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Enhancing the Effectiveness of Fiscal Policy Enhancing the Effectiveness of Fiscal Policy for Domestic Resource Mobilizationfor Domestic Resource Mobilization

Patrick N. OsakwePatrick N. Osakwe

Chief, Financing Development, UNECAChief, Financing Development, UNECA

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OUTLINE OF PRESENTATIONOUTLINE OF PRESENTATION

BackgroundBackground The Case for Domestic Resource The Case for Domestic Resource

MobilizationMobilization Facts on Development Finance and Facts on Development Finance and

Resource MobilizationResource Mobilization Fiscal Policy and the Financial crisisFiscal Policy and the Financial crisis Improving Domestic Resource MobilizationImproving Domestic Resource Mobilization

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I. BackgroundI. Background

There is a significant gap between domestic There is a significant gap between domestic savings and investment requirements in Africasavings and investment requirements in Africa

Domestic and external resources are needed to Domestic and external resources are needed to close this financing gap.close this financing gap.

The global financial crisis has led to the drying up The global financial crisis has led to the drying up of external finance and rekindled interest in of external finance and rekindled interest in boosting domestic resource mobilization as a boosting domestic resource mobilization as a sustainable source of financing development. sustainable source of financing development.

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II. The Case for Domestic Resource II. The Case for Domestic Resource MobilizationMobilization

1.1. Domestic finance is less volatile than external Domestic finance is less volatile than external financefinance

2.2. It permits country ownership of development It permits country ownership of development policies and outcomes.policies and outcomes.

3.3. Reduces reliance on external flows and the risk of Reduces reliance on external flows and the risk of the Dutch disease. the Dutch disease.

4.4. Creates incentives for more accountability and Creates incentives for more accountability and transparency in use of public resourcestransparency in use of public resources

5.5. Reduces vulnerability to revenue losses from Reduces vulnerability to revenue losses from trade reformstrade reforms

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III. Some Facts on Development Finance III. Some Facts on Development Finance and Resource Mobilizationand Resource Mobilization

There are four key sources of development There are four key sources of development finance in Africafinance in Africa

Domestic savingsDomestic savings Private capital flowsPrivate capital flows Foreign aidForeign aid RemittancesRemittances

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Africa has made progress in Development FinanceAfrica has made progress in Development Finance

  In US Dollars (Billions)In US Dollars (Billions) 20022002 20032003 20042004 20052005 20062006 20072007

Domestic Domestic revenuerevenue 137.6137.6 168168 209.8209.8 267.6267.6 321.6321.6 366.9366.9

Private flowsPrivate flows 17.117.1 20.020.0 28.728.7 45.245.2 51.551.5 81.081.0

ODAODA 21.421.4 27.127.1 29.529.5 35.535.5 43.543.5 38.738.7

RemittancesRemittances 12.912.9 15.615.6 19.519.5 22.322.3 27.227.2 38.038.0

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Savings ratios in Africa are low relative to developing country Savings ratios in Africa are low relative to developing country average as well as domestic investment requirementsaverage as well as domestic investment requirements

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Africa’s low aggregate savings ratio masks wide Africa’s low aggregate savings ratio masks wide differences in savings pattern across countriesdifferences in savings pattern across countries

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Africa’s revenue performance is similar to those of Africa’s revenue performance is similar to those of other developing regionsother developing regions

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Africa has also made progress in boosting tax Africa has also made progress in boosting tax revenuerevenue

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There has been a significant decrease in the share of There has been a significant decrease in the share of trade taxes in domestic revenuetrade taxes in domestic revenue

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IV. Fiscal Policy IV. Fiscal Policy andand the Financial Crisis the Financial Crisis

Fiscal policy has short and long term functionsFiscal policy has short and long term functions Stabilization of the economyStabilization of the economy Increasing productive capacityIncreasing productive capacity

Effective discharge of the short term function Effective discharge of the short term function requires a counter-cyclical fiscal policy. requires a counter-cyclical fiscal policy.

But fiscal policy in Africa has been pro-cyclicalBut fiscal policy in Africa has been pro-cyclical Conditions imposed by international financial institutionsConditions imposed by international financial institutions Financing tends to be pro-cyclicalFinancing tends to be pro-cyclical Fiscal rulesFiscal rules Political economy reasonsPolitical economy reasons

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Fiscal Challenges from Financial CrisisFiscal Challenges from Financial Crisis

Global slowdown has a negative effect on growth Global slowdown has a negative effect on growth and government revenue in Africa.and government revenue in Africa.

Governments are under pressure to increase social Governments are under pressure to increase social spending to cushion impact of shock on vulnerable spending to cushion impact of shock on vulnerable groups.groups.

