Africa’s Rise—Interrupted?

The region’s future depends on much more than fluctuations in commodity prices

Is Africa’s surge of progress over? During the past two decades, many countries across the continent changed course and achieved significant gains in income, reductions in poverty, and improvements in health and education. But the recent optimism seems to have swiftly given way to a wave of pessimism. Commodity prices have dropped, the world economy has slowed, and economic growth has stalled in several sub-Saharan African countries. If high commodity prices alone drove recent advances, the prospects for further gains seem dim.

But the reality is more complex, and the outlook—especially over the long run—is more varied than many now suggest. To be sure, many countries are confronting some of the most difficult tests they have faced for a decade or more, and even with sound management, progress is likely to slow in the next few years. But for others—especially oil importers with more diversified export earnings—growth remains fairly buoyant. At a deeper level, although high commodity prices helped many countries, the development gains of the past two decades—where they occurred—had their roots in more fundamental factors, including improved governance, better policy management, and a new generation of skilled leaders in government and business, which are likely to persist into the future.

Managing the global slowdown—alongside other growing threats such as climate change—will require strong leadership, forceful action, and difficult choices. Overall growth is likely to slow in the next few years. But in the long run, the outlook for continued broad development progress is still solid for many countries in the region, especially those that diversify their economies, increase competitiveness, and further strengthen institutions of governance.

Two decades of progress

The recent slowdown follows two decades of strong progress, at least for many countries, that began in the mid-1990s and included faster economic growth, higher incomes, declines in poverty, widespread improvements in health and education, and other development gains (see Chart 1). Since 1995 GDP growth across the continent has averaged about 4.3 percent a year, fully 3 percentage points higher than in the previous two decades. But it would be misleading to suggest that rapid growth rates were universal across the continent. They varied widely, with about half the countries in the region moving forward and others changing little. In the 20 fastest growing countries—excluding oil exporters—GDP growth averaged a robust 5.8 percent for two decades, and real incomes per person more than doubled. But in other countries, growth was much slower, and in eight countries, income per person actually fell. Some of the differences are stark: in Rwanda real income per person more than doubled; in Zimbabwe it fell 30 percent.

radelet chart 1

Where growth accelerated, poverty finally began to fall. The share of people living in extreme poverty (less than $1.90/day in constant 2011 prices) dropped from 61 percent in 1993 to 43 percent in 2012, a decline of nearly 1 percentage point a year for two decades. In some countries (for example, Senegal), poverty declined even more; in others (Democratic Republic of the Congo), not at all.

The gains in health were even bigger. Since the mid-1990s the share of children dying before their fifth birthday has fallen more than half, from 17 percent to 8 percent. Remarkably, every single country in sub-Saharan Africa has reduced child mortality in the past two decades. Malaria deaths have fallen by half, and deaths related to HIV/AIDS and tuberculosis have both fallen by one-third. More than three-quarters of children are enrolled in primary school, up from just half in the 1980s. More than two-thirds of girls now complete primary school, which will increase their earning potential; equally as important, it means that they will have fewer children and that those children will be healthier and better educated (see “In the Driver’s Seat” in this issue of F&D). These trends bode well for the future, as they signal the beginnings of a strong human capital skills base.

Four key forces helped propel the resurgence in the countries that moved forward.

radelet chart 2

First, there was a marked improvement in governance, at least in many countries. According to the U.S. think tank Freedom House, the number of electoral democracies in Africa has jumped from just four in 1990 to 23 today. With democracy came better governance, including more political freedoms, less violence, greater adherence to the rule of law, stronger public institutions, a better business environment, and less corruption. The new democracies are far from perfect, but the differences in the quality of governance are reflected in the World Bank’s annual Worldwide Governance Indicators scores. In 2014 the average governance rank for sub-Saharan Africa’s 23 democracies was the 42nd percentile globally (ahead of both India and China), while for the nondemocratic countries it was the 19th percentile (see Chart 2). A few nondemocratic countries improved governance, but these are exceptions rather than the rule.

Second, there are more skilled leaders and policymakers. A new generation of managers, technicians, and entrepreneurs is rising to the top of government agencies, civil society organizations, and private businesses. The leaders in central banks and key government ministries are far better trained, more experienced, and more capable than their predecessors 20 years ago.

