Get the plumbing right: Financial integration should support Africa’s trade integration


By Amadou Sy, Nonresident Senior Fellow, Brookings Institution and Advisor, African Department, IMF1

Learn more about this timely topic at the upcoming
18th International Economic Forum on Africa

Africa-plumbingAfrican countries trade much more with countries outside the continent than with each other within the continent. According to the United Nations Economic Council for Africa, trade between African countries stands at about 16% of the continent’s total trade, the lowest intra-regional trade globally. Compare this with 19% intra-regional trade in Latin America and 51% in Asia.

Policies to reduce obstacles to intra-African trade have been a priority for African policy makers. After forging ahead with stronger trade integration within existing Regional Economic Communities (RECs), African policy makers took an additional step in 2018 with the Continental Free Trade Agreement (CFTA). Signed now by 44 African countries, the CFTA marks a milestone on the road towards a single continental market for goods and services.

However, lost in the debate about leveraging Africa’s trade integration for stronger and more inclusive economic growth is a policy discussion on increased financial integration. This is not surprising as architects often pay little attention to the plumbing of the buildings they are designing. Yet, plumbers should be taken more seriously. Indeed, the African financing infrastructure can be seen as the plumbing of the continent’s trade integration. And what are some of the necessary building blocks? 

First, expanding intra-African trade finance: Trade finance includes the financing of import and export transactions through loans, letters of credit, factoring, and export credit and insurance. According to the African Development Bank (AfDB), banks devoted only 20% of their trade finance to intra-African trade.

Second, establishing well-functioning payments and settlement systems: Properly functioning and cost-efficient payment and settlement systems help support intra-regional trade and finance exchanges as well as remittances. Solutions are needed to reduce transaction costs associated with foreign currency clearing, settlements, currency risks and remittance transfers. For example, the Society for Worldwide Interbank Financial Telecommunication (SWIFT) indicates that about half of intra-African import and export settlements involve a bank outside Africa.

Third, addressing currency risks: Costs from trading in more than 30 different regional currencies need to be reduced. High market volatility and administrative measures by central banks with occasionally low foreign-exchange (forex) reserves remain an issue. Furthermore, the number of countries adopting more flexible exchange-rate regimes has increased, resulting in increased market volatility as exchange rates are frequently used to absorb external shocks. Many countries rely on administrative measures in forex markets and ration foreign currencies when international reserves are low. Instruments to mitigate currency risks, such as swap arrangements, would help strengthen cross-border investments. And in the absence of private-sector involvement, multi-lateral solutions could be considered. The World Bank’s private finance arm, the International Finance Corporation (IFC), for example, issues bonds in local currency but typically swaps its positions back to U.S. dollars. The IFC’s efforts to kickstart local swap markets are laudable, but ultimately domestic banks and corporations should play a role, bolstered by banking and forex market regulations. Solutions such as swap arrangements or a multi-currency clearing center should also be considered. At the same time, innovation is proceeding rapidly and mobile payments can now occur between some African countries with different currencies. Regulators will have to keep pace with such developments without unnecessarily stifling their benefits.

Fourth, facilitating intra-regional remittances: Remittances can be an important source of foreign exchange for some countries. They have exceeded 10% of GDP in Togo, Cabo Verde, Senegal, Nigeria and Lesotho. However, transfer costs within Africa are the highest in the world. For instance, it costs about USD 19.50 to USD 21 to transfer USD 200 from South Africa to Malawi, Angola, Mozambique, Botswana or Zambia. World Bank data suggests these costs are up to 10 times higher than the cheapest transfers from Singapore, the United Arab Emirates or Saudi Arabia.

In addition to building the plumbing of financial infrastructure in these concrete ways, policy makers can’t overlook key trends transforming this area. Consider four:

Pan-African Banks: A recent IMF study shows how Africa’s financial sector has changed over the past decade with the expansion of African banks.2 Ten African banks now have a presence in at least 10 countries on the continent with one being present in more than 30 countries. These pan-African banks can facilitate intra-African trade. At the same time, they raise new challenges for regulators as their cross-border operations span different regulatory regimes and different supervisory authorities. Work is underway to address these challenges with exchanges between supervisors and harmonised data and practices.

Africa-to-Africa Investment (A2A) and Global Value Chains3 : Multinational companies themselves finance several operations through suppliers’ credit. A recent AfDB study notes the emerging trend of Africa-to-Africa (A2A) investment. The A2A report features eight publicly-listed and privately-owned African companies operating in consumer services, finance, industry, media and diversified portfolios, and investment, with home bases in North Africa (Morocco), West Africa (Nigeria, Togo), East and Central Africa (Ethiopia, Kenya), and Southern Africa (Mauritius, South Africa). Identifying and addressing the obstacles to financing A2A investments and the value chains involved are critical for furthering African trade integration.

FinTech: Mobile payments could help reduce transaction costs. For instance, telecom operator Orange Money is present in 11 countries in sub-Saharan Africa, and mobile-to-mobile payments in CFA francs are possible between West African countries including Cote d’Ivoire, Mali and Senegal. Similarly, in East Africa, Tigo offers cross-border mobile money transfers with automatic currency conversion between Tanzania and Rwanda. What’s important is striking the right balance between regulatory objectives and the pace of innovation.

Informal Cross-Border Trade (ICBT): ICBT accounts for an important share of intra-Africa trade, reaching even 40% in the Common Market for Eastern and Southern Africa. ICBT is also high between Benin and Nigeria or Cote d’Ivoire and Ghana. Informal traders have developed their own mechanisms to finance their operations outside the formal financial sector. Understanding how informal trade is financed could help create jobs, especially for youth and women, reduce poverty and ultimately contribute to the formal sector. In addition to many e-commerce players identifying the informal sector as a crucial market, traditional financial institutions can contribute too. The African Export Import Bank (AFREXIMBANK) expressed significant interest in extending trade finance and payment products to informal cross-border traders.

We know today’s reality: Transaction costs are high in Africa when a U.S. clearing bank has to be involved every time two African countries trade amongst themselves in U.S. dollars. Or banks with corporate clients in different countries in an African region need to deal with multiple currencies, high market risks and exchange restrictions. Or African migrants face the highest costs in the world to send remittances from one African country to another. Financial integration, however, can drive overall integration by facilitating regional trade, investments and remittance flows. It is now up to policy makers to harmonise regulations further and build capacity, especially in cross-border banking supervision, while keeping pace with key trends and innovation. The architects of African trade integration must also be plumbers, because investing in the “plumbing” of financial integration ultimately provides quick gains and a sustainable path forward.

1 The views expressed in this article are those of the author and do not necessarily represent the views of the IMF, its Executive Board or IMF management.