Innovation Financing Option For Development in 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.

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.

 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 expectations. Tax revenue remains less than 15 percent of GDP for a quarter of sub-Saharan African economies. Similarly, gross savings for 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. 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 micro contributions, 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.

Unlocking value from diaspora flows

There are opportunities to unlock significant additional value from these flows.The use of diaspora bonds could be expanded. The issuance of government bonds specifically targeted at a country’s emigrant population is a time-tested but underused way to raise money for development. For instance, the pioneers of diaspora bonds have leveraged them over time to raise more than $25 billion and $11 billion, respectively .For sub-Saharan African countries, the World Bank has estimated that these instruments could raise as much as $5 billion to $10 billion annually, but so far their potential has been almost completely untapped. One could imagine exciting uses for these bonds, such as the funding of education or infrastructure. To assist this expansion, donor-country governments could give their counterparts in developing countries reliable demographic data that would facilitate the marketing of bonds to diaspora. Customizing the regulatory framework for the creation and sale of bonds in foreign countries at the international level could also help spread their use by lowering the costs of compliance across multiple jurisdictions and speed up the regulatory-approval process.

Stimulating private-capital flows

Private capital is an enormous source of global wealth that has not historically played as significant a role in development as its scale would suggest. Private capital is constantly seeking investment opportunities.    However, it only commits to those prospects that meet its appetite for risk and reward. Due to a variety of factors, many opportunities in developing countries are often perceived as overly risky or uncertain for the majority of investors. Institutions that offer to guarantee portions of loans made for such investments help investors rebalance their assessments of risk and reward and subsequently unlock considerable capital into developing countries. . These guarantees have stimulated more than five dollars of private capital for every dollar spent by the World Bank. Yet this type of support remains a very small portion of the bank’s approach to financing in developing countries.

Private capital can contribute to development is by fueling the growth of small and medium-size enterprises (SMEs) in developing economies. Such companies are often underfunded in these regions because they typically are too small for commercial lending but too large for microcredit financing. There could be an opportunity for multiple players to collaborate in the creation of a set of financial instruments to serve this segment. Local commercial banks could provide the capital and deliver the funds when sharing some of the risk with large multilateral organizations or major foundations that provide first-loss guarantees. Donors could play a role in funding pilot programs or supporting demand-side capacity-building initiatives such as credit-scoring initiatives or skill building for entrepreneurs. One promising area to test this is the agricultural sector, a driving force of growth in many developing economies.

Encouraging private voluntary contributions through matching funds

Governments are in a unique position to encourage large amounts of voluntary contributions from private corporations and citizens by setting up matching programs. They are distinguished in having the credibility to intervene on social issues in a fair and responsible way, as well as the resources to implement matching programs at meaningful scale. Government matching programs not only mobilize new resources but also engage a broader set of players in sharing the responsibility for global development.Countries could commit to establishing a national-challenge fund that matches commitments from corporations and individuals up to a specified limit. Corporations, in addition to contributing their own funds, could employ innovative means to engage and raise funds from their employees and customers. Governments could identify priority development topics and select eligible private-sector recipients for challenge-fund proceeds. The most powerful partnerships would be ones where private-sector players could also contribute their core capabilities beyond straight financing, such as having telecom companies offer solutions based on mobile technology.

Tackling sector-specific inefficiencies

Focusing on raising revenues, and most could technically be applied to a variety of purposes (for example, health, water, education). Countries could also find powerful ways to unlock the value of their development dollars by examining particular market inefficiencies of specific sectors that can benefit from development aid. Take health, for example. One market inefficiency is that large private-sector pharmaceutical companies have little incentive to invest in research and development for developing-country health issues. To create these missing incentives, several countries created an “advance market commitment” that provided reassurances in the market for a new pneumococcal vaccine. This was a groundbreaking approach that used dollars donated for vaccine purchase to their maximum effect.