how various factors affect resource requirements. To achieve the GDP growth target of 5 percent a year by 2000 proposed in Sub-Saharan Africa: From Crisis to Sustainable Growth the quantitative scenario in this paper shows that Sub- Saharan Africa could require gross external capital of $28-29 billion a year, on average, for the period 1991-2000 (or $21 bil in a year in constant 1988 dollars, which compares to an actual gross external capital inflow of about $28 billion in 1988). While this amount is large for Sub-Saharan Africa, it is relatively small as a share of total capital flows to the developing world (12-14 percent in 1988). As in the past, this amount can be financed by a combination of new money and debt relief (including arrears). Roughly, about half the gross capital inflows would finance net imports of goods and services (other than interest), needed for current and future growth, and the other half would finance debt service payments on borrowing that financed past expenditures. Annual requirements would be high initially to cope with debt obligations, lower in the middle years of the decade, and higher at the end as debt servicing rises and the trade deficit continues to widen. Gross external financing at this level would be roughly equal to 15 percent of Sub-Saharan GNP, compared to gross national savings of 13 percent. Achieving this scenario will require appropriate domestic policy reforms, especially those designed to raise investment to a level equivalent to 25 percent of GDP, and to achieve a dramatic improvement in the efficiency of capital. The conceptual framework used in this paper for estimating external resource requirements is based essentially on the two-gap model, in which the gap between domestic savings and gross investment must equal the difference between imports and exports, which is financed by external capital or foreign savings. In the formulation of the two-gap model used in this paper, the relationship between imports and targeted output determines the required level of imports of goods and non factor services, An assumed export growth rate determines the export level. Thus, the external financing gap is largely a function of the target (growth of GDP) and two assumptions that together lead to the export-import (X-M) gap, plus projected debt service obligations. The investment-savings (I-S) gap is derived from the X-M gap. The assumed relationship between output growth and investment indicates the level of new annual investment required to att-in the target GDP growth rate. Domestic savings are calculated as a residual to make the I-S gap equal to the X- M gap. Behind this simple formulation lies a complex set of economic, structural and behavioral relationships. These projections are based on specific assumptions about key variables. Because these variables can be changed through specific policy actions, assumptions about policies help determine the structural economic changes and external resources needed to achieve certain targets. But there is no explicit formulation in the projections model linking the value of key variables to specific policy reforms. Instead, these linkages are discussed qualitatively. 2 To provide a context for the discussions, the paper starts with a section on the economic history and evolution of Sub-Saharan Africa. A section on savings, investment and efficiency of capital follows dealing with the feasibility of achieving the desired growth targets, the policy instruments av3ilable to attain them, and the policy reforms that African countries should implement to boost the demand for investment as well as private and public savings. The final section analyses the external resource requirements, as projected by the model, and discusses implications for other relhted economic and financial variables. A detailed description of the assumptions and the model is annexed to the paper. 