Third, and related, economic and social policies have improved significantly. Macroeconomic management has been much more effective, with more flexible exchange rates, lower inflation, smaller budget deficits, and higher levels of foreign exchange reserves. Strong state control has given way to more market-oriented economic systems. Governments have removed many distortions that hindered growth, which led to more open trade, greater choice for farmers when it came to buying inputs and selling their products, less red tape, and a lower cost of doing business. It is partly because of these policy improvements that many countries were able to weather difficult global shocks in recent years, including the food crisis of 2007 and the global financial crisis of 2008–09.

Fourth—the key condition that is now beginning to change—during much of the past two decades world economic conditions were generally favorable.Trade expanded rapidly and with that came access to new technologies and ideas, alongside bigger markets. China became both a big market for exports and a major source of investment in many countries. Interest rates were low, making borrowing for infrastructure projects far more affordable. And from 2002 through 2014, rising commodity prices helped the major oil exporters (Angola, Republic of Congo, Ghana, Nigeria, and others) alongside other resource exporters, such as Liberia, Namibia, and Zambia. Rising prices did not help all countries—the majority of African countries are oil importers that were hurt by higher prices, and many saw relatively little change in key prices—but commodity prices buoyed economic activity in much of the region.

radelet 2

In addition to these four key forces, foreign aid played an important secondary role. Aid was particularly important in improving health, and helped save millions of lives through programs that increased access to vaccines, improved child health, and fought diseases such as tuberculosis, malaria, and HIV/AIDS. And the preponderance of academic research in recent years concludes that aid has helped accelerate growth on average and consolidate democracy in some countries, especially since the mid-1990s (for a good recent summary of this research, see Arndt, Jones, and Tarp, 2015).

The view that Africa’s surge happened only because of the commodity price boom is too simplistic. It overlooks the acceleration in growth that started in 1995, seven years before commodity prices rose; the impact of commodity prices, which varied widely across countries (and hurt oil importers); and changes in governance, leadership, and policy that were critical catalysts for change. This broader understanding of the drivers of progress is crucial in considering the prospects for the future: sub-Saharan Africa’s long-term future will not be determined by the vagaries of the commodity markets alone, but by how well these and other challenges are managed.

Choppy waters

However, global circumstances have changed significantly, and many countries are confronting some of their most difficult challenges in a decade or more. Growth has slowed significantly around the world, including in several important export markets. Growth in Europe has slowed sharply, and the U.S. recovery remains modest. As growth has slowed, so has trade. World trade expanded by nearly 7 percent a year in the decade between 1998 and 2007, but since 2012 the pace has fallen by more than half to just 3 percent a year.

Perhaps most important, China’s growth has dropped to about 6 percent, well below the pace of recent years. China’s trade with sub-Saharan Africa exploded from less than $20 billion in 2003 to more than $170 billion in 2013. But China’s weakened growth and its efforts to put greater emphasis on its domestic economy have led to a sharp slowdown in trade with Africa and a significant contraction in some countries, especially Angola, the Republic of Congo, Equatorial Guinea, South Africa, and Zambia—China’s main African trading partners. The changes are not all negative: the rapid rise in wages in China creates new opportunities for African countries to expand manufacturing. But the relationships with China are again changing rapidly, and managing them carefully will be central to continued long-term growth in many countries across the region (see “A Fork in the Road,” in this issue of F&D).

With growth slowing, commodity prices have dropped significantly. The prices of corn, copper, and cotton have all fallen by more than 20 percent since 2013, and iron ore and oil prices have dropped more than 50 percent. These declines have had a wide-ranging impact on export earnings, budget revenues, investment, employment, exchange rates, and foreign exchange reserves. The effects are particularly large in the oil producers (Angola, Republic of Congo, and Nigeria, among others) and in countries that export iron ore (Liberia, Sierra Leone, South Africa), copper (Republic of Congo, South Africa, Zambia), and diamonds (Botswana, Namibia, South Africa).

radelet chart 3

Correspondingly, growth in sub-Saharan Africa slowed from 5 percent in 2014 to 3.5 percent in 2015, and the IMF projects that it will remain subdued at 3 percent in 2016. Once again, there is wide variation, with some countries hit hard and others actually benefiting from price changes (see Chart 3). Oil exporters have seen the biggest drop in growth, alongside iron ore, copper, and diamond producers. South Africa, one of the region’s major economic engines, has been rocked by drought, falling export prices, and growing political struggles, and growth is now only about 1 percent. In Nigeria, the other regional powerhouse, last year’s successful political transition was followed by immediate challenges stemming from the steep decline in oil prices, widening fiscal and trade imbalances, and a hesitant response from policymakers. Angola, Liberia, and Zambia also have been hit hard.

