Sunday, 8 November 2015

Africa´s Resource Gaps are Tightening

The structural slowing of potential output growth in emerging market economies that led to lower commodity prices has been simulated in the latest IMF WEO, released in October 2015 (Scenario Box 1, p 25). In particular, the marked decline in investment and growth in China—together with the generalized slowdown across emerging market economies—implies a sizable weakening of commodity prices, particularly those for metals, resulting in a weakening of the terms of trade for commodity exporters. Lower expected growth leads to lower investment. Africa´s resource mobilization might tighten via the various resource constraints for investment and output. The Bacha (1990) three-gap model has highlighted the foreign-exchange constraint, the private domestic-saving constraint and the fiscal constraint[1].

Countries at early stages of development (optimally) pursue an investment-based strategy, which relies on existing firms and managers to maximize investment.  Most of Africa is still at that early stage. High domestic savings and investment rates have underpinned latecomer development in the 19th century in Europe and in the 20th century in Asia. In Africa growth after 2000 tended to be higher in countries with higher investment shares in GDP, as discussed at length in AEO 2014),and investment tended to be higher in countries with higher national savings. 

Table 1: Variables to Determine Financing Needs
Structural, rigid short term
·         Import content of investment
·         Crowding-in coefficient 
·         Global interest rate
Policy, rigid short term
·         Private savings 
·         Remittances 
·         Net factor payments abroad 
·         Net capital inflows: of which
direct foreign and portfolio equity investment
·         Private investment 
·         Exports 
·         Imports
·         Exchange rate, in monetary union
Policy, manageable
·         Public investment 
·         Change in FX reserves 
·         Exchange rate, unless monetary union
·         Net capital inflows, of which
Loans, foreign bonds and aid inflows

The gap model provides a consistent list of variables that matter for resource mobilization in Africa. To be sure, only some of those variables can be influenced by policy, at least in the short term. Therefore, the gap equations also provide the basis – as was their historical motivation 50 years ago already – to quantify Africa´s public financing needs. Table 1 attempts to classify the variables into three categories, although the underlying distinctions may be fluid and somewhat arbitrary: structural (rigid short term); policy (rigid short term); and policy (manageable). 

Investment in Sub-Saharan Africa has traditionally been constrained by low domestic savings. Only in the ´golden decade´ of the 2000s the region recorded a saving rate that averaged almost a fifth of its combined output.  Since 2009, Africa´s saving rate has been declining, and the IMF projects for 2015 the domestic savings rate to drop even further (Table 2), to a meagre 15.4 percent of GDP. This compares to an average saving rate of 31.9 percent projected for the total of emerging and developing countries in 2015. Sub-Saharan Africa is the developing region with the world´s lowest saving rate. First and foremost, investment and future output are saving constrained.

 Table 2: Financial Balances 2001-08 and 2015p,
SS Africa and Total Emerging and Developing Countries (EMDC)
- percent of GDP -

As domestic investment is projected to remain sustained at more than 20 percent of GDP in the Fund projections but savings are depressed, the current account is pushed into deficits, exceeding five percent of combined GDP in Sub-Saharan Africa. The projected deficit on Africa´s current account is consequently considerable, mostly financed by running down official reserves. This begs the danger of currency attacks, with subsequent currency mismatches and balance-sheet recession.

[1] Edmar l. Bacha (1990), “A three-gap model of foreign transfers and the GDP growth rate in developing countries”, Journal of Development Economics, Vol. 32, Issue 2, April, pp. 279–296, doi:10.1016/0304-3878(90)90039-E. While it can be objected that the gap model is too structuralist, it seems relevant in the current African situation as several constraints can be taken as given for short-term analysis.