ISS TODAY OP-ED: More balanced global tax won’t be enough to cure Africa’s chronic capital deficit

On 22 November 2023, a coalition of 125 mostly developing countries led by Nigeria won an important United Nations (UN) General Assembly vote on drafting a convention on international rules on tax and combatting illicit financial flows.

The UN vote was a victory for African tax activists who have long demanded that the international community wrest control of global tax reform from the Organisation for Economic Co-operation and Development (OECD). Activists, and many governments, suspect the OECD isn’t an entirely trustworthy custodian of this responsibility. Many of its wealthy member states benefit from dodgy financial practices like domiciling their African operations in offshore tax havens.

The 2015 UN High-Level Panel estimated that at least $50-billion in illicit finances flowed from Africa annually. In 2020 the UN Conference on Trade and Development reported that from 2013-15, Africa lost $88.6-billion on average each year in illicit capital flight. 

If all that outflow was channelled back into the continent’s public treasuries — and used for the right purposes — Africa would get an undoubted shot in the arm as it suffers from a severe and chronic capital deficit. And fiscal constraints are clearly holding back the growth of African economies. 

On 29 November last year, the African Development Bank (AfDB) revised downwards its gross domestic product (GDP) forecasts for Africa for 2023 and 2024 to 3.4% and 3.8%, from 4.0% and 4.3% respectively. It said the lower figures reflected “the persistent long-term effects of Covid-19, geopolitical tensions and conflicts, climate shocks, a global economic slowdown, and limited fiscal space for African governments to adequately respond to shocks and sustain post-pandemic economic recovery gains”.

Crippling inflation
The AfDB zoomed in on inflation, saying that while advanced economies had tamed post-Covid-19 increases, inflation continued in Africa, rising from 14.5% in October 2022 to 18.5% in October 2023 — the highest in a decade. The IMF puts this even higher, at an average 20.7% in 2023, with food inflation also still in double digits, keeping an estimated 158 million Africans acutely food insecure.

The AfDB said this was weighing down the continent’s short- to medium-term economic performance and hurting the poor. It blamed inflation on “supply shocks in agriculture, stronger imported inflation due to weaker local currencies, relatively high commodity prices, and the persistence of fiscal dominance in several African countries”.

‘Fiscal dominance’ occurs when national debt and fiscal deficits rise too high, making it difficult to control inflation by monetary policy, i.e. raising interest rates as advanced economies do. The AfDB said inflation had stubbornly resisted “large doses of tight monetary policy”, citing three of Africa’s largest economies as struggling hardest. Nigeria’s inflation was at 25% last year, despite 18% interest rates; Egypt had 24% inflation despite 19% interest rates; and Ethiopia experienced 32% inflation despite 8% interest rates. 

Rising debt
In its October 2023 forecast, the IMF noted that Africa’s mean fiscal deficit had expanded sharply to 7.9% of GDP in 2020, primarily due to Covid-19. Public debt had also ballooned to 66% of GDP in 2020. Since then, the mean fiscal deficit had dropped to 4.5% in 2023, but average public debt had eased only slightly to 65.2%. 

Of Africa’s 39 low-income countries, 10 were in debt distress, 12 were at high risk of debt distress, and the remaining 17 were at medium risk. So, the median African country was paying 10% of government revenue on debt service, more than double the ratio of 10 years ago and three times the level of advanced economies.

Like the AfDB, the IMF blamed Africa’s ‘difficult’ 2023 mainly on the tightening of global monetary policy to curb the rapid increase in inflation in 2022. The subsequent drop in global growth had shrunk external demand for African exports, pushed up domestic interest rates and raised foreign borrowing costs, partly through persistently depreciating African exchange rates. “Adding to high debt levels and deep structural challenges, these factors have combined to reduce access to external funding – yet another shock for a continent still emerging from … Covid-19.”

However, the IMF forecasted some signs of hope in a slight decrease in global interest rates, the normalisation of global supply chains, and moderation in several commodity prices — particularly international food prices, which had dropped by over 20% in 18 months. This was especially critical for Africa. 

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The IMF said Africa was responding with slightly increased economic activity driven partly by a continued recovery in services and tourism, stronger-than-expected remittance inflows, improved agricultural output, and increased resource extraction. This accounts for the slight uptick in average African GDP it foresees in 2024, from 3.2% to 3.8%.

The AfDB warns, however, that further tightening of global financial conditions could increase depreciation pressure on African currencies, push up debt service costs, force more countries into debt distress, and lower spending on social services. It could fuel inflation and trigger higher local interest rates, stifling growth. 

Geopolitical tensions impacting Africa
The AfDB also says deepening geopolitical tensions could further disrupt global trade and investment. The IMF calculates that 10 years of heightened geopolitical tensions could cost sub-Saharan Africa a permanent decline of up to 4% of GDP.

Both the IMF and AfDB recommend that in the short term, African countries maintain tight interest rates to control inflation. But ultimately, deep structural reforms are vital. These include curbing central banks’ tendency to print money, mobilising more domestic tax, and providing households and businesses with reliable electricity, water, internet and transport. 

It also includes diversifying resource-dependent economies and pivoting from government-led growth to private-sector innovation, boosting female labour force participation, and financing renewable energy. Countries would need to implement their African Continental Free Trade Area commitments. And it would mean addressing chronic political instability and conflict. 

Against that backdrop, the UN decision to create a body to take charge of global taxation and illicit financial flows is surely helpful. But who knows how long it would take. And in any case, it pales against the multitude of structural reforms that African countries must undertake to set themselves on the road to sustainable prosperity. DM

Peter Fabricius, Consultant, Institute for Security Studies (ISS) Pretoria.

First published by ISS Today.