3 Economic change and evolution The last thirft veam About thirty years ago colonialism was ending in Africa. African leaders were optimistic about their political, economical and social future, and the donor community, sharing this optimism, contributed substantial resources. Resources were channeled substantially toward industrialization. Agriculture took second place, basically supplying raw matcria!s and providing tax revenues. In addition, the government paid' a lot of attention to the social sector and infrastructure. The development strategy, fully supported by donors, entailed a dominant role for the government, which adopted multi-year plans, created public enterprises, set prices, controlled trade and directly allocated credit and foreign exchange. This strategy appeared to pay off at first. GDP grew at 5.9 percent a year during 1965-73, about the same rate as for other developing countries. Strong export demand and high investment, financed from export eamings, commercial borrowing and aid, boosted the GDP growth rate. However, with time, the developing strategy showed its first failures, as countries begun to stumble after the first oil shock.1 By the middle of the 1970s Africa's performance started to lag behind that of other developing countries. By the 1980s output began to decline. As the crisis deepened, African I The biggest increases in oii prices, here referred to as oil shocks, took place in 1973-74 and 1979-80, and are the basis for the periods selected to average data. 4 countries started reforms programs, and GDP growth began to recover in the second half of the 1980s, but growth rates have remained below those ir. other developing countries except in 1989. In 1965 Sub-Saharan Africa and Spain had about the same size economy (US$27 and 24 biilions respectively); 23 years later, Spain's US$ 340 billion output was more than double that of Sub-Saharan Africa's, with only 8 percent of Sub-Saharan Africa's population and only 2 percent of its land mass. Spain graduated from the ranks of developing countries. Sub-Saharan Africa became instead the Third World of the Third World. Table 1 Growth of GDP, 1967-89 (percent per year) 1967-73 1974-80 1981-84 1985-87 1988 1989 Sub-Saharan Africa 7.0 2.7 -1.1 2.6 2.5 3.6 less Nigeria 4.4 2.0 1.9 3.1 1.5 2.2 Non-African developing countries 6.5 5.4 3.5 5.4 5.8 3.4 Source: World Bank data files Performance has varied greatly from country to country. Average annual GDP growth during 1961-87 ranged from 8.3 percent for Botswana to -2.2 percent for Uganda. Oil exports greatly affected performance, with oil exporters doing well or badly according to fluctuations in the oil prices. Middle-income countries have, in general, fared better than low income countries and small economies better than large ones. Domestic policies also had a major impact on countries' economic performance and their external financing requirements. 5 Despite the rich diversity of the countries that make up the centinent, there are many common serious problems now constraining their development: the highest population growth rate in the world and in Africa's known history; low levels of investment and saving, inefficient resource use, weak institutional capacity and human resources, rccent declines in per capita income and living standards, growing ecological deterioration, and increasing marginalization from the rest of the world. The crisis Sub-Saharan Africa has by now experienced a decade of falling per capita incomes and has shown signs of erosion of its land and human resources. In the late 1970s most African countries (in particular the SPA countries expanded public consumption and investment. Instead of raising savings, they financed much of this with foreign funds, taking advantage of expanded borrowing based on unprecedented high export prices and negative real interest rates in international markets. This quick expansion required rapidly rising imports, which grew faster than during any other period in the past thirty years (7.6 percent annually for the years 1974-80). Imports were partly financed by nonconcessional borrowing. This borrowing continued up to 1982-83 despite a sudden rise in international interest rates, as borrowers and lenders believed that the high export volumes prior to the first oil shock could be soon restored, and that the high export prices would continue. These expectations did not materialize and soon the boom became bust. In 1984 nonconcessional lending was sharply reduced, in 1985 there was virtually none. The first half of the 1980s indicated that the development strategy adopted by most African countries at the time of their independence had failed to cope with these realities and to achieve 6 what had been expected. The region was undergoing a severe crisis as shown in Table 2. Their economies were sliding rapidly. The high growth (7 p~ercent a year) achieved before the first oil shock first gave way to slower growth (2.7 percent annual average for 1974-80) that was not sufficient to match the rapidly expanding population. Later, during 1980-84 both output and gross national income (GNY) shrank a. an average annual rate of 1.1 percent a year. The loss in income was caused by the drop in output and exports; an all-time favorable terms of trade spared the region an even worse loss. 7 Table 2 Evolution of key ewDomic indicatos for Sub.Saharan Afica, 1967-88 (average annual percentage change, unless otherwise indicated) . ............................... .... ..............v*.................................. ...... ....... ........................... . 