An Unnecessary Headache


Windhoek –  African countries, which have over the years been struggling to raise capital to finance infrastructure projects that are key to economic development and economic integration, should consider using foreign currency reserves to plug the financing gap.

A working paper for the African Development Bank written by Cedric Achille, Mbeng Mezui and Uche Duru reveals that African economies need not struggle at all for funding for key infrastructure projects.

The analysts, in their paper titled “Holding Excess Foreign Reserves Versus Infrastructure Finance: What Should Africa Do?” say that financing infrastructure in Africa should not be as much of a headache as it is now for the continent.

In their view, it is a problem that simply requires new thinking on financing mechanisms at a time that lack of sound infrastructure continues to hamper Africa’s growth prospects and efforts at economic integration.

Between 2001 and 2011, African countries held reserves of more than US$150 billion each year. The continent needs US$93b yearly to finance its infrastructure needs.

Simply put, reassigning how reserves are used will meet the infrastructure financing gap without resorting to begging investors to come in from outside Africa.

The analysts say dealing with the constraints on governments’ ability to invest is imperative for the continent, given that the demand for infrastructure is anticipated to increase considerably in the coming years to meet the needs of a growing population and larger greater urbanisation.

The IMF defines reserves as external assets that are readily available to and controlled by monetary authorities for direct financing of external payment imbalances and to intervene in the exchange markets.

Reserves also reflect a particular economy’s international trade surpluses, and foreign debt and FDI balances.

Foreign exchange excesses from African countries were in the range of US$165.5b and US$193.6b per year from 2001 to 2011.

Avenues, the experts recommend, should be found to utilise a portion of these reserves to meet the infrastructure financing gap the continent needlessly faces.

Analysts say there may be room for creating investment vehicles for holding a part of assets as less liquid, higher yielding wealth.

In 2011, the IMF World Economic Outlook report estimated the total of foreign exchange reserves held by African countries at US$512b compared to US$10.8 trillion worldwide.

This means that Africa holds less than five percent of the world’s foreign reserves.

Experts say there should be debate on the optimal size of reserves for African countries and how much of this money can be invested for better returns such as in infrastructure.

Studies have also found that the composition of African reserves highlights the high exposure of reserve holders to global financial risks such as what happened with the 2008 global financial crisis.

“More than 95 percent of African non-gold reserves are held in foreign exchanges compromising currency (mainly the US dollar) and deposits with monetary authorities and banks and securities (US/foreign government securities, equity, bonds and notes, money market derivatives),” the analysts say.

“Consequently, the worth of African reserves is exposed to change with instabilities in the reserve currency (especially the US dollar) or broader international financial market volatilities.

“In addition, the IMF survey in 2009 showed that reserve build-up in developing countries is analogous to build-up of deficits in reserve asset countries, especially the US.

“Thus, tunings in the US might have vital costs for the rest of the world, especially the reserve-accumulating countries,” the analysts add.

They also point out that maintaining these currency reserves comes at a huge cost to domestic economies. The burden of maintaining reserves include the social cost of inevitable domestic consumption and investment as well as financial costs and the strain on monetary policy arising from struggles to sterilise the impacts of excessive monetary expansion through higher national interest rates.

This has the negative effect of piling increased fiscal pressure, which could make reserve build-up unaligned with fiscal policy objectives or reserve accumulation that may even disturb the macro-economic policy framework.

“The social cost of holding excess reserves was considerably high in many African countries between 2000 and 2011 and more so for commodity export dependent countries.”

Algeria, Botswana and Libya have the highest social cost in percentage of GDP. The study found out that on average, the excess reserves, in percentage of GDP went from 2.8 percent in 2000, for 43 countries surveyed, to 10 percent in 2011.

The excess reserves represent a total amount of US$350b in 2011 over US$512b available for the entire continent.

The study found out that yearly net excess reserves averaged US$193.6b between 2000 and 2011.

Between 2000 and 2011, the excess reserves represented 66 percent in Algeria, 71 percent in Botswana, 29 percent in Angola, 19 percent in Morocco and 17 percent in Nigeria.

“These results show that the level of reserve far exceed the level required to mitigate potential capital flight. This excess reserve level is more than the total amount required to finance African infrastructure,” the study says.

The analysts also say that the social costs of maintaining the reserves are higher in Algeria, Botswana and Angola than in any other African countries.

Economies such as those of Algeria, Angola, Botswana, Cote d’Ivoire, Cameroon, Senegal and Nigeria – which are driven by commodities exports – have the highest social costs in percentage of GDP.

The study also shows that the social cost of holding excess forex reserves could range between 0.35 percent to 1.67 percent in average in GDP terms, between 2000 and 2011.

Previous studies have revealed that the total cost of holding excess reserves is around US$300b per year in developing countries.

“It is clear that excess foreign reserves held by African countries can meet the infrastructure financing needs of the continent which has been estimated at US$93b per annum.

“Investing just about 30 percent of the excess reserves in investment vehicle for infrastructure will go a long way in meeting the financing needs of infrastructure in the continent.”

The analysts cite a 2012 IMF report on reserve adequacy for Central African Economic and Monetary Community which found out that reserve adequacy for the region is sufficient and that there is room for creating a regional fund for holding of assets as less liquid, higher yielding wealth.

The AfDB further argues that investing in its infrastructure portfolio or African private equity infrastructure funds would have earned more revenues for African countries in general in comparison to holding these excess reserves in their current form.

“By channelling the yearly excess reserves to finance infrastructure, the continent will reduce the social cost of holding excess reserves for its economies.”

The study cites the examples of Singapore, Korea, China, Kuwait, Emirate of Abu Dhabi, Mexico, Chile, Peru, Colombia and Brazil as some of the countries, which have used forex reserves for economic development.

The analysts say that there are various options on financing infrastructure using excess reserves such as investing in the African Infrastructure Fund, in which equity could be held by central banks or sovereign wealth funds.

Another option is the African Infrastructure Finance Facility, Regional Equity Funds or multilateral banks.

“African foreign exchange excesses can meet the infrastructure financing gap of the continent. There is room for creating investment vehicles for holding a part of assets as less liquid, higher-yielding wealth,”

Such investments focus on economic infrastructure projects with a regional impact, innovative mechanisms for cross-border infrastructure investments encourage quick handling interventions, deal with political risk, credit risk and refinancing risk.

The investments also manage a portion of African countries’ surpluses foreign exchange reserves, and enable better customisation and sophisticated methods to come across countries’ needs.

“In the context of the current resource boom, African countries need to have a new mind set to diversify their income sectors, asset and security holdings and to engage more strategically in priority productivity-enhancing public investments.”

October 2013
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