Working Paper 41 - Informal Finance for Private Sector Development in Africa

More than a decade after substantial macroeconomic reforms were initiated in many Africancountries, aggregate growth, has at best remained inconsistent in many of those reforming countries.While the reasons for poor aggregate performance vary across countries, there is substantial evidencethat in many countries, poor private sector investment response in the medium-to-long term has delayedlong term growth. The poor response of the private sector might generally be attributed to varyingfactors in different countries. Indeed, various surveys suggest that a more vigorous response from theprivate sector in many countries has been impeded by a number of institutional, structural, and financialconstraints. (See Box 1).The apparent dearth of medium-term financing, the rudimentary nature of capital markets and theweaknesses in financial intermediation in general have made it difficult for private businesses to find themeans of financing other than short term bank credit. On the other hand, the generally low profitabilityof many private firms and the low overall level of domestic savings limit the prospects for investmentfinancing from their own resources.While the obstacles to private sector development are many, the financial constraints have receivedthe most attention from both governments and donors. Throughout the 1980s, it was fashionable toblame the financing constraints of the private sector on the inadequacies of banking systems and theirpoor perceptions of the creditworthiness of the small ventures that dominate African economies.Increasingly, however, possible solutions to the underlying factors behind the reluctance of commercialand other banks to lend to small enterprises are being sought, as more and more people begin tounderstand the problems of banks in relation to their structures and policy bottlenecks.In view of the continuing problems with finance, it is not surprising that reform of the financialsector became a major component of economic reform programmes in many countries. Reforms werenecessitated by the observation that various policy regimes shifted the allocation of investible fundsfrom the market to the government. In many countries, banking institutions simply became institutionsfor financing the budget deficit or covering operating losses incurred by parastatals. Reforms were alsomade necessary by the fact that financial repression generally hindered the development of the institutionalcapacity of financial institutions in their development of the commercial viability of their operations. As banks failed to develop the capacity for risk assessment and monitoring of optimal management of theirloan portfolio, they became uninterested in investing in information capital which is crucial for thedevelopment of financial systems.The reform of financial markets has taken the form of significant liberalization as countries shiftedfrom the ‘repressive’ regimes, characteristic of the pre-adjustment era. Governments are no longerrequired to play major roles in determining credit flows through a system of subsidies, interest rateceilings, credit allocation and direct intervention.