By contrast, most sub-Saharan African countries are oil importers, and they have benefited from the drop in fuel prices. Some countries, such as Côte d’Ivoire, have gained both from a rise in export prices (in this case, cocoa) and the drop in oil import prices. Similarly, many countries are food importers and have been helped by the decline in prices for rice, wheat, and other food products. Countries with more diversified exports are experiencing a more moderate impact on export prices, coupled with gains on the import side. Kenya, Mozambique, Rwanda, Tanzania, and Uganda are still expected to grow by 5 percent or more this year.

But countries across the region face several other long-term challenges, starting with weaknesses in infrastructure for power, roads, and water (see “Impediment to Growth” in this issue of F&D). World Bank researchers estimate that infrastructure deficiencies in Africa have reduced growth by more than 2 percentage points a year. Only about one-third of rural Africans live within two kilometers of an all-season road, compared with two-thirds in other regions. And while many parts of Africa have abundant water, the lack of water storage and irrigation facilities undermines economic activity. The impact of these shortages will only grow as climate change advances.

Demographic shifts present another major test. Sub-Saharan Africa’s population is projected to climb from 965 million in 2016 to 2.1 billion in 2050. Nigeria alone could have 400 million people by 2050, more than double its current size. Urban populations will grow especially quickly, posing major challenges in job creation, infrastructure, education, health, and agricultural production. But demographic shifts also provide an opportunity: history shows that population growth is not necessarily a constraint on growth. Larger urban populations, a growing share of working-age people, and increased female labor force participation all present opportunities to expand manufacturing and services—much as happened in Asia in recent decades—especially when accompanied by investment in infrastructure and education.

Perhaps the most difficult challenge of all will be climate change. Temperatures in sub-Saharan Africa are expected to rise between 1.5 and 3 degrees Celsius by 2050, and weather patterns, temperatures, and rainfall are expected to be more erratic. There will be myriad effects, including a rise in sea level in coastal regions, lower water tables, more frequent storms, and adverse impacts on health. Arguably worst will be the blow to output and labor productivity in agriculture, the dominant source of income in Africa, especially for the poor.

The road ahead

Dealing with these challenges will test the skills of Africa’s new generation of leaders. But once again, the effects are likely to vary widely: countries with the most diverse export bases will probably be affected the least, while those with narrow export bases and weak governance will suffer most. Continued long-term progress through this challenging period calls for action in four areas.

radelet 3

First up is adroit macroeconomic management. Widening trade deficits are putting pressure on foreign exchange reserves and currencies, tempting policymakers to try to artificially hold exchange rates stable. Parallel exchange rates have begun to emerge in several countries. But since commodity prices are expected to remain low, defending fixed exchange rates is likely to lead to even bigger and more difficult exchange rate adjustments down the line. As difficult as it may be, countries must allow their currencies to depreciate to encourage exports, discourage imports, and maintain reserves. At the same time, budget deficits are widening, and with borrowing options limited, closing the gaps requires difficult choices. At the core will be the ability to mobilize domestic resources and increase tax revenues, which will allow countries to control deficits while financing critical investments in roads, power, schools, and clinics. The amounts involved are significant: Every 1 percentage point increase in revenue as a share of GDP for sub-Saharan Africa as a whole raises an additional $17 billion a year. In some countries, it might make sense to augment domestic revenue with borrowing, especially for priority infrastructure projects. But the burden of debt is accelerating, interest rates are rising, and spreads on sovereign bond issues in Africa are climbing quickly—putting the brakes on further borrowing.

Second, countries must move aggressively to diversify their economies away from dependence on commodity exports. Governments must establish more favorable environments for private investment in downstream agricultural processing, manufacturing, and services (such as data entry), which can help expand job creation, accelerate long-term growth, reduce poverty, and minimize vulnerability to price volatility.

The effects of the current commodity price shocks are so large precisely because countries have not diversified their economic activities. The exact steps will differ by country, but they begin with increasing agricultural productivity, creating more effective extension services, building better farm-to-market roads, ensuring that price and tariff policies do not penalize farmers, and investing in new seed and fertilizer varieties. Investments in power, roads, and water will be critical. As in east Asia, governments should coordinate public infrastructure investment in corridors, parks, and zones near population centers to benefit firms through increased access to electricity, lower transportation costs, and a pool of nearby workers, which can significantly reduce production costs. Financing these investments will require a deft combination of prudent borrowing mixed with higher domestic revenue. At the same time, the basic costs of doing business remain high in many countries. To help firms compete, governments must lower tariff rates, cut red tape, and eliminate unnecessary regulations that inhibit business growth. Now is the time to slash business costs and help firms compete domestically, regionally, and globally.

