Sub-Saharan Africa grew at a rate of five percent in 2013, and is expected to grow by six percent this year. Impressive data, but unless this growth is accompanied by a 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 effect on income 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 five billion dollars in sovereign bond receipts in 2013 alone.
But major challenges remain in ensuring the proceeds are allocated efficiently towards infrastructure programs.
What can be done to help sustain Africa’s growth through financial sector development?
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.
Average private sector credit as a percentage of gross domestic product (GDP) was 18pc on average in sub-Saharan Africa. This contrasts with many developed countries, where it exceeds 100pc, with bloated financial sectors providing part of the problem.
Financial sector support to the real sector of the economy remains weak in many African countries, with corporate lending at the short end. There is a lack of adequate competition, which has led to the 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 sized 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 small businesses frequently get left out in the cold. This shows that there is a real need for inclusive finance for sustained growth.
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 economies wherein the 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 in most Africa countries. Beyond financial sector efficiency, additional solutions, such as improving the collateral process, credit information and other targeted interventions, could help further.
A strategic financial sector is important for allocating long-term savings to long-term development needs. Infrastructure financing needs in Africa amount to nearly 100 billion dollars a year. Increases in sovereign bond receipts and domestic resource mobilisation are promising but not yet enough.
The presence of large natural resource rents can be a boon to the region, which is why it is crucial to think about the mechanisms that can ensure the availability of long-term finance. An important debate will need to be had on the role of development banks or similar coordinating institutions, such as sovereign wealth funds, which can match the supply and demand of finance.
The challenge for African countries to fix the financial sector for sustained growth and structural transformation is a big one. It must grow in depth, but governments also need to regulate the financial sector to prevent banking crises; implement appropriate regulation that does not leave whole segments, such as the SME sector, excluded; reduce interest rate spreads by improving efficiency, reducing costs and incentivising innovation and finally improve strategic dimensions by coordinating mechanisms that can mobilise and allocate long-term finance for priority sectors.
There are already some promising examples in Africa, but valuable lessons could also be learned from other regions.
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