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AFRICA ACTION
Africa Policy E-Journal
August 2, 2003 (030802)

Africa: Economic Policy Lessons, 1
(Reposted from sources cited below)

The Economic Commission for Africa (ECA) annual Economic Report on
Africa, released on July 30, painted a sobering picture of slowed
growth rates for 2002 and "mixed" prospects for 2003, while citing
successes in some countries. In addition to a continent-wide
review, the report also contains detailed studies of Mauritius,
Rwanda, Ghana, Gabon, Egypt, Mozambique and Uganda

An earlier E-Journal posting contained summary observations from
the report on the current economic situation in Africa. Today's two
postings contains the sections from the report's overview with
policy proposals emerging from the country studies. The full report
is available in PDF format on the ECA website at
 http://www.uneca.org/era2003

+++++++++++++++++end summary/introduction+++++++++++++++++++++++

DISTILLING LESSONS FROM THE SEVEN COUNTRIES

The countries profiled in this year's Report reveal the range of
African policy challenges. Summarized here are four key challenges
in accelerating the pace of development:

I. Escaping poverty--going beyond averages. [below]

II. Achieving fiscal sustainability--exiting aid dependence.
[below]

III. Energizing African bureaucracies--enhancing the capacity to
deliver. [see part 2]

IV. Moving to mutual accountability and coherence--taking the best
route to development effectiveness. [see part 2]

The purpose is to highlight best and worst practices, draw lessons
from the experiences of the seven countries, and provide overall
policy guidance to African countries. The countries profiled this
year are Egypt, Gabon, Ghana, Mauritius, Mozambique, Rwanda, and
Uganda.

I. ESCAPING POVERTY--GOING BEYOND AVERAGES

The remarkable consensus and commitment for poverty reduction from
governments around the world led to the Millennium Development
Goals, to reduce the proportion of people in poverty by 50% by 2015
and to reduce other forms of human deprivation. Even if the
absolute poverty goal is achieved and prospects for doing this are
good for several African countries deep pockets of poverty will
remain within countries. People chronically poor suffer poverty
for many years, often for a lifetime, and are likely to transfer
their poverty to their children. These are the people who benefit
least from economic reforms. They experience social exclusion,
because of gender, ethnicity, disability, caste, or social
position.They often live in remote ar1eas under harsh agroclimatic
conditions.

Recent evidence suggests a strong relationship between poverty and
agroclimatic conditions in various African countries (ECA 2002).
Large differences in living standards between regions in the same
country are correlated with unequal distributions of natural
assets, differences in agroclimatic conditions, or differences in
geographic conditions, such as remoteness from markets and
transport routes (Bigman and Fofack 2000). This is intuitive.
Households in remote areas, living on fragile lands, would be
expected to have fewer opportunities and face greater risks and
vulnerability than households in better-endowed areas. It is also
consistent with the fact that poverty is more severe in rural
Africa than in urban. Several country profiles underscore this
important point the need to focus on spatial and temporal
dimensions of poverty. Uganda's solid economic growth averaging 6%
a year over the past decade has been accompanied by substantial
poverty reduction, but there remain vast regional disparities in
the incidence of poverty, with a clear spatial pattern. The more
affluent central crescent area around Lake Victoria has made great
strides in economic development, while the drier, more
disadvantaged northern part of the country has fallen even farther
behind. Uganda's case is of concern because the spatial divide in
poverty has been accentuated by almost two decades of civil
conflict.

The spatial dimensions of poverty are also evident in Egypt, Ghana,
and Mozambique. In Egypt--one of Africa's emerging modern
economies--the absolute level of poverty has declined, but in upper
Egypt it increased between 1996 and 2000. In Ghana, national
statistics show a decline in poverty from 52% to 40% over the past
decade lifting 2 million people out of poverty. But those
statistics mask an increase in poverty in 3 of 10 regions central,
northern, and upper east. In Mozambique one of the fastest growing
economies in Africa poverty remains stubbornly high at 62% of the
population, but it is clearly worse in the north.

The countries covered in this report suggest several ways of
tackling spatial-temporal poverty. This overview highlights three
particularly innovative strategies: poverty-sensitive distribution
formulas for fiscal transfers, public expenditure tracking systems,
and private provision of social services.

