The Macroeconomics of
Financing Basic Utilities for All
Terry McKinley
Director, International Poverty Centre
“Financing Access to Basic Utilities for All”
Multi-Stakeholder Consultation, Lusaka, 23-25 April 2007
1
Some Research Background
UNDP has supported 25 national reports on
Economic Policies for Growth, Employment and
Poverty Reduction since 2002
The motivation has been to promote greater policy
dialogue and provide policy alternatives on
economic policies
www.undp-povertycentre.org/reports.htm
1.
2.
3.
Coverage: Asia-Pacific, Eastern Europe and the CIS, Middle
East, and sub-Saharan Africa
Focus: a) fiscal, monetary and exchange-rate policies and b)
financial liberalization, trade liberalization and privatization
UNDP has also supported a global project on “Privatization
and Poverty Reduction” (most studies are in low-income
countries in Africa)
2
The Conclusion of the Studies



Privatisation and commercialisation of public
services are often not compatible in low-income
countries with achieving the Millennium
Development Goals
See Working Paper #22 of the International Poverty
Centre: “Can Privatisation and Commercialisation of Public
Services Help Achieve the MDGs: An Assessment?”
www.undp-povertycentre.org
Also see the IPC Policy Research Brief #3: “Privatising
Basic Utilities in Sub-Saharan Africa: the MDG Impact” and the
ensuing debate in One Pagers
Central Questions: How will access to public
services—such as water, sanitation and
electricity—be financed? What are the
Macroeconomic Implications?
3
Access to Electricity:
Percentage of Population
Region
Africa
1970 1990 2000
Total Total Total
14
25
34
2000
Urban
2000
Rural
63
17
S. Asia
17
32
41
68
30
E. Asia
30
56
87
98
81
Latin America
45
70
87
98
51
All Developing
25
46
64
86
51
4
Access to Electricity:
The Need for Public Investment
How to reach households without electricity?


Two-thirds of households in Africa—83% in rural areas?
59% of households in South Asia—70% in rural areas?
We have to dramatically ‘scale up’ public
investment in order to expand the electrical grid
or provide alternative cheaper sources of energy
Costing the public investment needed to reach the MDGs
has provided a stronger impetus for a change in strategy
A greater need for Economic Policies that support Rapid
Growth and Economic Development, not just
Macroeconomic Stabilization
5
The Need for Public Investment-Led
Economic Policies
According to conservative economists,
increased Public Investment will:
1. ‘Crowd out’ (displace) private investment
2. Cause accelerating inflation and appreciation
of the exchange rate
3. Increase the Fiscal Deficit and the Public Debt
Public Investment Has Been in Long-Term
Decline (See graph): From 10% to 7% of GDP
6
Public Investment in Developing Countries,
1970-2000 (as a share of GDP)
11
10
9
8
7
6
5
4
Simple average
Weighted average
7
Why Is Increasing Public
Investment Justified?
It will stimulate private investment, not
dampen it (example: electricity)
It will increase the productive capacity of the
economy so that inflation is contained
Governments should borrow to finance
public investment (deficit financing)
 It creates future revenue and welfare benefits
 Current revenue should cover current expenditures
 So incurring deficits is normal for investment
purposes (ODA finances larger deficits)
8
The Macroeconomic Implications
of Expanding Basic Utilities
Fiscal policies need to be more expansionary
(investment focused)
Monetary policies should be consistent with
fiscal expansion
 Low inflation targets (3-5%) can be counterproductive
 Achieving such targets can drive up real rates of
interest
 Such interest rates slow private investment and
make public borrowing more expensive: the
result is a vicious circle
9
What Are the Alternative Sources
of Financing?
For low-income countries, a dramatic scaling up of
Official Development Assistance is needed
 Such a scaling up need not endanger
macroeconomic stability (e.g., accelerating inflation
and causing a ‘Dutch Disease’ appreciation)
 Refer to the Conference Papers from the IPC-supported Global
Conference on “Gearing Macroeconomic Policies to Reverse
the HIV/AIDS Epidemic”
www.undp-povertycentre.org/aids.htm
 Conclusions: 1) concerns about instability
are inflated and 2) if there are such problems,
they can be managed.
