‘Borrowed resources should be utilised effectively’

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The International Monetary Fund (IMF) recently published its regional economic outlook for Sub Saharan Africa. IMF resident representative for Zimbabwe Patrick Imam (PI) tells Business Times (BT) on the capital flows into the region and the policy implications in managing those flows. Find excerpts below:

BT: What are the main findings of the IMF’s October regional economic outlook?

PI: While sub-Saharan Africa is a very heterogenous region, the overall macroeconomic outlook for the region continues to strengthen. Overall growth is expected to increase from 2,7 percent in 2017 to 3,1 percent in 2018, reflecting domestic policy adjustments and a supportive external environment, including continued steady growth in the global economy, higher commodity prices, and a relatively accommodative external financing conditions. While fiscal imbalances are being contained in many countries, the adjustment has typically occurred through a combination of higher commodity revenues and sharp cuts in capital spending, with little progress on domestic revenue mobilisation. This is unfortunate, as cutting capital spending may be politically easier than containing say wages, but in the longer-run, it will hurt economic growth.

BT: What is the outlook over the medium term?

PI: Over the medium term, and assuming no changes in current policies, growth is expected to accelerate to about 4 percent. This is, however, too low to absorb the flow of new entrants into labour markets and to significantly raise living standards in the region.

In addition, I fear that the outlook for the region is surrounded by significant downside risks, particularly considering the elevated policy uncertainty in the global economy, such as rising interest rates in the US or protectionist trade policies for instance. To shield the recovery and raise medium-term growth requires reducing debt vulnerabilities and creating fiscal space through more progress on domestic revenue mobilisation, as well as policies to achieve strong sustainable and inclusive growth.

BT: What are the key messages and findings from the analysis capital flows to Sub-Saharan Africa? PI: One key message is that crossborder capital flows to sub-Saharan Africa have increased sharply since the global financial crises. Net capital flows, and excluding official aid flows, to the region have more than doubled from about $25 billion in 2007 to about $60 billion in 2017. Scaled by economic size, net capital flows to sub-Saharan Africa were three times higher than those to emerging market economies over the 2015-17 period. For sub-Saharan Africa, we are talking about flows of 3 percent of GDP, whereas for emerging markets it is closer to 1 percent of GDP. Much of this increase has been driven by non-resident inflows, particularly portfolio flows.

A second key message is that capital flows to Africa are driven by both global factors and the strength of domestic fundamentals. Global factors, notably, US interest rates, global risk aversion, and commodity prices, are found to be important drivers of capital flows. This also suggests that the region may be vulnerable to a tightening of global financial conditions going forward. However, I would also emphasise that strong domestic fundamentals and institutional quality are associated with a lower likelihood of large capital flow reversals. The final message is that capital flows offer potential benefits, but also carry risks. Their impact depends on the type of flow. FDI confers direct benefits in terms of spurring investment and growth and transferring technology. Portfolio flows on the other hand are prone to generating macroeconomic and financial vulnerabilities, such as currency volatility, or economic overheating, and rapid credit growth.

BT: What should policy makers do to ensure that capital flows facilitate economic development?

PI: Policymakers need to be prudent and ensure that borrowed resources are utilised effectively, enhance productivity, and promote sustainable economic growth. Historically, it’s the poor utilisation of foreign investment, leading in extreme cases to White Elephants, and the inability to repay back loans, that have caused crisis. Vigilance is therefore always warranted against the buildup of macroeconomic and financial imbalances.

BT: What are the main policy implications to manage capital flows? PI: There is a complex relationship between external finance, domestic macroeconomic stability, and investment and economic growth in the region. On the one hand, nonofficial external capital is needed to fill the resource gap and promote economic development.

On the other hand, the nature of such capital makes it a less reliable, and potentially riskier source of finance. So one has to walk a fine line, and try to manage the flows to maximise the benefits while containing the risks.

BT: Given this trade-off, on external finance, domestic macroeconomic stability, and investment and economic growth countries what do countries need to do? PI: The advice to countries is threefold. First, be prudent. A country needs to balance the trade-off between the potential benefits and risks of capital flows. Policymakers need to be prudent and ensure that the borrowed resources are utilised effectively, enhance productivity, and promote sustainable economic growth. Second, be vigilant. Vigilance is warranted against the build-up of macroeconomic and financial imbalances.

This means for instance that countercyclical macroeconomic and prudential policies, and in some cases foreign exchange intervention, should be adopted to limit vulnerabilities, build adequate buffers, and preserve debt sustainability.

Finally, build resilience. Given the fickle nature of capital flows, countries need to strengthen domestic fundamentals. The efforts should focus on attracting direct investment to the region through strong domestic macroeconomic fundamentals and an improved business climate.

These factors are likely to play an even more important role in attracting foreign capital going forward, as global financial conditions may tighten with the normalisation of monetary policy in advanced economies.

BT: Given the increasing volatility of capital inflows, should countries keep a relatively closed capital account?