Third, Africa’s surge of progress cannot persist without strong education and health systems. The increases in school enrollment and completion rates, especially for girls, are good first steps. But school quality suffers from outdated curricula, inadequate facilities, weak teacher training, insufficient local control, teacher absenteeism, and poor teacher pay. The coming years call for dramatic improvement in quality to equip students—especially girls—with the skills they need to be productive workers. Similarly, health systems remain weak, underfunded, and overburdened, as was illustrated so clearly during the recent Ebola virus disease outbreak (see “After Ebola” in this issue of F&D). Robust efforts are needed to improve access to health facilities, train providers, bolster the delivery of basic health services, and strengthen health systems more broadly.

Fourth, continued long-term progress requires building institutions of good governance and deepening democracy. The transformation during the past two decades away from authoritarian rule is remarkable, but it remains incomplete. Better checks and balances on power through more effective legislative and judicial branches, increased transparency and accountability, and strengthening the voice of the people are what it takes to sustain progress. Some nondemocratic countries have done well, but the majority of authoritarian governments have been governance disasters.

Finally, the international community has an important role to play. Foreign aid has helped support the surge of progress, and continued assistance will help mitigate the impacts of the current slowdown. Larger and longer-term commitments are required, especially for better-governed countries that have shown a strong commitment to progress. To the extent possible, direct budget support will help ease adjustment difficulties for countries hit hardest by commodity price shocks. In addition, donor financing for infrastructure—preferably as grants or low-interest loans—will help build the foundation for long-term growth and prosperity. Meanwhile, this is not the time for rich countries to turn inward and erect trade barriers. Rather, wealthy nations should encourage further progress and economic diversification by reducing barriers to trade for products from African countries whose economies are least developed.

It is easy to be pessimistic in the current global economic environment. But of course, it is always easy to be pessimistic. Most analysts were negative about Africa’s prospects in the mid-1990s, just as many countries there were turning around and beginning to rise. There was further pessimism during the global food crisis of 2007 and the 2008–09 financial crisis. But, against all odds, many countries across the region have experienced a remarkable transformation.

The global slowdown presents major challenges that will not be easily overcome. Over the next few years, growth will probably remain moderate across the region, and the pace of overall development progress is likely to slow. In some countries, especially those reliant on a few commodity exports, the slowdown could be quite significant. Policymakers may not be able to generate rapid growth right away, but they can do much to keep the slowdown in check and strengthen the foundation for lasting progress. Looking ahead over a longer-term horizon, the fundamental improvements under way in governance, capacity building, and encouraging a new generation of leaders point to favorable prospects.

With concerted action and courageous leadership, look for many African countries to continue to make substantial development progress over the next two decades and further reduce poverty, improve governance, and expand prosperity. ■

Steven Radelet is Director of the Global Human Development Program at Georgetown University’s Edmund A. Walsh School of Foreign Service and author of The Great Surge: The Ascent of the Developing World.


Arndt, Channing, Sam Jones, and Finn Tarp, 2015, “What Is the Aggregate Economic Rate of Return to Foreign Aid? World Bank Economic Review, July, pp. 1–29.

Opinions expressed in articles and other materials are those of the authors; they do not necessarily reflect IMF policy.


Time for a Policy Reset

Sub-Saharan Africa’s economies face severe strains and must take action to reignite sustainable growth
Time for a Policy Reset

Over the past few years, I have been heartened by the progress on the ground in sub-Saharan Africa. Along with the extended period of strong economic growth of the past 15 years came improvements in health indicators and standards of living. Now that the region’s economy has entered a rough patch, there is a risk that the progress that has reached so many will stall. A confluence of external and domestic factors is exerting severe strain on many countries, including the largest ones. So to reignite the engine of sustainable growth that has propelled the region in the recent past and secure favorable medium-term prospects, governments must implement a strong policy reset.

The pace of economic expansion in the region declined to 3½ percent in 2015, the slowest in some 15 years. The growth outlook varies greatly across countries in the region, but the IMF projects overall growth to slow further this year to 3 percent—well below the 6 percent or so observed over the past decade, and barely above population growth. Indeed, GDP per capita growth will be under 1 percent for two years in a row for the first time since the late 1990s.

World of multiple shocks

The slowdown reflects the adverse impact of the commodity price slump on some of the larger economies, tighter financing conditions, and, more recently, the drought in eastern and southern Africa.

