1. 1 Enhancing the Effectiveness of Fiscal Policy for Domestic Resource Mobilization Patrick N. Osakwe Chief, Financing Development, UNECA

2. 2 OUTLINE OF PRESENTATION  Background  The Case for Domestic Resource Mobilization  Facts on Development Finance and Resource Mobilization  Fiscal Policy and the Financial crisis  Improving Domestic Resource Mobilization

3. 3 I. Background  There is a significant gap between domestic savings and investment requirements in Africa  Domestic and external resources are needed to close this financing gap.  The global financial crisis has led to the drying up of external finance and rekindled interest in boosting domestic resource mobilization as a sustainable source of financing development.

4. 4 II. The Case for Domestic Resource Mobilization 1. Domestic finance is less volatile than external finance 2. It permits country ownership of development policies and outcomes. 3. Reduces reliance on external flows and the risk of the Dutch disease. 4. Creates incentives for more accountability and transparency in use of public resources 5. Reduces vulnerability to revenue losses from trade reforms

5. 5 III. Some Facts on Development Finance and Resource Mobilization  There are four key sources of development finance in Africa Domestic savings Domestic savings Private capital flows Private capital flows Foreign aid Foreign aid Remittances Remittances

6. 6 Africa has made progress in Development Finance In US Dollars (Billions) In US Dollars (Billions)200220032004200520062007 Domestic revenue 137.6168209.8267.6321.6366.9 Private flows 17.120.028.745.251.581.0 ODA21.427.129.535.543.538.7 Remittances12.915.619.522.327.238.0

7. 7 Savings ratios in Africa are low relative to developing country average as well as domestic investment requirements

8. 8 Africa’s low aggregate savings ratio masks wide differences in savings pattern across countries

9. 9 Africa’s revenue performance is similar to those of other developing regions

10. 10 Africa has also made progress in boosting tax revenue

11. 11 There has been a significant decrease in the share of trade taxes in domestic revenue

12. 12 IV. Fiscal Policy and the Financial Crisis  Fiscal policy has short and long term functions  Stabilization of the economy  Increasing productive capacity  Effective discharge of the short term function requires a counter-cyclical fiscal policy.  But fiscal policy in Africa has been pro-cyclical  Conditions imposed by international financial institutions  Financing tends to be pro-cyclical  Fiscal rules  Political economy reasons

13. 13 Fiscal Challenges from Financial Crisis  Global slowdown has a negative effect on growth and government revenue in Africa.  Governments are under pressure to increase social spending to cushion impact of shock on vulnerable groups.  There are concerns that the adoption of fiscal stimulus packages as well as pressure to bail out financial institutions in developed countries will reduce ODA flows to Africa.

14. 14 Issues for Discussion  How should fiscal policy respond to cyclical fluctuations in economic activities?  How can fiscal policy be used more effectively in support of the development needs and priorities of African countries?  How can Africa deal with the fiscal challenges posed by the global financial crisis?

15. 15 V. Improving Domestic Resource Mobilization  Effective mobilization of domestic resources in Africa requires progress in three critical areas:  Domestic revenue  Private savings  Enhancing role of ODA in domestic resource mobilization

16. 16 1. Strengthening Domestic Revenue Mobilization  African countries have made progress in increasing domestic revenue. However, in several countries there is a gap between tax capacity and tax revenues.  Economic growth is a necessary condition for success in revenue mobilization.  Increases pool of taxpayers  Requires structural change  Improved fiscal policies are needed to boost revenue.  Reduce tax exemptions and incentives to foreign investors  Increase rates on immobile factors (land and property) and luxury items  Adopt gradual approach to trade reform to ensure that it does not erode the fiscal base

17. 17  Good governance is crucial for revenue mobilization  Increase efficiency and accountability in use of public resources  Linking tax collection to service delivery and better public financial management are needed  Eradicate tax havens and address issue of stolen assets  Success in mobilizing revenue also requires dealing with the external debt problem of Africa.  High debt results in capital outflows and debt servicing difficulties  Increases vulnerability to external shocks with consequences for output and revenue mobilization

18. 18 Issues for Discussion  What are the channels through which fiscal policy affects mobilization of domestic revenue in Africa?  What should governments do to increase efficiency in use of government revenue?  How can African governments integrate into the multilateral trading system without eroding their fiscal base?  How can foreign investment be promoted without jeopardizing domestic revenue mobilization objectives?

19. 19 2. Boosting private savings  Private sector has an important role in boosting domestic savings in the region.  But increasing private savings requires increasing capacity of households and firms to generate income.  Governments can affect this capacity through creating an enabling environment for private sector development.  Requires reducing cost of doing business  Need for public investment in infrastructure

20. 20  Boosting private sector savings requires building domestic financial systems.  Weak financial infrastructure  Dominated by banks with a focus on short-term lending  Financing of deposit insurance schemes will boost confidence and encourage people to save in banks.  Strengthening domestic financial systems also require:  Market incentives to encourage banks to mobilize savings and channel them into productive investment  Promotion of linkages between formal and informal financial institutions  Rebuilding public financial institutions such as development and agricultural banks  Capital markets can play an important role in mobilizing savings in the region. But African countries have not exploited this potential.

21. 21 Obstacles to the use of capital markets for savings mobilization (% of respondents to ECA survey)

22. 22  Capital flight inhibits effective resource mobilization in Africa. It manifests itself in two ways:  Legal financial outflows in response to yield differentials. Macroeconomic and political stability as well as better governance and capital market development can reduce this type of outflow.  Off-shore movement of stolen public assets. Dealing with this type of capital flight requires better governance and law enforcement  Microfinance institutions can also play an important role in improving access of the poor to financial services and also boost rural savings. There is the need for more efforts to exploit this potential.

23. 23 Issues for Discussion  What factors militate against effective mobilization of private savings in Africa?  How can capital markets contribute more effectively to resource mobilization?  What national and international policy actions are needed to stem capital flight?  How can African countries exploit the potential of microfinance for domestic resource mobilization?

24. 24 3. Enhancing Role of ODA in Resource Mobilization  In the long-run, domestic resource mobilization should be the basis for financing growth and development.  But Africa needs aid in the short to medium term. Consequently, the key issue facing recipients and donors is how to make aid more effective and ensure that it supports the overall development goals of African countries.  Aid is more likely to support long-run development objectives of African countries if it is directed towards boosting capacity for domestic resource mobilization

25. 25  Why has aid not made a significant contribution to domestic resource mobilization?  Existing aid allocation mechanisms focus on closing a financial gap-----Undermines incentives for tax collection and savings.  There has been a shift in aid allocation from economic infrastructure and production to the social sectors with implications for increasing productive capacity and growth.  Historically, ODA flows to Africa have financed more of domestic consumption and capital outflows rather than investment----which is an engine of growth.

26. 26 ODA finances more of capital outflows and consumption

27. 27  Enhancing contribution of ODA to domestic resource mobilization requires actions in four key areas:  Directing ODA to building capacities to mobilize domestic savings  Placing more emphasis on economic infrastructure and public investments aimed at boosting productive capacities.  Management of the capital account when necessary.  Donors adopting a matching-funds approach to aid allocation

28. 28 Issues for Discussion  What is the impact of foreign aid on development financing in Africa?  Should African countries have an explicit strategy to exit aid-dependence?  How can ODA be directed towards boosting capacity for domestic resource mobilization in Africa?

29. 29 THANK YOU