Government spending should be poverty sensitive

Uganda has found that government expenditures (through various
fiscal transfer mechanisms) do not adequately redress regional
inequalities. The current transfer payment formula allocates 85% of
transfers according to the size of the district population and 15%
according to the geographical location, with no consideration to
poverty.

The regional distribution of transfers to local governments
indicates that the western region has received the largest share
(27%), followed closely by the eastern (26%), the central (25%),
and the northern (22%), where poverty is highest. But if the
transfer payment formula considered poverty across districts, in
addition to population and size of the districts, more transfers
would go to the northern districts. Such a povertysensitive
distribution would allocate 29% to the northern region, 26% to the
western, 23% to the central, and 22% to the eastern.

Public expenditure tracking systems

Addressing spatial poverty also depends on how resources are
translated into basic services for the poor in such areas as
health, education, water and sanitation, and energy. Public
spending on these services is often biased against the poor and
against rural dwellers. Ghana shows significant inequality in the
distribution of educational facilities among the 10 regions and
between rural and urban areas. Literacy and enrolment rates are
lower in the poorer northern regions, with poor school conditions,
low quality, irrelevant curriculums, and a lack of teachers.
Accentuating the problems: the higher cost of schooling,
with poor parents having to bear any additional costs.

Even when public spending is reallocated towards the poor, the
delivery of services too often fails the poor.This may be due to
corruption, imperfect monitoring of local government expenditures,
and weak capacity of local governments. Rwanda and Uganda have
tried to improve services by involving poor people in services
through the Poverty Reduction Strategy process and by improving
local expenditure monitoring systems.

Uganda has had impressive results with its Public Expenditure
Tracking System, introduced in 1996. The flow of intended
capitation grants reaching schools shot up from 13% (on average) in
1991-95 to about 80-90% in 1999-2000.

Private participation in service delivery Most public delivery
systems are highly centralized, with almost all human development
programmes designed and controlled by central authorities. Given
the weak national institutions, this centralization reduces the
effectiveness of human development efforts. These overly
centralized systems focus on inputs rather than outcomes, are
associated with low transparency and accountability, and ultimately
produce inferior service delivery (Jimenez 1995;World Bank 2000).

To improve service delivery, governments are relying more on
private provision and financing, as for health and education in
Egypt and Ghana. Private participation in the provision of health
services in Ghana is quite intensive, with about 42% of health
facilities owned by the private sector. But private facilities are
concentrated in the urban areas. Only mission hospitals are
predominant in the poor regions. The best way to improve private
participation in poor rural regions? Encouraging community-based,
NGO-run health and education facilities.

II. ACHIEVING FISCAL SUSTAINABILITY--EXITING AID DEPENDENCE

Many countries profiled in this report depend on foreign aid to
fund large amounts of government spending, consumption, and
investment. For instance, aid accounts for more than 50% of
Uganda's budget, 60% of Rwanda's, and 70% of Mozambique's. Yet
there is mounting evidence that aid in large quantities is a
double-edged sword initially helping but eventually weakening a
country's economic performance (Lancaster and Wangwe 2001). Recent
research shows that foreign aid crowds out private investment a
damning indictment, because the early rationale for foreign aid
(the two-gap model) was to narrow the gap between savings and
investment in poor countries (Clemens 2002). Private investment is
the most robust variable in explaining cross-country growth. And if
foreign aid crowds out private investment, the prospects for
greater prosperity in aid-dependent countries are slim.

Nowhere is this more evident than in Ghana, which has undertaken
significant reforms over the past 20 years but has little to show
in tangible benefits for the majority of its people. The high aid
dependence reflected in poor fiscal sustainability has hurt the
Ghanaian economy, with fiscal woes providing an important
explanation for the lacklustre economic performance. A chronically
weak fiscal position resulting in huge budget deficits and
associated spikes in inflation often associated with political
economy issues heightened uncertainty over the credibility of
government policies. This increased the risk premium associated
with investing in Ghana, leading domestic and foreign investors to
adopt a wait-and-see attitude.