The sharp decline in commodity prices in recent years has severely strained many of the largest sub-Saharan African economies. While oil prices have recovered somewhat since the beginning of 2016, they are still some 60 percent below their 2013 peak levels, a shock of unprecedented magnitude. As a result, oil exporters such as Nigeria and Angola, as well as most countries in the Economic Community of Central African States, continue to face particularly difficult economic conditions.

Growth will slow further for the region’s oil exporters in 2016, to 2¼ percent, from as high as 6 percent in 2014, according to IMF projections. For example, growth in Angola will likely be slowed by limited foreign exchange supply and lower public spending. Similarly, in Nigeria, economic activity is constrained by the lower oil prices and compounded by disruptions to private sector activity through exchange rate restrictions. Unfortunately, nonenergy commodity exporters, such as Ghana, South Africa, and Zambia, have also been hurt by the decline in commodity prices.

The shift in the sources of China’s growth—from resource-intensive investment and exports to more domestically driven growth—is certainly playing a role in the slowdown experienced by many countries in the region. During the 2000s, China became the region’s single largest trade partner, and African countries have enjoyed a healthy trade surplus with that country, especially since the global financial crisis. With the slump in commodity prices, this has changed dramatically, and the trade balance has recently turned negative. These trends are likely to continue to limit growth over the medium term.

For most of the region’s frontier markets, external financing conditions have tightened substantially compared with those before mid-2014, when markets enjoyed ample access to global liquidity. At the same time, some forms of capital flows to the region—notably, cross-border bank loans, relied on by more than just frontier markets—have declined significantly.

And on top of all this, several southern and eastern African countries are suffering from a severe drought that is putting millions of people at risk of food insecurity. The drought will probably dampen growth in a number of countries, including Ethiopia, Malawi, and Zambia, and food inflation is accelerating in many countries. Humanitarian needs are putting additional strain on the budgetary and external positions of many of the affected countries. The impact of the drought varies across countries, but whenever food security is precarious, there are severe human costs. And this already tragic situation could still get a lot worse; a shocking 40 to 50 million people are likely to be food insecure by the end of 2016.

Strong potential

This confluence of factors is exerting serious headwinds. But does this mean that the region’s growth momentum has stalled? I don’t think so—for several reasons.

First, the overall weak picture masks, as usual, widely varying circumstances—not surprising, given that the region is home to 45 very diverse countries. Many countries across the region, notably those with the lowest income, continue to register robust growth. Most oil importers are generally faring better, with growth over 5 percent, often supported by ongoing infrastructure investment and strong private consumption. For instance, growth in Kenya is projected to rise to 6 percent in 2016, aided by investment in the transportation sector, a pickup in electricity production, and a rebound in tourism. Similarly, Senegal is expected to see continued strong growth at 6½ percent, supported by improving agricultural productivity and a dynamic private sector. In Côte d’Ivoire, high cocoa prices and good agricultural production, as well as an anticipated boost in investment following the recent presidential election, should drive growth to 8½ percent this year. In some other countries, such as the Central African Republic, growth prospects are now rebounding from severe shocks or with the attenuation of conflict. And the decline in oil prices has benefited many of these countries, though the drop in other commodity prices and currency depreciations have partly offset the gains.

More broadly, the region’s medium-term growth prospects continue to be favorable. True, the near-term outlook for many sub-Saharan African countries remains difficult and clouded by risks. But generally the underlying domestic drivers of growth over the past decade or so still persist. In particular, the much improved business environment and favorable demographics are likely to play an important role in supporting growth in the coming decades.

Pressing the reset button

While the region’s growth potential remains strong, the current slowdown highlights that the region is not immune to the multiple transitions afoot in the global economy. As a result, to reap the region’s strong potential, a significant policy reset is critical in many cases. Such a reset is particularly urgent in two groups of countries—the region’s commodity exporters and countries with access to international capital markets.

For natural resource exporters, a robust and prompt shift in policy response is needed given the prospect of an extended period of sharply lower commodity prices. To date, commodity exporters—particularly oil exporters—have generally responded hesitantly and insufficiently to the historically large terms-of-trade decline they are experiencing. Faced now with rapidly depleting fiscal and foreign reserves and constrained financing, they must respond quickly and strongly to prevent a disorderly adjustment and to lay the groundwork for a quicker, durable, and inclusive economic recovery.

