afdb africa economic brief · 2.2 securitization of future receivables one of the innovative ways...

A f r i c a n D e v e l o p m e n t B a n k

AfDB

1 – Introduction

Despite Africa’s widening financing gap toaddress its core development problems tra-ditional sources of finance have proved tobe inadequate in quantity and composi-tion. Official Development Assistance (ODA)and Foreign Direct Investment (FDI), one ofthe major sources of external finance conti-

nued to decline as a share of GDP over thelast decades (Figure 1). Certainly, there havebeen relative improvements in the flow ofnet FDI and ODA since 2000. However,both are still lower than their level in 1995.On the other hand, remittances by migrantsfrom Africa increased steadily from 2.2% ofGDP in 1995 to about 3% of GDP in 2008.

KEY POINTS

• Among other regions of the world,Africa, particularly Sub-Saharan Africaremains less diversified in its externalresource flows, and depends on Offi-cial Development Assistance (ODA) tofinance public investment. Innovativefinance is crucial to enhance efficiencybut also mitigate volatility in the flow ofexternal resources that characterizethe traditional sources, including ODA.

• Remittance inflows to Africa were esti-mated around 37 billion USD in 2010marking a significant jump from justunder 10 billion in 1995 and have over-taken ODA. This figure is significantlyunderstated due to prevalence of infor-mal channels of remittances. Reducingremittance cost as well as increasingtransparency in banking transactionscould increase official remittances byabout 3 billion USD every year overand above the trend.

• Securitization of future flows of remit-tances can generate an extra 2 billionUSD annually for African countries.

• Diaspora Bonds have a rich history ofbailing out countries in times of crisisand in some cases financing key deve-lopment undertakings. Often DiasporaBonds are long-term in nature only tobe redeemed upon maturity, and arerelatively cheaper to the issuer. Thereis little experience in Africa in exploi-ting Diaspora Bonds, but the potentialis enormous. It is expected that closeto 10 billion USD could be raised an-nually from the wealth of the Diaspora.

Mthuli [email protected]+216 7110 2062

Charles Leyeka [email protected]+216 7110 2175

Leonce Ndikumana [email protected]+216 7110 2076

Diaspora Bonds and Securitization of Remittances for Africa’s Development Abebe Shimeles*

Chief Economist ComplexVolume 1 • Issue 7December 2010www.afdb.org

1 Principal Research Economist, EDRE.2.

Africa Economic Brief

Sources: Author’s computation using data from the African Development Bank.

Figure 1: Net Flow of ODA, FDI and Remittances in Africa: 1995-2009

The other underlying feature is that bothFDI and ODA are subject to high degreeof uncertainty denying policy makersmuch needed degrees of freedom in ma-king investment plans. The coefficient ofvariation of FDI and ODA during 1995-2009 was respectively more than fiveand three fold compared to remittances.

In addition to predictability of aid its allo-cation and utilization are also important

areas of concern. A comparison of opti-mal aid allocation versus actual flow ofaid for selected African countries suggestthat only 20% of global aid allocated toAfrica is consistent with the objective ofpromoting growth and poverty reduc-tion. If global aid were reallocated in sucha way that donors’ ultimate objective is topromote growth by supporting countriesthat utilize effectively aid for develop-ment, then, existing aid would be suffi-

cient to reach goal 1 of the MDGs. Thisresult indicates that there is substantialleakage and wastage in the delivery, al-location, and utilization of aid for deve-lopment.

Both for reasons of efficiency as well aspredictability, Africa need to exploit thepotential for innovative finance that canplay a major role in sustaining and acce-lerating growth.