The huge fiscal deficits led to explosions in domestic debt.
Financing the domestic debt has crowded out credit to the private
sector, further constraining financing options for firms. Financing
deficits by issuing high-yielding treasury bills inverted the yield
curve for government securities, giving higher rewards to investors
in short- dated securities than in long-dated securities.With many
investors preferring short-term government treasury bills, private
firms have had trouble raising long-term capital. This has also
shifted resources from the securities market to the government bill
market, leaving the securities market thin and illiquid.

Egypt's fiscal deficit has also been on the rise. Like Ghana, it
has seen rapidly rising domestic debt, with interest payments on
this debt, along with the wage bill, taking up around half of
public expenditure. Because these areas of expenditure cannot be
cut back easily, they seriously reduce the authorities' room for
maneuver in fiscal policy. With sluggish economic growth and high
domestic interest rates the ratio of domestic debt to GDP is likely
to continue to rise, posing difficulties in macroeconomic
management.

Heavily Indebted Poor Country status confers benefits and risks

Foreign aid provided through concessional loans to many African
countries over the past several decades has created large debt
overhangs and significant debt servicing obligations. The poor
fiscal state of several African countries and their high levels of
external debt led the World Bank and the International Monetary
Fund (IMF) to develop the Heavily Indebted Poor Countries (HIPC)
Initiative. The programme contemplates forgiving a fraction of
these countries' bilateral and multilateral debt.

The funds freed by debt relief are to be devoted to effective
social programmes, which in the eyes of the multilateral
institutions will reduce poverty. In addition, the country is
expected to impel broad economic reforms to strengthen the
productive sector and increase the potential for growth. An
important principle guiding the programme is that in the post-HIPC
era the country will achieve "external sector sustainability", and
thus not require new rounds of debt forgiveness. The Bank and the
IMF (2001, p. 4) have stated this principle in the following way:
[B]y bringing the net present value (NPV) of external debt down to
about 150 percent of a country's exports or 250 percent of a
country's revenues at the decision point, [the programme] aims to
eliminate this critical barrier to longer term debt sustainability
for these countries.

An important question tackled here is what type of fiscal policy
will be consistent with maintaining debt sustainability in the
post-HIPC era. As the excerpt above suggests, the multilaterals
have focused on policies required to stabilize the ratio of
external debt to exports. The Ghana profile shows that a
comprehensive answer to the fiscal sustainability question requires
going beyond the country's external debt to the sustainability of
aggregate public sector debt, including both foreign and domestic
debt. Ghana has accumulated a significant stock of domestic debt,
purchased by the local banking sector, pension funds, and
individuals. Indeed, by ignoring domestic debt, sustainability
analyses may underestimate the fiscal effort that poor countries
will have to make in the post-HIPC era.

Such large fiscal adjustments could have important political
economy consequences (Edwards 2002). First, the adjustments may
reduce the funds available to implement the antipoverty programmes.
And second, very large reductions in primary expenditures may lead
to political instability and backtracking on reform.

Slipping back into the debt trap

Unless HIPC countries, such as Ghana, Uganda, and Rwanda, receive
substantial concessional aid in the future, their public sector
debt is likely to become unsustainable once again. Uganda, the
first country to graduate from the enhanced HIPC programme in 2000,
is in a difficult situation. The debt and debt service indicators
in net present value terms show that its debt sustainability has
not improved since it received HIPC debt relief. The net present
value of debt to exports ratio increased from 170% in 2001 to 200%
in 2002 and is projected by the IMF to increase to 208% in 2003,
well above the threshold of 150% under the enhanced HIPC framework.
Similarly the net present value of the debt-GDP ratio is projected
to increase from 20% in 2001 to 22% in 2003.

The reason for sliding back into the debt trap: without large
volumes of concessional assistance, these countries would be forced
to undertake major fiscal adjustments to achieve sustainability
(Edwards 2002). Adjustments of this magnitude usually crowd out
social expenditures, including poverty alleviation programmes, and
tend to create political economy difficulties.