There are concerns that the adoption of fiscal There are concerns that the adoption of fiscal stimulus packages as well as pressure to bail out stimulus packages as well as pressure to bail out financial institutions in developed countries will financial institutions in developed countries will reduce ODA flows to Africa. reduce ODA flows to Africa.

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Issues for DiscussionIssues for Discussion

How should fiscal policy respond to cyclical How should fiscal policy respond to cyclical fluctuations in economic activities? fluctuations in economic activities?

How can fiscal policy be used more effectively in How can fiscal policy be used more effectively in support of the development needs and priorities of support of the development needs and priorities of African countries? African countries?

How can Africa deal with the fiscal challenges How can Africa deal with the fiscal challenges posed by the global financial crisis? posed by the global financial crisis?

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V. Improving Domestic Resource MobilizationV. Improving Domestic Resource Mobilization

Effective mobilization of domestic resources Effective mobilization of domestic resources in Africa requires progress in three critical in Africa requires progress in three critical areas:areas:

Domestic revenueDomestic revenue Private savingsPrivate savings Enhancing role of ODA in domestic resource Enhancing role of ODA in domestic resource

mobilizationmobilization

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1. 1. Strengthening Domestic Revenue MobilizationStrengthening Domestic Revenue Mobilization

African countries have made progress in increasing African countries have made progress in increasing domestic revenue. However, in several countries there is a domestic revenue. However, in several countries there is a gap between tax capacity and tax revenues.gap between tax capacity and tax revenues.

Economic growth is a necessary condition for success in Economic growth is a necessary condition for success in revenue mobilization. revenue mobilization.

Increases pool of taxpayersIncreases pool of taxpayers Requires structural changeRequires structural change

Improved fiscal policies are needed to boost revenue. Improved fiscal policies are needed to boost revenue. Reduce tax exemptions and incentives to foreign investorsReduce tax exemptions and incentives to foreign investors Increase rates on immobile factors (land and property) and luxury Increase rates on immobile factors (land and property) and luxury

itemsitems Adopt gradual approach to trade reform to ensure that it does not Adopt gradual approach to trade reform to ensure that it does not

erode the fiscal baseerode the fiscal base

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Good governance is crucial for revenue Good governance is crucial for revenue mobilizationmobilization

Increase efficiency and accountability in use of public Increase efficiency and accountability in use of public resourcesresources

Linking tax collection to service delivery and better public Linking tax collection to service delivery and better public financial management are neededfinancial management are needed

Eradicate tax havens and address issue of stolen assetsEradicate tax havens and address issue of stolen assets

Success in mobilizing revenue also requires Success in mobilizing revenue also requires dealing with the external debt problem of Africa. dealing with the external debt problem of Africa.

High debt results in capital outflows and debt servicing High debt results in capital outflows and debt servicing difficultiesdifficulties

Increases vulnerability to external shocks with Increases vulnerability to external shocks with consequences for output and revenue mobilization consequences for output and revenue mobilization

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Issues for DiscussionIssues for Discussion

What are the channels through which fiscal policy affects What are the channels through which fiscal policy affects mobilization of domestic revenue in Africa?mobilization of domestic revenue in Africa?

What should governments do to increase efficiency in use of What should governments do to increase efficiency in use of government revenue? government revenue?

How can African governments integrate into the multilateral How can African governments integrate into the multilateral trading system without eroding their fiscal base?trading system without eroding their fiscal base?

How can foreign investment be promoted without How can foreign investment be promoted without jeopardizing domestic revenue mobilization objectives? jeopardizing domestic revenue mobilization objectives?

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2. 2. Boosting private savingsBoosting private savings

Private sector has an important role in boosting domestic Private sector has an important role in boosting domestic savings in the region.savings in the region.

But increasing private savings requires increasing capacity But increasing private savings requires increasing capacity of households and firms to generate income.of households and firms to generate income.

Governments can affect this capacity through creating an Governments can affect this capacity through creating an enabling environment for private sector development. enabling environment for private sector development.

Requires reducing cost of doing businessRequires reducing cost of doing business Need for public investment in infrastructure Need for public investment in infrastructure

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Boosting private sector savings requires building domestic Boosting private sector savings requires building domestic financial systems. financial systems. Weak financial infrastructureWeak financial infrastructure Dominated by banks with a focus on short-term lendingDominated by banks with a focus on short-term lending Financing of deposit insurance schemes will boost confidence Financing of deposit insurance schemes will boost confidence

and encourage people to save in banks.and encourage people to save in banks.

Strengthening domestic financial systems also require:Strengthening domestic financial systems also require: Market incentives to encourage banks to mobilize savings and Market incentives to encourage banks to mobilize savings and

channel them into productive investment channel them into productive investment Promotion of linkages between formal and informal financial Promotion of linkages between formal and informal financial

institutionsinstitutions Rebuilding public financial institutions such as development Rebuilding public financial institutions such as development

and agricultural banksand agricultural banks

Capital markets can play an important role in mobilizing savings Capital markets can play an important role in mobilizing savings in the region. But African countries have not exploited this in the region. But African countries have not exploited this potential potential ..