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AfDB Africa Economic BriefChief Economist Complex

Volume 1 • Issue 7 • December 2010 • www.afdb.org

Source: Shimeles (2010)

Figure 2: Optimal (simulated) Aid vs. Actual Aid Allocation in Selected African Countries

Certainly these figures are understateddue to prevalence of unofficial remittanceinflows in most countries in Africa. Barriersinclude hefty transaction costs andconcern on the transparency of bankswhere large transfers are involved. Stu-

dies show that while remittances in gene-ral are cost inelastic, often sent to rescuefamilies under financial stress, still consi-derable gains can be expected if interna-tional norms for interbank transfers aregradually implemented across Africa. Exis-

ting studies show that the average cost ofremitting money from London to Lagos isaround 14%. It is even more costly to re-mit money within the continent. For ins-tance the cost of sending money fromCotonou to Lagos is estimated at 17%.


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AfDBAfrica Economic BriefChief Economist Complex


2 Figures provided by World Bank (2011).3 Ratha et al (2008).

2 – Innovative Finance for Sustained and StrongGrowth in Africa

For reasons of efficiency and predictabi-lity of development financing, Africa needto exploit the potential for various forms ofinnovative finance to accelerate and sus-tain growth. In this context, remittancesdeserve serious attention from policy ma-kers and development practitioners.

2.1 Mobilization of remittances

Non-traditional sources of finance,such as remittances have grown in im-portance in the last decade in manyAfrican countries. In 2010, Nigeria re-ceived close to 10 billion USD in remit-tances, ranking first in Africa followedby Egypt (7.7 billion USD) and Morocco(6.4 billion USD). The whole continentis estimated to have received close to

37 billion USD net remittance inflows in2010. In terms of its impact on the eco-nomy, remittances make up more than5% of GDP in at least 12 African coun-tries in 2009 (Figure 3). For countriessuch as Lesotho (24%) and Togo (10%)remittances represent a lifeline contri-buting smoothing household con -sumption, boosting foreign exchangereserves, financing domestic invest-ment2.

Source: Authors’ computations based on Migration and Remittances Fact Book 2011.

Figure3: Remittances in Selected African Countries in 2009 (% of GDP)


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4 This paragraph draws heavily from Ketakar and Ratha (2009).5 The discussion in this and following paragraph draws from Ratha et al (2008).

Perhaps it is more in other less developedregions of the continent. In addition, im-proved systems of regulation and trans-parency could encourage transfer of largefunds for different purposes, including in-vestment, retirement benefits or others3. It is also important to note that remit-tances in recent years generally havecompeted very closely with that of Offi-cial Development Assistance, setting adifferent trend in the sources of externalresources for African countries. The cri-sis caused a decline in ODA flows toAfrican countries by almost 50% in2009 while remittances remained resi-lient (Figure4). In absolute terms, remit-tances actually continued to rise. Thereis therefore every reason for African

countries to target seriously the mobili-zation of remittances for developmentpurposes.

2.2 Securitization of future receivables

One of the innovative ways to capitalizeon remittances as well as future recei-vables such as export revenues andtourism receipts is securitization. Thiswill help countries in Africa access in-ternational capital markets, reduceconvertibility risk, and obtain invest-ment-grade ratings. Securitization is atransaction that involves a potentialborrower pledging future hard-currencyreceivables as collateral to a special

purpose entity that issues the debt4.The flow of foreign currency from re-mittances, and other sources (oil reve-nues, airline ticket receivables, etc) areused to service the debt. Because re-mittances have become increasinglylarge and predictable, the benefit ofsecuritizing them is substantial. The se-curitization potential for key receiva-bles is estimated around 17 billion ayear of which close to 2 billion USDcan be raised from future flow of re-mittances5.

The securitization of future revenues isnot new in Africa. The African Export-Import Bank (Afreximbank) facilitateda number of future flow securitizations.

Source: OECD data base

Figure 4: ODA Flows in current millions of USD to Africa (net disbursements)


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Table 1: Potential market for Diaspora Bonds

Source: Ratha et al (2008).