1967-73 1974-80 1981-84 1985-87 1988 GDP 7.0 2.7 -1.1 2.6 2.5 Export volume 17.1 0.2 -7.5 2.1 1.2 Import volume 4.3 7.6 -6.8 -0.7 -2.8 GDI (percent of GNP) a/ 16.7 22.3 16.7 15.0 16.6 GNS (percent of GNP) a/ 13.0 17.2 9.0 8.8 8.0 Private consumption 4.1 1.8 1.1 1.3 2.2 Gross ODA (percent of GNP) b/ 3.2 3.6 4.2 6.6 8.9 Terms of trade index (1980=100) a/ 83.9 84.4 101.3 83.0 74.2 GNY Total 3.9 4.5 -1.1 0.7 2.4 Per capita 1.2 1.7 4.1 -2.4 -0.9 Notes: a/ Refers to 1966-73 b/ Refers to 1970-73 Source: World Bank data files The increase in the investment rate that took p!ace in Sub-Saharan Africa in 1974-80 did not translate into higher output growth in the following periods, as could have been expected. The drop in output that occurred in 1981-84 was caused in part by the very low efficiency of investment. (Once the reform programs began to help raise the efficiency of investment, GDP increased despite lower investment rates, see Table 2). The crisis was pervasive, affecting all areas of the economies. During 1981-84 export and import volumes fell (by 7.5 and 6.8 percent annually, respectively); investment as a percentage of GNP went back to the 1966-73 levels (16.7 percent); gross national savings as a percentage of GNP averaged only 9 percent, or about half their 1974-80 level; foreign direct investment expanded at the lowest rate of the iast thirty years; export market shares continued to erode. To make matters worse, net nonconcessional capital flows coUlapsed, and the negative real interest rates of the past gave way 8 to very high ones. Debt at 45 percent of GNP in 1983-84 was more than double its 1975 level, and the debt service payments, despite rescheduling, reached 27 percent of exports in 1984 or 4 times higher than in 1975. Despite the crumbling economies private consumption continued to grow during 1981-84, albeit at a small and reduced rate (1.1 per cent a year), financed by a rapid decline in the gross national savings rate (which reached an all time low of 7.3 percent of GNP in 1983) and modestly increasing net ODA flows. However, this consumption growth was lower than population growth, and per capita consumption declined at 2 percent a year. The crisis of the 1980s was less severe for the oil importing countries than for the oil exporters, in part because export earnings fell loss and they relied more on foreign aid than on commercial borrowing. During 1981-84 GDP still grew, albeit at a negligible rate (1.1 percent annual average), the lowest of any other period in the past thirty years. Private consumption also continued to grow (at 1.2 percent), but the rate was half what had been in the past. After slowing down in the previous period, both export and import volumes dropped at a rate of 2.6 and 3.5 percent a year, respectively. The investment share of GNP (17.7 percent) was lower than during 1974-80, but was still the second highest of all periods under review. However, the gross national savings share of GNP fell to an all time low (7.8 percent). The resulting investment-savings gap (9.9 percent of GNP) was the largest of any other period in the past thirty years, and much larger than the gap for Sub-Saharan Africa as a whole. High population growth, oil price and international interest rates shocks, war and drought contributed to the crisis in Sub-Saharan Africa, but weak economic management was also a major cause. Inappropriate domestic policies and lack of policy implementing capacity were key impediments to improved economic performance. The need to redress the mistakes of the past and 9 make the necessary adjustments began to be felt in the early 1980s. The inability of African economies to respond to the shocks of the 1980s had made the case for reforms too strong to ignore. The reforms By the mid-1980s many Sub-Saharan countries had begun the reform process; by mid-1990, 29 Sub-Saharan African countries had active Bank-supported adjustment programs, and 27 had IMF- supported programs. Reforms programs started at first in the area of macroeconomic stabilization; fiscal, monetary, exchange rate and other macroeconomic reforms were used to bring aggregate expenditures in line with total available resources. The programs