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Obstacles to the use of capital markets for savings mobilization (% of Obstacles to the use of capital markets for savings mobilization (% of respondents to ECA survey)respondents to ECA survey)

Limited Investment Instruments

25.6%

Weak Capital Market

Infrastructure23.2%

Poor Legal and Regulatory Framework

5.6%

High Market Risk4.0%

Corruption and Governance

8.8%

Macroeconomic Instability

8.0%

Lack of Access to Information

15.2%

Low Expected Returns9.6%

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Capital flight inhibits effective resource mobilization in Capital flight inhibits effective resource mobilization in Africa. It manifests itself in two ways:Africa. It manifests itself in two ways:

Legal financial outflows in response to yield Legal financial outflows in response to yield differentials. Macroeconomic and political stability differentials. Macroeconomic and political stability as well as better governance and capital market as well as better governance and capital market development can reduce this type of outflow.development can reduce this type of outflow.

Off-shore movement of stolen public assets. Off-shore movement of stolen public assets. Dealing with this type of capital flight requires Dealing with this type of capital flight requires better governance and law enforcementbetter governance and law enforcement

Microfinance institutions can also play an important role in Microfinance institutions can also play an important role in improving access of the poor to financial services and also improving access of the poor to financial services and also boost rural savings. There is the need for more efforts to boost rural savings. There is the need for more efforts to exploit this potential.exploit this potential.

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Issues for DiscussionIssues for Discussion

What factors militate against effective mobilization What factors militate against effective mobilization of private savings in Africa?of private savings in Africa?

How can capital markets contribute more effectively How can capital markets contribute more effectively to resource mobilization?to resource mobilization?

What national and international policy actions are What national and international policy actions are needed to stem capital flight?needed to stem capital flight?

How can African countries exploit the potential of How can African countries exploit the potential of microfinance for domestic resource mobilization? microfinance for domestic resource mobilization?

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3. 3. Enhancing Role of ODA in Resource MobilizationEnhancing Role of ODA in Resource Mobilization

In the long-run, domestic resource mobilization should be In the long-run, domestic resource mobilization should be the basis for financing growth and development.the basis for financing growth and development.

But Africa needs aid in the short to medium term. But Africa needs aid in the short to medium term. Consequently, the key issue facing recipients and donors is Consequently, the key issue facing recipients and donors is how to make aid more effective and ensure that it supports how to make aid more effective and ensure that it supports the overall development goals of African countries. the overall development goals of African countries.

Aid is more likely to support long-run development Aid is more likely to support long-run development objectives of African countries if it is directed towards objectives of African countries if it is directed towards boosting capacity for domestic resource mobilizationboosting capacity for domestic resource mobilization

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Why has aid not made a significant contribution to Why has aid not made a significant contribution to domestic resource mobilization?domestic resource mobilization?

Existing aid allocation mechanisms focus on closing a Existing aid allocation mechanisms focus on closing a financial gap-----Undermines incentives for tax financial gap-----Undermines incentives for tax collection and savings.collection and savings.

There has been a shift in aid allocation from economic There has been a shift in aid allocation from economic infrastructure and production to the social sectors with infrastructure and production to the social sectors with implications for increasing productive capacity and implications for increasing productive capacity and growth. growth.

Historically, ODA flows to Africa have financed more Historically, ODA flows to Africa have financed more of domestic consumption and capital outflows rather of domestic consumption and capital outflows rather than investment----which is an engine of growth.than investment----which is an engine of growth.

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ODA finances more of capital outflows and consumptionODA finances more of capital outflows and consumption

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Enhancing contribution of ODA to domestic Enhancing contribution of ODA to domestic resource mobilization requires actions in four key resource mobilization requires actions in four key areas:areas:

Directing ODA to building capacities to mobilize Directing ODA to building capacities to mobilize domestic savingsdomestic savings

Placing more emphasis on economic infrastructure Placing more emphasis on economic infrastructure and public investments aimed at boosting productive and public investments aimed at boosting productive capacities.capacities.

Management of the capital account when necessary.Management of the capital account when necessary.

Donors adopting a matching-funds approach to aid Donors adopting a matching-funds approach to aid allocationallocation

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Issues for DiscussionIssues for Discussion

What is the impact of foreign aid on What is the impact of foreign aid on development financing in Africa? development financing in Africa?

Should African countries have an explicit Should African countries have an explicit strategy to exit aid-dependence? strategy to exit aid-dependence?

How can ODA be directed towards boosting How can ODA be directed towards boosting capacity for domestic resource mobilization capacity for domestic resource mobilization in Africa? in Africa?

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THANK THANK YOUYOU