The optimal size of a fiscal deficit

The fiscal sustainability question in Rwanda is slightly different.
Tensions are emerging between the requirements for macroeconomic
stability and for poverty reduction and post conflict construction.
The fiscal deficit, on the rise in recent years, is projected to
remain high over the medium term. The reason is the increase in
public expenditures to address poverty reduction goals set out in
the Poverty Reduction Strategy and the need for post-conflict
reconstruction for demobilization and for establishing peoples
courts, the genocide survivors fund, and governance commissions.
Some development partners recommend that a country like Rwanda,
with large fiscal deficits financed by grants and international
borrowing, should reduce the deficit in the medium term rather than
mobilize additional resources.

Further contradictions have emerged with Rwanda's HIPC status. The
use of exports in the HIPC debt ratios implies that absolute levels
of debt per capita will be particularly low for a closed economy,
such as Rwanda. This has increased the debt relief but it will also
reduce the possibilities for new borrowing. So, over the medium
term, rising spending needs for poverty reduction and post-conflict
reconstruction mean that Rwanda is unlikely to adhere to low debt
to GDP ratios as required by HIPC.

The reason? Doing so would reduce the government's ability to
contract new loans. It is clear that adherence to HIPC debt ratios
has hidden costs that may easily outweigh the benefits.

Several lessons from Rwanda question the relevance of current
modalities in the HIPC programme. First, as illustrated in the
profile, Rwanda's underlying debt sustainability indicators appear
to be flawed. Much of the sustainability analysis by the World Bank
and IMF is based on rather optimistic assumptions for future
economic performance, the external environment, and projected
financing needs.

Second, macroeconomic sustainability cannot be divorced from
political sustainability. The legacy of violence must be
considered, especially with past civil violence a strong predictor
of future violence. The needs of social and political
reconciliation are therefore critical. And a macroeconomic
programme that does not address these issues could be dangerous.

An alternative to the HIPC criteria would be to link debt relief to
a proportion of revenues needed for essential spending, possibly
with different limits set for different groups of countries. One
proposal is to add a criterion for countries emerging from conflict
putting an upper limit to the fiscal revenues used for debt
servicing. HIPC needs must also take greater account of external
shocks and the critical role of declining terms of trade in the
buildup of debt, an issue so far neglected (Birdsall and Williamson
2002; Nissanke and Farrarini 2002).

Even strong performers are concerned about fiscal imbalances

The Mauritius profile highlights another angle in fiscal
sustainability. With stellar macroeconomic performance, the economy
grew 5 6% a year over the last 20 years. Inflation remained in
single digits. And the fiscal deficit averaged about 4% a year
between 1985 and 1999. But in 2001 it jumped to about 6.7% of GDP,
and for 2002 it is expected to remain around 6% 6.5%, narrowing to
previous levels from then onward.

These higher deficits are the result of a massive investment
programme by the government to prepare the Mauritius workforce and
infrastructure for economic diversification away from the
traditional sectors of sugar, textiles, and apparels, now losing
their potential as engines of growth, and towards a knowledge-based
economy. There is concern among some development partners that
higher deficits will threaten fiscal sustainability. The analysis
here shows that this may not be the case.

The main issue is to resolve the tension between higher deficits in
the short term and investment that may yield higher returns in the
medium to long terms.

A smooth exit requires a strong private sector

Exiting aid dependence and improving the fiscal position of African
countries will require governments to implement policies and use
resources to promote growth that will expand public revenues and
obviate the need for future aid.

A strong private sector is critical to achieving this goal. Only
through a strong private sector that contributes to the state's
coffers will the abysmally poor fiscal position of African
countries be improved. The point is not that countries should not
improve tax administration and reduce leakages due to inefficient
spending it is that they should also take actions to broaden the
tax base, so that they can get more tax revenues for the same
marginal tax rate.

Managing the transition to less development assistance and more
private capital flows will require a combination of measures to
increase domestic resource mobilization, provide greater debt
relief, reform the current aid regime, improve market access, and
enhance the policy environment. This will include improving the
business climate strengthening corporate governance, commercial
justice systems, and the regulatory environment. It will also
include improving pricing and access in electricity,
transportation, and telecommunications, igniting the private
sector's supply response.

+++++++++++++++++++++Document Profile+++++++++++++++++++++

Date distributed (ymd): 030802
Region: Continent-Wide
Issue Areas: +economy/development+

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