that followed, in the later 1980s, focused more on increasing output and reducing the social costs of adjustment. These reform programs increased the emphasis on adjustment policies to improve productivity and increase production and exports by liberalizing external and domestic trade, raising producer prices, strengthening the financial sector, restructuring public enterprises, improving public investment programming, reordering public expenditure priorities, and improving performance in key sectors, especially agriculture and industry. These reform efforts have resulted in some improvements in many countries in the real exchange rate, real interest rates, fiscal balances, trade liberalization, pricing and public management, and other policies. Even though the results for all Sub-Saharan Africa are dampened by those countries that have not engaged in reforms, the trends show how output growth has been restored for the region, 10 reaching 3.6 percent in 1989, compared to -1.1 percent in 1981-84. Export performance is beginning to turn around, but import volumes are still declining, albeit at a iower pace than before the reform period. Gross domestic investment and national savings, which reached their lowest point in 1983-85, are no longer declining as a percent of GNP (although the gap between the two remains about the same as in the early 1980s). Private consumption began to recover in 1985-87 and improved in 1988, as stronger output growth was channeled more into consumption than savings. (See Table 2.) Achievements are much more transparent when the record for reforming countries is examined separately. Despite delays, slippages, reversals, and other signs of mixed policy performance, the progress that they have achieved since the mid-1980s is, on balance, positive as can be seen from Table 3 below, showing the performance of countries eligible for the Special Program of Assistance (SPA), which covers most reforming countries. 11 Table 3 Evolution of key economic indicators for SPA couni 1967-88 c (average annual percentage change, unle otherwie indcated) 1967-73 1974-80 1981-84 1985-87 1988 GDP 3.8 1.4 0.4 3.3 4.0 Export volume 4.7 1.1 -5.5 6.0 0.1 Import volume 3.6 1.9 -2.3 4.0 5.0 GDI (percent of GNP) a/ 15.2 19.1 17.2 17.7 17.7 GNS (percent of GNP) a/ 12.0 10.6 8.5 7.9 6.8 Private consumption 2.2 0.1 -0.5 2.7 2.2 Gross ODA (percent of GNP) b/ 4.7 7.5 10.! 12.5 15.0 Terms of trade index (1980=100) a/ 124.0 129.9 109.5 107.2 108.5 GNY Total 3.6 0.8 0.9 2.7 5.8 Per capita 0.8 -2.0 -2.2 -0.6 2.4 …-- - -- - -- -- - -- - -- - -- -- - -- - -- - -- -- - -- - -- - -- -- - -- - -- - -- -- - -- - -- - -- -- - -- - -- - Note: a/ Refers to 1966-73 b/ Refers to 1970-73 c/ Eligible countries at the end of 1989 included: Benin, Burundi, Central African Republic, Chad, The Gambia, Ghana, Guinea, Guinea-Bissau, Kenya, Madagascar, Malawi, Mali, Mauritania, Mozambique, Niger, Sao Tome and Principe, Senegal, Somalia, Tanzania, Togo, Uganda and Zaire. Source: World Bank data files GDP growth has averaged about 3.4 percent annually since reforms started, close to the average before the first oil shock, thus reversing a decade of declining per capita growth. Imports and exports have performed very strongly, reversing a decline. Because of the high GDP and export growth and favorable terms of trade, gross national income increased at an average of more than 4 percent a year during 1985-88, and per capita income has increased in 1988 for the first time since the first oil shoclk Private consumption in the SPA countries has posted increases after the reforms started, but not sufficiently high to offset population growth. However, the share of gross domestic investment in GNP has improved only modestly from its 1981-84 level, and the share of national saving in GNP has continued to deteriorate. To compensate for the low national savings (7 percent 12 l of GNP in 1985-88) donors have over time considerably stepped up their ODA contributions, which reached about 14 percent of the SPA countries' GNP during 1985-88, or almost three times the share in 1970-73. This ever-growing recourse to outside resources for growth and development reflects the failure of the African economies to achieve sustainable growth. External flows and the inmestment-savings gap in Sub-Saharan Africa As national savings dwindled and public consumption and investment continued, external resources have been used to finance growing fiscal deficits on both current and capital budgets. The investment-savings gap has increased two and a half times in 22 years, growing from 3.7 percent of GNP in 1966-73 to 7.4 percent in 1985-88 While in 1966 almost 90 percent of investment was financed by Sub-Saharan Africa's savings, in 1988 only 50 percent was. I ne persistent widening of this gap has occurred mainly in the IDA-only countries 2/. In Nigeria the gap decreased to its lowest point in 1974-80 and in the 1980s it was half than in the late 1960s and early 1970s. In other IBRD countries the gap increased to its highest point in 1974-80 and decreased in the 1980s, so that in 1988 it was at the same level than in 1967-73. (See Table 4.) 