For countries that are not part of a monetary union, exchange rate flexibility should be part of the first line of defense against commodity price declines, as part of a broader macroeconomic policy package. Because the fall in revenues from the extractive sector will likely be long lived, many affected countries also must contain fiscal deficits and build a sustainable tax base from the rest of the economy. In their consolidation efforts, countries should aim to preserve priority spending, such as social expenditures and growth-friendly capital investments, also with a view to maintaining their longer-term development goals.

Driven by the favorable external financing environment of recent years, fiscal and external current account deficits have grown substantially in many of the region’s frontier markets, as they sought to strengthen their weak infrastructure, including roads, railways, and electricity and water networks. Now that external financing is much tighter, these countries will need to reduce their fiscal deficits—depending on the country’s circumstances—either by better prioritizing spending or by boosting tax revenues. That will help these countries rebuild cushions against possible worsening of external conditions.

Indeed, the current challenges sub-Saharan Africa faces are a sobering reminder of the need to strengthen resilience against external shocks. Structural measures, such as enhancing the business climate and improving the quality of public investment, would nurture the private sector and help diversify the export base and sources of growth and jobs beyond commodities. In addition, further developing the region’s financial sector, including by strengthening legal frameworks and corporate governance, could also help.

Now is the time to reset policies to address current challenges and ensure the resumption of Africa’s strong rising path. The required measures may cause a short-term slowdown in growth, but they will prevent the risk of crises if action is not taken promptly. With that, I believe countries in the region will be well positioned to reap their substantial economic potential. ■

Antoinette M. Sayeh is Director of the IMF’s African Department.

Opinions expressed in articles and other materials are those of the authors; they do not necessarily reflect IMF policy.


Cashing In on the Digital Revolution

Digitization makes finance accessible, lowers costs, and creates opportunity

It is the topic du jour for policymakers in almost every developing economy—especially in sub-Saharan Africa. Financial inclusion makes saving easier and enables accumulation and diversification of assets, boosting economic activity in the process. As its economies continue to grow, the region must take one crucial step if it wants to escape the poverty trap, and even more so now as commodity exporters face a downward terms-of-trade trend: deliver more financial services to people and institutions.

Yet access to financial services for the poor has been limited. Minimum bank balance requirements, high ledger fees (costs for maintaining micro accounts), and the distance between poor people’s homes and bank outlets hinder their access to financial services and credit. Moreover, unaffordable “collateral technology” (the system of fixed assets required for loan approval) raises costs more than anything else, and the financial products available are often not suitable for customers with low and irregular income.

Banks have had to bear high costs to provide financial services to the poor. Market segmentation, low technological development, informality, and weak regulation increase the costs of doing business. In Kenya, and in Africa more broadly, markets are heavily segmented according to income, niche, and location, and their sophistication, level of development, and formality or informality reflect that segmentation.

High customer-monitoring costs, perceived higher risk, and a lack of transparent information have been almost insurmountable challenges for banks, and microfinance and other specialized institutions have not been able to fill the gap.

A new landscape

The global financial crisis changed the landscape. Foreign banks scaled back their activities in some African countries, while new local banks increased their presence. The relative success of microfinance institutions in some countries (especially those that introduced a new technological platform to manage micro savings and deposit accounts) encouraged domestic banks to expand their networks. At the same time, nonbank financial institutions, such as savings and loans and cooperatives, formalized their activities. In response, regulators began introducing alternative models that helped cut intermediation costs. For example, agency banking allowed banks to locate nontraditional outlets in remote areas where brick-and-mortar branches and outlets are not financially feasible. Bank representatives at such outlets can perform authorized tasks, such as opening bank accounts, processing loan applications and loan repayments, and so forth.

These changes were driven by demand. Market participants pressured regulators to build their capacity to cope with innovations and to develop institutions to support financial sector growth. Greater credit information sharing and the development of information for market participants, deposit insurance, and financial intelligence units generated a virtuous circle.

But these changes pale compared with the transformation introduced by the emergence and low cost of digital financial services. In Kenya, mobile-phone-based technology (M-Pesa) for the delivery of financial services lowered transaction costs significantly and started a revolution in the payment system. M-Pesa is an electronic money transfer product that allows users to store value on their mobile phone or mobile account in the form of electronic currency. This currency can be used for a number of purposes, including transfers to other users, payments for goods and services, and conversion to and from cash.

Suddenly, businesses did not have to give their employees time off to take money to their villages to care for relatives or small farms. Employees no longer had to travel long distances carrying cash and exposing themselves to robbery and other dangers. Relatives back home did not have to make long trips and risk assault or blackmail by local criminals who tracked the frequency of their travels. The digital revolution allowed people to make financial transactions and money transfers from the comfort of their homes. The lower cost left them with more disposable income, and they now had a secure way to store cash, even those working in the informal economy.

