Innovative financing for development: Opportunities and policy options for Africa

Emmanuel Nnadozie, director of the economic development and NEPAD division at the United Nations Economic Commission for Africa.

The central role finance plays in development is well-known in the development literature. So too are the challenges African countries face in mobilizing internal and external financial resources to transform the structure of their economies, unleash high and sustained levels of economic growth, create jobs and achieve their development potential. Indeed, mobilizing domestic and external finance is critical to Africa’s investment needs. Hence, the need for African countries to raise sufficient financial resources to accelerate and sustain growth and achieve their development goals, including the Millennium Development Goals (MDGs), has been widely acknowledged in various circles. However, over the years, the existing traditional sources of finance — both domestic and external — have proved inadequate in satisfying these financial requirements. For example, the 2010 World Bank Africa Infrastructure Country Diagnostics Report estimates Africa needs more than $90 billion annually to develop its infrastructure, but has managed to raise only about half of that — mostly from domestic sources.

The global crisis threatened to reverse earlier advances, as African countries experienced weaker export revenues, lower investment and growth rates, and shrinking remittances and FDI flows. Further, climate change is already having and will continue to have severe economic consequences for Africa with far-reaching impact on growth and poverty reduction. Adapting to the impact of climate change will be costly to African countries and is projected to cost them anywhere between $25 billion and $50 billion dollars a year, increasing pressure on development budgets.

Nearly 10 years after the adoption of the Monterrey Consensus by the Heads of State and Government at the International Conference on Financing for Development and four years before the 2015 MDGs target date, available evidence indicates the majority of African countries will not meet the goals if current financing trends continue. Since 2002, achieving the targets set under the Monterrey Consensus on Development Financing has proved to be a challenge. Within the context of domestic resource mobilization, the performance of both tax revenue and savings remains below the Monterrey expectations. Tax revenue remains less than 15 percent of GDP for a quarter of sub-Saharan African economies. Similarly, gross savings for Africa (excluding North Africa) declined from a decade-high of 24.2 percent of GDP in 2006 to 19.8 percent in 2010, which is comparatively much lower than other developing regions such as Developing Asia (44.9 percent), and Middle East and North Africa (34.8 percent) in 2010. Further, although external private capital inflows to Africa have increased over the past decade, they have fallen short of the required targets.

Notwithstanding this worrisome picture, significant progress has been made in debt relief and access to international resources, although much less in domestic resource mobilization, foreign aid and international trade. Mobilizing domestic resources should be the answer to the challenge of development finance in Africa. Unfortunately, as shown earlier, the reality is there is a significant investment gap despite commendable efforts to mobilize investment finance across the continent. Indeed, the issue of enhancing domestic resource mobilization attracted the attention of African policymakers long before the Monterrey Consensus. As the Economic Commission for Africa’s “Economic Report on Africa 2011” points out, this is mainly because eventual dependence on domestic financial resources will help to achieve and sustain high growth rates, in addition to giving African countries greater policy space and ownership of their development agenda.

The situation calls for new and innovative ways to mobilize additional financing that can provide African countries with increased resources for development. Innovative financing refers to a range of nontraditional mechanisms to raise additional funds for development through innovative projects such as microcontributions, nontraditional taxes, public-private partnerships and market-based financial transactions. The following issues relating to innovative financing are examined further: the potential for innovative financing, the potential sources of innovative finance and policy options.

The potential for innovative financing

The recent global financial crisis underlined the fact that African countries face significant exposure to the current sources of external finance and the need to find other more sustainable, predictable and complementary sources. Given the heavy reliance on overseas development assistance by a number of African countries, the crisis exposed the risks associated with its volume and volatility. Consequent to the global crisis, foreign direct investment declined from a peak of $73 billion in 2008 to about $53 billion in 2010. This is a wake-up call for Africa to look to new and more resilient sources of external finance.

Several innovative mechanisms are being discussed at various forums, which tap on both the official and private sources of finance. These include taxes on global activities that are either taxed little or not at all, such as air-ticket solidarity levy or international financial transactions levies, prefinancing mechanisms based on financial markets with public guarantees (the International Finance Facility for Immunization or IFFIm) or relying on States (advanced market commitments), market mechanisms (carbon emission auctions), and voluntary contributions by the private sector facilitated or channeled by the public authorities (migrants’ remittances, diaspora bonds, voluntary solidarity contributions).

Potential sources of innovative finance

Within the context of ODA, new and innovative financing mechanisms have generated more than $6 billion. At end-2010, the IFFIm funds raised by government-guaranteed bonds for the immunization programs raised more than $3 billion. UNITAID, a drug-purchase facility to make HIV/AIDS, malaria and tuberculosis treatments more affordable, has committed more than $1.4 billion. In addition, donors have committed more than $1.5 billion to help pneumococcal vaccines. According to the 2011 UNECA/OECD’s “Mutual Review of Development Effectiveness Interim Report,” the Adaptation Fund (for climate change) generated $224 million as of January 2011. To attract more external private capital, various mechanisms have either been implemented or suggested in the literature. For example, African countries can tap new sources of finance from their diaspora communities by issuing tailored financial instruments and/or providing a framework that is conducive for remittances. It is estimated that sub-Saharan African countries can potentially raise a minimum $23 billion by reducing the cost of international migrant remittances, issuing diaspora bonds, and securitizing future remittances and other future receivables. On the domestic market, the potential exists for such mechanisms as the intergenerational levies on non-exhaustible natural resources.

Domestic and international policy options

Governments have a crucial role to play in ensuring the huge potential market for new sources of development finance is realized. Most of the suggested innovative mechanisms rely on building the confidence of the private sector to participate in this market. Governments therefore need to be in the forefront in 1) developing and encouraging the market for these instruments where there is clear market failure (e.g. through provision of partial guarantees or securitization of future public financial flows), 2) providing an appropriate legal and policy environment that will encourage market development and deepening, and 3) ensure the new mechanisms do heighten macroeconomic and debt sustainability risks.

Further, the other suggested mechanisms (e.g. carbon taxation, taxation on international financial transactions or air tickets) can only be implemented through collaboration and coordination among governments. Lastly, international development institutions can leverage their various strengths to help in building the capacity of the market players (including governments) and provide technical assistance and relevant information that help in promoting the various markets and instruments for innovative finance. In this regard, ECA will continue to intensify its efforts through policy support, knowledge and experience sharing and technical support to African countries in mobilizing resources for development.

Understandably, innovative financing should not be seen as a panacea but rather as an important complement for closing the investment gap in Africa. One of the key lessons of the 2009 global economic and financial crisis for Africa is the need to pay more attention to domestic resource mobilization through tax reforms, sound management of natural resource revenues, good governance and accountability, deepening the tax base, building tax administrative capacity, and balancing different types of taxes. African countries working together with their partners must deal with illicit capital flows out of Africa, which are increasingly draining financial resources needed for development in the continent.

Want to read more about innovative financing for development? Check out Busannovate, a blog brought to you by Devex in partnership with the United Nations Foundation, and launched with a thought-provoking guest opinion by Nobel Peace Prize winner Muhammad Yunus.

About the author

  • Emmanuel Nnadozie

    Emmanuel Nnadozie is the director of the economic development and NEPAD division at the United Nations Economic Commission for Africa. He was the former senior economist and chief of the United Nations Coordination Unit for AU/NEPAD support and focal point for the African peer review mechanism at ECA. Nnandozie previously served as chief planning officer at the World Bank's Agricultural Development Program in northern Nigeria.