2/ Countries eligible to borrow IDA credits but not IBRD loans. 13 Table 4 Investment and savings in Sub-Saharan Africa, 196648 (average annual percentage of GNP) 1966-73 1974-80 1981-84 1985-87 1988 Sub-Saharan Africa Gross domestic investment 16.7 22.3 16.7 15.0 16.6 Gross national savings 13.0 17.2 9.0 8.8 8.0 Gap a/ 3.7 5.1 7.7 6.2 8.6 Nigeria Gross domestic investment 14.8 22.8 13.8 10.3 13.6 Gross national savings 10.3 23.7 8.8 8.4 8.7 Gap a/ 4.5 -0.9 5.0 1.9 4.9 Other IBRD countries Gross domestic investment 22.2 29.5 26.4 21.8 19.6 Gross national savings 14.2 12.2 13.7 14.7 11.7 Gap a/ 8.0 17.3 12.7 7.1 7.9 IDA-only countries Gross domestic investment 16.1 18.8 16.8 16.1 16.3 Gross national savings 13.8 10.6 7.3 6.9 5.7 Gap a/ 2.3 8.2 9.5 9.2 10.6 …-- - - - - - - - - - - - - - - - - - . . . . . - - . . . . . . - - . - - - - - - - - - - -... Note: a/ Defined as investment minus savings Source: World Bank data files The decline in savings in Sub-Saharan Africa can be explained by three factors: a) declining income, which leaves fewer resources for public and private consumption and savings; b) the govemment's negative savings that resulted from growing recurrent budget deficits; and c) some misclassification of foreign inflows that may make the level of domestic savings look lower than it actually is. National accounting identities define all net foreign capital as investment (by definition, net capital inflows finance the gap between domestic investment and national savings). From the perspective of changes in the stock of national savings, this definition may be correct -- the increase 14 in foreign liabilities created by the capital inflows reduces the contribution that national savings make to national assets. (If capital inflows are in the form of transfers, however, the definition is inappropriate because the inflows do not give rise to liabilities.) In practice, however, some of the capital inflows finance consumption, not investment, and smaller inflows would reduce consumption as well as investment. In these cases, the accounting identities make the investment rate appear higher than it is and the national savings rate appear lower than it is. Increases in net capital inflows will increase the discrepancy between apparent and actual rates. To illustrate, between 1970 and 1988, gross national savings declined by 5.3 percentage points of GNP; over the same period, net external financing increased by 5.5 percentage points of GNP. This overstatement of investment and understatement of savings presents a critical problem in projecting financing requirements, but may also help explain the puzzle posed by the declining savings rate in Sub-Saharan Africa, at a time when per capita incomes only stagnated. Net external flows to Sub-Saharan Africa have almost doubled as a percentage of GNP during the past two decades. Net loan disbursements plus grants and net foreign investment amounted to 6 percent of Sub-Saharan Africa's GNP in 1970, but to 10.9 percent in 1988. Moreover, the net flows have become more concessional. In 1970 less than half the net flows were concessional compared to five sixths in 1988. 15 Savings, Investment and efficiency of capital This section discusses the links between some key economic policies and the model's targets and variables, indicating how policy actions would help achieve target growth for Sub-Saharan Africa. It also reviews the region's past performance to give an idea of the feasibility of reaching the desired targets in the medium term. The section starts with a discussion of the need for investment required to reach the target growth rates. The relation between investment and output growth is a key behavioral parameter determining output growth. Second, there is a discussion of factors determining the demand for investment, which argues that inadequate demand for investment in Sub-Saharan Africa is an important impairment to investment and growth. Third, this section then analyses, domestic