Country Diaspora stock (‘000) Potential Diaspora saving (USD billion)

South Africa 713 2.9

Nigeria 837 2.8

kenya 427 1.7

Ghana 907 1.7

Ethiopia 446 1.6

Total SSA 15,854 28.5

It arranged for Ghana to borrow 40 mil-lion USD in favor of a developmentbank where the loan was backed byWestern Union remittance receivables.In Nigeria Afreximbank facilitated a loanof 50 million USD against flow of re-mittances through Moneygram.

The potential of securitization in low in-come African countries is unexploitedfor a number of reasons. Weak financialsector development, inadequate wor-king relationship and experience in in-ternational banking, low capacity to en-force contracts and protect creditors,all contribute to the difficulty of imple-menting a complex instrument as se-curitization of future flows. But, giventhe urgent need to scale up develop-

ment finance in the continent, it is im-portant to bank on innovative debt ins-truments.

2.3 Diaspora bonds

“Diaspora Bonds” are debt instrumentsissued by a homeland government toraise capital mainly from the Diaspora asalternative to borrowing from the inter-national capital market, multilateral fi-nancial institutions or bilateral loans fromgovernments. The practice of the Dias-pora Bond goes back to the early 1930sby Japan and China, continuing into thepresent day with the State of Israel Bondstanding out as a unique example whichmobilized close to 25 billion USD in thecourse of the last 30 years6. The Resur-

gent India Bond issued right after thesanction the country faced following itstest of a nuclear bomb raised close to 11billion USD from the Diaspora. Greece isall set to raise capital from the Diasporaas early as in 2011 as borrowing fromthe international market became costlyand its financing needs becoming evermore acute.

Africa has little experience in tappinginto the wealth and savings of the Dias-pora to finance much needed develop-ment projects. The closest a countryhas come to raising significant capitalthrough Diaspora Bond is Ethiopia’s re-cent attempt to finance its ambitious hy-dro-electric power generation project.The bond, aptly called Millennium Bond,

was issued by the country’s power au-thority and underwritten by the NationalBank of Ethiopia. Three types of bondswere issued according to their maturitydate, 5, 7, and 10 years, each bearingan interest rate of 4%, 4.5% and 5%,

respectively. The effort is certainly com-mendable especially given the country’srecent resurgence in growth, which re-quires adequate stable financing to sup-port the growth momentum in the me-dium term.

Diaspora Bonds certainly have a hugepromise for Africa. Currently it is estima-ted that close to 16 million African mi-grants from Africa live in Middle East andOECD countries. Given assumptionsabout labor market participation (em-

6 See Chander (2001).

ployment rate) and earnings, it is esti-mated that migrants from Africa couldpotentially save approximately 10 billionUSD annually which under the rightconditions could be invested in DiasporaBonds. This figure would be much higherif concerted effort is made to appeal tothe 140 million-strong African Diasporawho currently lives in the Western He-misphere.

Diaspora Bonds are generally cheaper asthe motives for purchasing such bondsare not entirely for purposes of profit.The keen desire to be involved in deve-lopment of home country is the key mo-tive for the members of the Diaspora toacquire such bonds.

3 Conclusions

Africa’s financing gap to achieve strongand sustained growth is astronomical,and cannot be met only through traditio-nal sources such as ODA and FDI. Par-ticularly starved of finance is the privatesector. The contribution of small scalebusinesses and informal sector opera-tors in Africa for national developmenthas received recognition in recent years.Surveys show that high cost of finance ingeneral and lack of access to finance inparticular for small scale and informalsectors operators is the highest inAfrica7. Removing this constraint cer-tainly helps attain strong, sustained andshared growth in the years ahead.

The potential for non-traditional, innova-tive sources of development finance forAfrica is impressive. In 2010, remittances

are expected to overtake ODA flows bya significant amount and are also pro-jected to increase steadily. Other sourcesof innovative finance such as securitiza-tion of future receivables, Diaspora Bondand others could bring in a combinedadditional 15 to 20 billion USD a year.But, there is much work to do so that thepotential of innovative sources of financecan be realized.