Kenya: a four-step virtuous process

Cashing In on the Digital RevolutionKenya still enjoys the advantages of an early start in pushing the frontier of financial inclusion through digital financial services. Geospatial surveys show how much financial institutions have responded to an increasingly welcoming environment (see chart). In Kenya a much larger share of the population is within 5 kilometers of a “financial access touch point” and had many more such touch points per person than was true in other countries in the region.

Kenya stands out for its people’s use of mobile-phone-based money—in less than 10 years the share has grown from zero to more than 75 percent of the adult population. Banks have worked closely with telecommunications companies, which has allowed them a higher market presence there than in many emerging markets. In recent years, the insurance sector has expanded as well, targeting Kenya’s emerging middle class, and group-financing programs have also grown. This virtuous circle—facilitated by adaptive and flexible regulatory frameworks, reforms in financial infrastructure, and rapid improvements in skills and capacity—can be divided into four phases:

Expansion of the mobile-phone technological platform for person-to-person transfers, payments, and settlements (products such as M-Pesa): In Kenya, the value of these transactions has reached the equivalent of 4.5 percent of annualized GDP a day.

Introduction of virtual savings accounts using a digital financial services platform complemented by virtual banking services to manage micro accounts: in other words, digital financial services entered the core of banking intermediation.

Use of transaction, saving, and financial operations data from the digital financial services platform to generate credit scores and evaluate and price microcredit risk: This data analysis has helped overcome the so-called collateral technology hurdle, which has long been the main obstacle to financial access by the poor and has hindered the development of credit markets in Africa.

Expansion of digital financial services for cross-border payments and international remittances: Regional cross-border payments and international remittance transfers are starting to come on board. The Kenyan example shows that once the process reaches this phase, demand for regulations to cope with innovations and more intensive use of technology to monitor this market can even discourage money laundering and the financing of terrorism.

Immediate impact

Traditional financial institutions were initially skeptical: it was hard to fathom how financial services, especially banking services, could be provided through a mobile phone. They soon saw the advantages of linking communication and transactions in real time. M-Pesa allows transactions to take place across different segments of the market using the same platform. Commercial banks eliminated the extra costs charged to high-risk potential customers, because M-Pesa’s real-time settlement platform does not require traditional risk assessment. There was an unbundling effect: payments and liquidity distribution took place outside the halls of banking, allowing banks to tailor their products to small-scale demand (Klein and Mayer, 2012). In a sense, commercial banks and microfinance institutions saw that investing in a technological platform suited to handling micro accounts was an opportunity to expand their deposit base and market share. Moreover, they realized that greater capacity and higher intermediation would encourage microsavers to deposit even more in the banking system.

Cashing In on the Digital Revolution

TCashing In on the Digital Revolutionhe impact was immediate: total access to financial services of all kinds has increased steadily in recent years in several African countries, despite some decline in the reach of informal len
ders (see Chart 1). FinScope surveys conducted by the Financial Sector Deepening Trust (with networks throughout Africa) show a dramatic decline in the share of the “excluded” population. For example, in Rwanda, 89 percent of the population had some kind of financial access in 2016. This was made possible by the expansion of activities of savings and credit cooperatives and growth in digital financial services supported by online government services (Rwanda FinScope, 2016).


The drop in exclusion is also remarkable in Kenya (25 percentage points in the past 10 years), explained by entrance into markets of supervised institutions, including banks (accessibility grew from 15 to 42 percent of the population between 2006 and 2016). Progress in Tanzania and Uganda up to 2013 was also notable (28 and 15 percentage point reduction in exclusion, respectively, between 2009 and 2013), mainly explained by growing activities of nonbank institutions (see Chart 2).

The Kenyan example shows that financial inclusion is more about opening financial services to the poor than just providing affordable financing. Banks’ bet on expanding the infrastructure for greater financial presence has been largely successful. More bank branches (especially in rural areas), automated teller machines in growing urban centers, and bank agents in remote locations have all paid off in new and highly profitable business opportunities. And Kenyan banks are now exporting their redefined business models to the rest of Africa, supported by their expanded deposit base. Some 11 Kenyan banks now have more than 300 branch outlets in east Africa (including South Sudan).