savings. Given the importance of public savings in increasing gross domestic savings, it suggests policy measures to reduce the current public deficit. A discussion about private savings follows, with the conclusion that raising private savings will be a medium-term effort contingent on establishing predictable macroeconomic conditions and achieving growth. Fourth, this section discusses policy actions to improve the efficiency of investment, needed to reach the target growth rates. Key policies cover public sector management, financial intermediation, relative prices, and institutional and human capital development. Finally, this section summarizes the impact of principal policy actions available to modify the main behavioral parameters of the model and discusses the mechanisms through which these actions operate. l/ 3/ This discussion is based on the conceptual framework developed in the World Bank's publication Adjustment Lending Policies for Suistainable Growth. 16 Need fo-r In the model, the GDP growth rate determines the need for investment, depending on the incremental-output-ri,tio (ICOR), which is a behavioral parameter determined by policies and by economic factors exogenous to the model. The ICOR, commonly referred to as the efficiency of capital, is often approximated by the ratio of the investment rate to the rate of growth of production 4/. Although economic growth is determined by many variables, which are affected by different policy actions as well as by non-controllable events, the effects of these variables can be summarized by the level of investment and its productivity. However, no unique instrument of economic policy can lead to the desired levels of investment and capital efficiency. Achieving an aggregate growth rate of 5 percent by 2000 would require an annual investment rate of 25 percent of GDP, provided that the ICOR is not higher than 5 (or the efficiency of capital is at least 20 percent). Reaching these levels of investment and efficiency of capital will not be easy. In the past (during 1968-88), the region as a whole achieved an average annual growth rate of 3.5 percent (2 percent when Nigeria is excluded), and an investment to GDP ratio of 17.5 percent (18 percent when Nigeria is excluded), with an implied efficiency of capital of 20 percent (11 percent when Nigeria is excluded). Only ten Sub-Saharan countries had investment rates and efficiency of 4/ A higher value for the ICOR implies lower efficiency of capital, and vice versa. (The efficiency of new capital investment is the reciprocal of the ICOR.) Actual values for ICORs can be estimated in various ways, but the simplest is the rate of new investment over the rate of GDP growth in the same year. (In the empirial presentation in this paper, the ICOR is usually calculated as investment in the previous year divided by the increment of GDP (valued at the previous year's price).) As with most summary empirical measures, the ICOR masks several complexities and will vary depending on the length of the period chosen, whether current or constant prices are used, exogenous effects on output levels (including those caused by changes in expenditures resulting from changes in the terms of trade), changes in utilization of capacity, and various delays between the time when investments are made and production begins to increase (for example, investments in human capital may have a longer lead time than investments in farms and factories). 17 capital that yielded average annual growth rates equal or superior to the 5 percent target during 1968- 88 (Chart 1). In three of these countries good performance can be explained largely by unusually high oil export revenues. The 1980s witnessed a deteriorating situation (see Chart 2), caused by a less favorable international economic environment and the accumulating effects of past government economic intervention. During the period 1980-88, the arithmetical average annual growth rate for Sub-Saharan Africa was about 1.i percent (1.7 percent excluding Nigeria), with investment reaching about 16 percent of GDP (about 18 percent excluding Nigeria). Lte efficiency of capital during this period was only 7 perccnt (10 percent excluding Nigeria). While some increase in growth from recent low levels can be expected from larger and better use of (reportedly extensive) idle capacity, to go beyond past levels of growth will require substantial increases in both investments and capital efficiency. To achieve them decisive policy action is needed, leading to more competitive, as well as