‘Rich beggar’ paradox that is Africa’s forex reserves

Saturday March 29 2014

Central bank governors want some of the excess foreign reserves used for infrastructure development and to seal financing deficits. TEA Graphic

African countries are holding outside the continent cash reserves totalling nearly $200 billion, which they fear to invest locally owing to rising risks at home.

The funds, nearly a third of the more than $500 billion in total reserves held by the countries, have been invested mainly in developed economies, said the UN’s Economic Commission for Africa (ECA).

The UN agency said that this denied the continent’s economies the much needed funds, which could be used to seal financing deficits, especially in building infrastructure.

As such, the agency is pushing for discussions with the International Monetary Fund (IMF) on how the forex reserve funds can be used to give the local currency market the necessary buffers and be considered as financing vehicles on the continent.

“It is troubling that, unlike other developing regions of the world, African countries hold in aggregate more deposits in the Bank for International Settlements (BIS) reporting banks than they receive in loans from them,” said Carlos Lopes, the executive secretary at the ECA, adding that the continent has put up to $500 billion in foreign reserves.

BIS is a global association of central banks which serves as a bank for members.


Remain in overseas banks

This trend, economists said, suggests that the bulk of revenues from exports of African oil and commodities are not intermediated by local banks. Instead, they remain in overseas banks, which recycle about 60 per cent of these deposits as cross-border loans back to African banks and the non-bank sector.

“This situation is totally unacceptable,” Dr Lopes told a meeting of African central bank governors in Abuja, Nigeria, on Thursday and added that central banks must ensure more productive use of Africa’s reserves.

In times of shocks and a volatile market, the central banks intervene using the reserves to calm the market and stem the volatility.

January 2014 data showed that the central banks of Kenya, Uganda and Tanzania were holding a combined $14 billion in forex reserves.

READ: Central banks move to shore up forex reserves

“You cannot accumulate public debt forever, hence the need to think outside public borrowing,” said Njuguna Ndung’u, the Central Bank of Kenya governor.

Need for flexibility

Prof Ndung’u added: “We need flexibility in seeking funds to finance infrastructure and tap into the reserves and repackaging available instruments to attract more monies such as diaspora-focused bonds and Shariah-compliant bond facilities.”

The push for better use of the excess foreign reserves is expected to complement other fundraising initiatives across the continent.

The African Development Bank (AfDB) estimates that Africa requires at least $100 billion annually for infrastructure projects for the next 10 years. The bank plans to create a fund that could raise as much as $50 billion for infrastructure.

The Africa 50 Infrastructure Fund will tap monies from sovereign wealth funds, insurance and pension funds as well as Africans living and working in the diaspora.

READ: Is East Africa ready for sovereign wealth fund?

“It is clear that excess foreign reserves held by African countries can meet the infrastructure financing needs of the continent,” said Cédric Mbeng Mezui, a senior economist at AfDB.

“Investing just about 30 per cent of the excess reserves in investment vehicles for infrastructure will go a long way in meeting the financing needs of infrastructure on the continent.

“Such a move would put close to $200 billion into infrastructure. We should, however, be careful.”

Some African economies, such as Ghana, are running foreign reserve deficits.

“We need to think of the optimal excess reserves which can be put into such a proposal,” said Henry Kofi Wampah, the governor of the Central Bank of Ghana.
The excess reserves can also be used to finance syndicated loans to ensure countries retained price and financial stability, he said.

Economists have warned that growing conflict in most African countries was raising the continent’s political risk, dimming hopes of such funds being repatriated to fund infrastructure.

Economists at the AfDB, ECA and the African Union Commission attending the Abuja meeting warned that conflicts have emerged as the biggest risk factor on the continent.

“Conflicts are now a major risk issue across Africa and investors are taking note,” said Dr Lopes.

Prospects of instability

The greater East African and Great Lakes regions are facing prospects of instability with conflicts in the Democratic Republic of Congo (DRC), South Sudan, Central African Republic (CAR) and Somalia.

The Organisation for Economic Cooperation and Development (OECD) considers all countries in the larger East African region, apart from Tanzania, as fragile states, based on a 2013 report.

Burundi, CAR, Chad, DRC and Eritrea are listed as some of Africa¹s fragile states. Others are South Sudan, Sudan, Somalia, Ethiopia, Rwanda, Uganda and Kenya.

However, Anthony Maruping, the African Union Commissioner for Economic Affairs, said the huge levels of reserves was helping to lift investor confidence in Africa.

“With reserves safely in foreign financial vehicles and banks, investors know they can invest in Africa since there is some level of financial stability,” he said. “But we need to contain the growing amounts of illicit outflows leaving Africa annually.”

The Global Financial Integrity, in its latest report, said countries in the East African Community (EAC) saw a combined $1.33 billion moved out of the region through illicit financial transactions over 10 years, raising questions over the efficiency of regulations meant to curb illegal capital outflows.

Ranked 66th out of 143 economies surveyed, Uganda leads the EAC pack with illicit financial transactions costing it at least $680 million. At 86th, Tanzania lost $333 million and Rwanda, ranked 106th, $158 million. Kenya lost an estimated $112 million while Burundi, the EAC’s smallest economy, lost $49 million.

READ: $1.33bn siphoned out of EA in 10 years

Central bankers at the conference said most African economies were battling a significant gap between the demand for investments and the availability of investible funds.

The situation, they said, was due, in part, to low levels of savings, large spreads between the lending and savings rate, weak financial intermediation, shallow capital markets and limited competition among banks.

While central banks have succeeded in ensuring price and financial stability through monetary policy interventions to tame inflation, this has not led to job creation and the infrastructure deficits continue to grow, said Sarah Alade, the acting governor, Central Bank of Nigeria.

However, the search for funds is exposing countries to high financial sector risks, which could destabilise the economies in the coming years.