Cashing In on the Digital Revolution

At the same time, contrary to common belief, increased financial access has led to improved quality of bank assets when accompanied by better financial oversight. The recent drop in the share of nonperforming loans in total loans reflects mainly better credit appraisal—thanks to measures such as the 2010 Credit Information Sharingregulation, which helped reduce the disparity in information between lenders and prospective small-scale borrowers (see Chart 3).

Welfare gains

Kenya is a good example of the potential benefits of financial inclusion. Based on a model by IMF economists Dabla-Norris and others (2015), we estimated the reduction in transaction costs and the impact on Kenya’s growth from financial inclusion. First, it generates additional funds channelled to entrepreneurs. Second, lower transaction costs help improve the efficiency of contracts. Finally, more efficient allocation of funds in the financial system allows talented people without resources to become entrepreneurs.

All these channels are expected to be significant in Kenya given that country’s substantial increase in access to credit by small and medium-sized enterprises—from 25 percent to 33 percent between 2006 and 2013 (World Bank Enterprise Surveys). Our preliminary results show a reduction in transaction costs of 65 percent during 2006–13, with an annual contribution to GDP growth of about 0.45 percentage point (Morales and others, forthcoming).

This boost to credit access took place even though it was partly offset by the rollout of stronger financial regulations, which raised monitoring costs and collateral requirements. This implies that financial inclusion through adequate policies could complement efforts to strengthen the financial regulatory framework, by helping banks expand their lending base while enhancing their soundness. The dramatic reduction in transaction costs spurred by digital financial services has clearly played a key role in this achievement.

Digital financial services not only contribute to financial development, they also support financial stability. With less need for cash for transactions, more economic agents can send and follow financial market signals, contributing to a more solid and vibrant financial system. The environment for monetary policy improves as a result.

In addition to these benefits, there are other reasons why proactive policies enhance financial inclusion:

  • Achieving inclusive growth without fast progress in financial inclusion in low-income countries is very difficult. According to World Bank Enterprise Surveys, in most African countries, small and medium-sized enterprises still report lack of access to financial services as their main obstacle to conducting business. These enterprises are a key sector of the economy because of their potential for employment generation and reduction of the informal sector.
  • For low-income countries with some degree of financial intermediation, there is a clear correlation between financial inclusion and human development (IMF, 2014), which points to a need to improve the regulatory technology.
  • Successful financial inclusion discourages policies that constrain market development. In several African countries initiatives still focus on specialized institutions, such as development banks or other institutions that lend to particular sectors—in agriculture or to small and medium-sized businesses—or on initiatives to introduce interest rate controls, despite overwhelming evidence against their effectiveness. As more and more citizens benefit from financial inclusion, the case for inappropriate measures will weaken.

In addition to lowering the costs of transactions, financial inclusion opens the door for potentially game-changing opportunities: innovative pension plan support and government-targeted social protection, expansion of regional payment systems within regional blocks, enforcement of policies to stop money laundering and the financing of terrorism, and a better environment for forward-looking monetary policy to replace years of financial repression and reactive policies. ■

Njuguna Ndung’u is an associate professor of economics at the University of Nairobi and was previously Governor of the Central Bank of Kenya. Lydia Ndirangu is the Head of the Research Centre at the Kenya School of Monetary Studies. Armando Morales is the IMF Resident Representative in Kenya.


Dabla-Norris, Era, Yan Ji, Robert Townsend, and D. Filiz Unsal, 2015, “Identifying Constraints to Financial Inclusion and Their Impact on GDP and Inequality: A Structural Framework for Policy,” IMF Working Paper 15/22 (Washington: International Monetary Fund).

FinScope Surveys, various issues (Midrand, South Africa: FinMark Trust).

International Monetary Fund (IMF), 2014, Regional Economic Outlook: Sub-Saharan Africa—Fostering Durable and Inclusive Growth (Washington, April).

Kimenyi, Mwangi S., and Njuguna S. Ndung’u, 2009, “Expanding the Financial Services Frontier: Lessons from Mobile Phone Banking in Kenya” (Washington: Brookings Institution).

Klein, Michael, and Colin Mayer, 2012, “Mobile Banking and Financial Inclusion: The Regulatory Lessons,” World Bank Policy Research Working Paper 5664 (Washington).

Morales, Armando, Lydia Ndirangu, Njuguna Ndung’u, and Fan Yang, forthcoming, “Measuring the Impact of Financial Inclusion in Kenya,” IMF Working Paper (Washington: International Monetary Fund).

World Bank Enterprise Surveys, various issues.

Opinions expressed in articles and other materials are those of the authors; they do not necessarily reflect IMF policy.