stable, prices and exchange rates, simpler regulations, and greatly improved institutional efficiency. While the policy measures and their sequencing will have to be tailored to the circumstances of each country, the sooner the measures are put in place, and the more substantial they are, the better will be their contribution to economic performance. The challenge for Sub-Saharan African countries becomes even bigger when account is taken of the need for large investment in human resources and basic infrastructure. Investment in human capital both improves current living conditions for the population and increases the productivity of physical investment, providing the basis for sustained growth. Public investment in infrastructure, complementary to production activities, is also critical to improve efficiency of capital as well as to foster investment opportunities. However, neither of these two forms of necessary investments is likely to be quickly translated into significant increases in output. Moreover, in most countries, 18 substantial expenditures are needed simply to make up for past neglect and deterioration of sosial facilities and infrastructure. Therefore, because a large share of investment wil' have relatively lower productivity in the near-term, to achieve the overall rates of capital efficiency required to meet the target growth, the efficiency of directly productive new investment will need to surpass the 20 percent productivity postulated for overall new investment. Or, altematively, the level (or rate) of new investment will have to be higher than the postulated 25 percent of GDP to compensate for the lower efficiency caused by the special problems of the region. 19 Chart I. tnvosta.nt and GroWth in Sub-Seharcn Africa. 1968-1988 0. 4 0. 3 0 BWA 0.12 0.11I 0.10 0.09 0. 0- 0.07 0.0O KN( & 0.Oa - _ _ _ . . . a _ -- OWS sa P GAS 4~ R*40 O G S NCA tlv s 9 .04 - Ms 0.03 - E, C I TGO O.82~~~~~~E-- - S3X aa \;s ca 9 ° 0.02 N 'KA 9 0 0.01 - SSA 0 1 -0.01 -0.02- - 0.00 0.20 0.40 Irt11sftnen/CDP at current pru-es Abbroviations a SSA Sub-Saharan Africa SSA oxcl. NCA Sub-Sahsr&a Africa excluding Nigeria SSA 1990 Target for sub-Saharan Africa to achiove in 1990 SSA 2000 Target for sub-Sabaran Africa to achieve in 2000 1 DEN Benin 21 M1I alawi I A Botswana 23 I. MaLi 3 SWO Durkina Paso 23 MIT Mauritania 4 SUR Burundi 24 M S HaunitLus 5 CMi Caeroon 23 hO2 Mosambique 6 CPV Cape Verde 26 NZR Niger 7 CAP Central African Republic 27 NGA Nigeria 8 TCD Chad 26 REA Rwanda 9 COX Comoros 29 SEN Senegal 10 COO Congo 30 SYC Seychelles 11 CIV Coto D'tvoire 31 SLZ Sierra Leone 12 ETH Ethiopia 32 SOM Somalia 13 GAB Gabon 33 SDN Sudan 14 CMI Gambia 36 SWZ Swaziland 15 GH4 Ghana 35 TZA Tanzaaia 16 GNU Guinea-Bissau 36 TGO Togo 17 ZEN Kenya 37 UGA Uganda 18 LSO Lecotho 38 ZAR Zaire 19 LBR Liberia 39 ZHJ Zambia 20 MDG Madagascar 40 ZWe Zimbabwe Notes: Both variables were defined as the arithmetical averages of yearly -- -- indicators. The parameters of the regression line were calcuLated by least square method using the averages of the 40 countriee as observations. Sources: World Tablas. 1989-90 Edition, Prom the data files of the World Bank. The Johns Hopkins University Proes, Baltimore and London. 1990. both book and diskette versions. Sub-Saharan Africa, PrQM Crisis to Sustainable Growth. A Long-Term Parspective Study, The World Bank, VWahington. D.C. 1989. 20 Chart 2 Investment and crowth in Sub-Saharan Africa. 1980-1968 0. 14 0. 13 0. t- 0.11 - 8WA 0.10 0.09 0.08 0.07 0 CO 0.08 - c a\ 0.05 - AUR Q A XVII. GDI# =GDP# - C# - X# + M# XVIII. GNP# = GNP / PGDP XIX @PTOT = Px / PM XX. ToTAdj# = (priT- 1) * X# XXI. GNY# = GNP# + ToTAdj# Balance-of-payments equations: XXII. Xgnrs aXRT X XXIII. Mgnts aMRT M XXIV. Nonlnt = Nonlnttl v' (I + rNonln) PGDP / PGDP XXV. NFY = INT + Nonlnt XXVI. @NPT = NPT' (I + rN)T) * PMUJV / PMuvt XXV1I. @NOT NOT"' (I + rNOT) POECDGDP / POECDGDP"I XXVIIT. @DFI = DFIt- 1 (I + rDFI) PMUV / PMULV XXIX. @STD STD)'' * (I + [(1 + aM * rGDP) PM / PM 11aST XXX. NDST = STD - STD'' XXXI. R = aR Mgns i 12 XXXII. ChR = R - R' XXXIII. DS = INT + AMT X;XIV. GAP = Mgn8s - Xgnfs + Nonlnt - NPT - NOT - DFI - GDMLT + DS - NDST + ChR 82 List of symbols: a, Share of investment in GDP, exogenous aM Elasticity of imports relative to GDP growth, exogenous aMRT Constant, exogenous adjustment between the imports of goods and non-factor services in the system of national accounts and balance of payments aR Target level of international reserves to finance imports defined as months of coverage, exogenous asr Elasticity of