Holding Excess Foreign Reserves Versus Infrastructure Finance: What Should Africa Do?

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Financing infrastructure needs in Africa necessitates new thinking on financing mechanisms. Currently, there is a lively debate on the funding and use of foreign exchange (forex) reserves as one of the funding sources for financing infrastructure. Forex reserves have been viewed from different perspectives as monetary policy and debt intervention instruments and/or national assets for economic development.

This paper deals with the following questions: What are the objectives of foreign exchange reserves management? What are the levels of forex reserves in African countries; are these reserves adequate? What are the innovative mechanisms to enhance their management? How much can be invested for financing infrastructure in Africa?

The study has: (i) extracted data on the foreign exchange reserve, debt and infrastructure needs of African countries from different IMF, World Bank and AfDB databases; (ii) estimated the adequacy level of foreign reserve for these countries based on two commonly used methodologies – the traditional metric method of import cover and the Wijnholds and Kapteyn (WK) method; (iii) then estimated the excess foreign reserve and the social cost of holding this excess based on comparison to other alternative investment opportunities such as investments in African infrastructure. Based on these estimations, the study has shown that: (i) African countries have held excess reserves in the range of $165.5 and $193.6 billion on average per year between 2000 and 2011. This is more than the infrastructure financing gap identified at $93 billion per year; and (ii) holding these excess reserves when compared to alternative investments in domestic infrastructure in the continent, also implies a social cost of up to 1.65% in GDP terms on average. These findings echo the position of Stiglitz (2006) who opined that the total social cost of holding excess reserves is around $300 billion per year in developing countries, which is approximately equal to the amount of resources needed by developing countries to fund basic investments to meet the MDGs.

These analyses indicate that there is room for the use of these excess reserves through novel investment vehicles to complement existing development partners while focusing on the following: i) economic infrastructure projects with a regional impact; ii) innovative mechanisms for cross-border infrastructure investments; iii) encouraging quick handling interventions (more flexible rules, systems and procedures); and iv) deal with political risk, credit risk, and refinancing risk. Such envisaged investment vehicles should be driven by performance accountability criteria to manage parts of these excess reserves through investments in less liquid, higher-yielding wealth as compared to the status quo.