Factors that generally allow for the flou-rishing of informal channels for the trans-fer of remittances need to be identifiedand dealt with adequately. Often, highfees charged by official money transferagencies force migrants to seek alterna-tive means of money transfer. Some stu-dies report that a 1% decline in the costof remitting money could increase thevolume of remittances by about 0.22.Greater transparency and flexibility by lo-cal banks can also help increase the vo-lume of remittances and encourage mi-grants to engage in investment activities.Securitization of future flow of remit-tances adds substantial capacity for na-tional governments to raise capital chea-ply from the international market tofinance important development projects.Africa is expected to gain an additional 2billion USD annually from such an instru-ment.

Diaspora Bonds are proven means ofraising cheap and long term financefrom migrants interested in the deve-lopment of their home country. Africahas a substantial migrant population li-ving in high income countries. Currentlythere are 16 million migrants with someform of attachment with the country oforigin. Close to 140 million people also

live in the Western Hemisphere with Afri-can descent that may not however beable to trace a specific country of originbut deeply interested in the develop-ment of Africa. Devising appropriateDiaspora Bond that responds to thesentiments of the migrant communitycould raise billions for purposes of de-velopment.

To tap the potential of remittances, it isnecessary to address key impediments,notably: weak and non-transparent le-gal systems for the enforcement ofcontracts, lack of competent financialinstitutions that can facilitate the mar-keting of such financial instruments, ge-neral mistrust of local institutions to ho-nor their obligations, lack of clarity onrules that govern Diaspora Bonds inthe host country and poor communica-tion with Diaspora networks which arecrucial in reducing investor risk arisingfrom information asymmetry.

The African Development Bank canplay a pivotal role in alleviating some ofthe institutional constraints that Africancountries face to exploit the potential ofinnovative sources of development fi-nance. Interventions could include:creating the platform to engage theDiaspora to participate in the develop-ment agenda of the African continent,assisting in establishing mechanismsfor guaranteeing Diaspora Bonds, pus-hing reforms in the financial sector andsupporting projects that enhance theperformance of African private equityfirms. This fits with the Bank’s strategyof supporting private sector develop-ment and economic governance re-forms.


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7 Aig-Imoukhuede (2010) reports that more than 65% of firms in Africa reported that cost of finance is a major constraint for growth and about 45% said thataccess to finance is key for their development. Shimeles (2006) reported that informal sector operators in Ethiopia consider access to finance a major bottleneckfor their growth.


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REFERENCES

Aig-Imoukhuede, A. (2010), “Innovative financing: looking beyond the glo-bal financial crisis”, Presentation at the G8 Africa Business Forum

Arabache, J.S. and Page, J. (2009), “How fragile is Africa’s recent growth?”Journal of African Economies, 19(1): 1-24

Chander, A, (2001)” Diaspora Bonds”, New York University Law Review:76(4): 37-53

Ketkar, S. and Ratha, D. (2009), “Future-Flow Securitization for Develop-ment Finance” in Ketkar, S. (ed), Innovative finance for development, WorldBank. Washingotn

Ratha, D., S. Mohapatra, and S. Plaza (2008), “Beyond aid: new sourcesand innovative mechanism for financing development in Sub-SaharanAfrica”, Policy Research Working Paper, 4609, World Bank, Washington

Shimeles, A. (2010), “Financing goal 1 of the MDGs in Africa: evidence fromcross-country analysis”, memo, Development Research Department, Afri-can Development

Shimeles, A. (2006), “Informal sector and national development in Ethio-pia”, memo, AERC, Nairobi, Kenya

World Bank (2011), “Migration and Remittances Fact Book 2011”, Wash-ington DC




© 2011 - AfDB - Layout, ERCU/YAL

The views expressed in the Africa Economic Brief are those of the authors and do not necessarily represent the viewsof the African Development Bank, the Board of Governors, the Board of Directors or the Governments they represent.

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