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Investment-Focused ODA
See the New IMF Analytical Framework:
 ODA should be ‘SPENT’: the
Government should spend more based on
ODA financing of a larger deficit
 ODA should be ‘ABSORBED’: the
Central Bank should sell the ODA-supplied
foreign exchange in order to finance
imports
 Otherwise the purpose of ODA is defeated
11
Investment-Focused ODA
The recent 2007 Evaluation of PRGF
countries in sub-Saharan Africa by IMF’s
Independent Evaluation Office found:
 Governments spent only 28% of ODA (72%
was saved)
 So almost three-quarters of ODA was not used
for development purposes!!!
 Worse still, if the inflation rate exceeded 5% in a
country, only 15% of ODA, on average, was
spent by governments
12
Monetary Policies and Inflation
But IMF now recognizes that inflation rates
of 5-10% need not be harmful to growth
Maintaining inflation rates of 3-5%, as in
the past, can often be unduly restrictive
Empirical evidence suggests that even
inflation rates up to 15% are not likely to
be harmful
Supply shocks (oil; food) can temporarily
drive inflation rates above 10%
13
Inflation Has Declined in Africa
It has been 5-10% since 1997
14
The Impact of ODA
Central Banks ‘Absorbed’ only 63% of
ODA (i.e., sold foreign exchange)
37% of ODA was used to build up
International Reserves
There are three possible uses of ODA:
1. Central Bank Reserves
2. Private Capital Outflow
3. Financing of Imports (a transfer of real
resources: widening the current account)
15
Using ODA Effectively
Is it justifiable to use ODA to build up
reserves?
Reserves substitute for the transfer of real
resources into the country
A modest build-up could be warranted as a
means to address Aid Volatility
The Problem: Central Banks ‘sterilize’ the
monetary impact of ODA, driving up
interest rates in order to contain inflation
16
A Danger of Exchange-Rate
Appreciation??
The IMF hypothesis:
More government spending domestically (on
non-tradables) increases inflation
2. Inflation appreciates the exchange rate
3. Appreciation damages the international
competitiveness of exports
1.
But in sub-Saharan Africa (as in Asia) aid
surges have been associated with
Depreciation (See Graph)
17
The Size of Aid Is Correlated with
Depreciation in Africa
250
COG
CMR
EGY
SLE
MRT
CIV
NGA
NER
200
SDN
DZA ZWE
GAB
BFA
TCD
BDI
SEN
ZAR KEN
BWA
MAR
RWA
TZA
GMB
CAF
TGO
LSO
TUN
150
GHA
MDG
MWI
GIN
ETH
UGA
ZAF
100 50
Real Overvaluation
ZMB
MOZ
0
10
20
30
40
Foreign Aid %GNI
overvalue
Fitted values
18
A Danger of Exchange-Rate
Appreciation??
 The danger of inflation depends on the supply
response to increased demand
 Fiscal policies (that increase government
spending) and monetary policies (that sell
foreign exchange) need to be coordinated
(see IPC Working Paper #10 & Conference Papers)
 But coordination of policies on whose terms?
 Fiscal policies have to be consistent with the
restrictive monetary policies of the Central
Bank???
19
Policy Coordination for Scaling Up
 Choose the opposite: monetary policies
should be supportive of expansionary fiscal
policies
 Short-term inflation and even some
appreciation could be part of the
adjustment process
1. Relative prices need to adjust in order to
transfer resources domestically and
facilitate their import into the country
 The exchange rate can be managed to deal
with such short-term problems (along with
coordinating fiscal and monetary policies)
20
The Problem of Aid Volatility
The volatility of aid is the chief
problem, not so much domestic
macroeconomic instability
ODA needs not only to be scaled up but
also made predictable
Otherwise it imparts instability to the
budgeting process and contributes to
macroeconomic instability
21