short-term debt stock relative to import growth, exogenous aXRT Constant, exogenous adjustment between the exports of goods ancl non-factor services in the system of national accounts and balance of payments AMT Scheduled amortization obligations of medium- and long-term debt, exogenous C Consumption ChR Changes in reserves DFI Net direct foreign investment DRI Reduction in interest obligations through debt relief, net of moratorium interest DS Scheduled debt sZrvice obligations GAP Residual financing gap before debt relief GDI Gross domestic investment GDMLT Gross disbursements of medium- and long-term loans, eogenous GDP Gross domestic product GDS Gross domestic savings GNP Gross national product after debt relief GNS Gross national savings after debt relief 83 GNY Gross national income after debt relief INT Scheduled interest obligations of short-, medium- and long-term debt, exogenous M Imports of goods and non-factor services (national account definition) Mgnfs Imports of goods and non-factor services (balane-of-payments definition) NDST Net disbursements of short-term loans NFY Obligations of net factor income to abroad Nonlnt Non-interest net factor service payments NOT Net official transfer receipts NPT Net private transfer receipts PDA Deflator of domestic absorption PoDP GDP deflator index PM Import price index merchandise goods (country/group specific), exogenous PMuW Unit value index of imported manufactured goods (based on G-5 exports to sub-Saharan Africa), exogenous POECDCNP GNP deflator of OECD countries (approximated by the average USS deflator for the G-5 countries), exogenous PRER Real excilange rate (S/local currency) index, exogenous PTOT Terms of trade index Px Export price index, exogenous R Value of intemational reserves rDFI Real growth rate of direct foreign investment, exogenous rGDp Real growth rate of GDP, exogenous rNonlni Real growth rate of non-interest net factor service payments, exogenous rNOT Real growth rate of net official transfer payment receipts, exogenous 84 rNV1r Real growth rate of net private transfer receipts, exogenous rxan o { Real growth rate of non-oil exports of goods and non-factor services, exogenous rxoi Real gromwth rate of oil exports, exogenous STD Short-term debt ToTAdj Gain or loss of national income resulting from terms-of-trade changes X Exports of goods and non-factor services (national account definition) Xgnfs Exports of goods and non-factor services (balance-of-payments definition) Xnon-oil Non-oil exports of goods and non-factor services XOd lOil exports 85 Bibliography: Chang, Kevin P.H. and Cumby, Robert E. 1990. 'Capital Flights in Sub-Saharan African Countries". World Bank Draft. Washington, D.C. Corden, Max W. 1990. "Macroeconomic Policy and Growth. Some Lessons of Experience". Annual Conference on Development Economics. World Bank. Washington D.C. Deaton, Agnus. 1989. 'Savings in Developing Countries". Annual Conference on Development Economics. World Bank. Washington. D.C. Dornbusch, Rudiger. 1990. "From Stabilization to Growth" Annual Conference on Development Economics. World Bank. Washington. D.C. Fischer, Stanley and Thomas, Vinod. 1990. "Policies for Econornic Development". World Bank Working paper 459. Washington, D.C. Khan, Moshin S. 1987. Research Observer. Vol. 2, No. 1. "Macroeconomic Adjustment in Developing Countries. A policy Perspective". OECD. 1989. Development Co,-peration in the 1990's. Paris. Pfeffermann, Guy P. and Madarassy, Andrea. 1989. "Trends in Private Investment in Thirty Developing Countries". IFC Discussion Paper No. 6. Washington, D.C. UNDP and World Bank: 1989. African Economic and Financial Data. Washington, D.C. 1989. Africa's Adiustment and Growth in the 1980s. Washington, D.C. 86 World Bank. 1989. Sub-Saharan Africa: From Crisis to Sustainable Growth. Washington, D.C. 1989. Worrd Debt Tables. 1989-90. Vols. 1 and 2 and underlying data files. Washington, D.C. 1989. World Development Report 1989. Washington, D.C. 1989. World Tables, 1988-89 edition and underlying data files. Washington D.C. 1990. World Development Report 1990. Washington, D.C. 1990. Special Program of Assistance. Proposal for the Second Phase. Washington, D.C. 1990. Adjustment Lending Policies for the Recovery of Growth. Country Economics Department, Policy and Research Series. Washington, D.C. 1990. World Tables 1989-90 Edition. Book and diskette versions. Washington D.C. Yeats, Alexander 3. 1989. "Do African Countries Pay more for Imports? Yes". World Bank working paper WPS 265. 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