Remittances, FDI and aid - exploring major money flows to Africa
Why foreign direct investments have the most positive impact on development
Hi everyone,
today we dive deeper into money flows. Remittances, foreign direct investments (FDI) and aid - what’s the situation, the challenges and what has the most impact on sustainable and inclusive development on the continent.
To spill the beans upfront, FDI has the most positive impact on job creation and economic growth - which is also why we don’t get tired of highlighting the opportunities that the African continent offers for investors.
Read on to learn more.
🕐 In a Hurry? Here's a 1-Minute Summary:
Dominance of Remittances: Remittances to Africa totaled $100 billion in 2022, the largest source of external financial flows, supporting household income, especially in rural areas. They accounted for 3.4% of Africa's GDP.
Foreign Direct Investment (FDI): FDI is essential for economic development but remains low, with Africa receiving only $45 billion in 2022, just 3.5% of global FDI. Key drivers include natural resources, infrastructure, technology, and financial services.
Overseas Development Assistance (ODA): Aid flows have decreased from 6.6% of GDP in 1990 to around 2.5% today, yet remain crucial for low-income countries. The United States, Europe, and increasingly China are primary donors.
Challenges to Financial Flows: High remittance costs, low FDI levels, declining aid, illicit financial flows, fragmented markets, and reliance on primary commodities hinder Africa's economic potential.
Impact on Development: FDI has the most significant positive effect on GDP per capita and poverty reduction. By 2043, increased FDI could raise GDP per capita by $142 and reduce the number of poor people by 15.5 million, making it the most impactful financial flow for Africa's long-term development.
⏳ Ready for a Deeper Dive? Here's the Breakdown:
Africa’s development significantly influenced by remittances, foreign direct investment and overseas development assistance
These financial sources play crucial roles in supplementing domestic resources, stimulating economic growth, and reducing poverty across the continent.
1. Dominance of Remittances
Remittances have become the largest source of external financial flows to Africa, 100 billion USD in 2022, surpassing both FDI and aid. This inflow is vital for household income, especially in rural areas, supporting essential needs such as food, education, and healthcare.
In 2022, remittances accounted for 3.4% of Africa's GDP. Projections for 2024 indicate a further 2.5% increase in remittance flows. However, the cost of sending money remains high.
2. Foreign Direct Investment
FDI is crucial for Africa's economic development and poverty reduction, but remains low. In 2021, Africa saw a record $83 billion in FDI, significantly rebounding from the pandemic-induced slump in 2020.
In 2022, global FDI inflows totaled $1.3 trillion, with Asia receiving $662 billion and Latin America over $200 billion, while Africa received only $45 billion, accounting for only 3.5% of global FDI. Per capita, FDI in Africa remains marginal compared to other regions.
Key drivers of FDI in Africa include natural resources, infrastructure, technology, and financial services sectors.
FDIs differ significantly between the countries. Egypt’s FDI more than doubled to $11 billion in 2022 due to increased mergers and acquisitions. Nigeria experienced negative FDI flows (-$187 million) due to equity divestments, though greenfield projects rose.
3. Overseas Development Assistance: Declining Yet Crucial
In 2022, 25% of international aid went to Africa. However, aid flows have declined from a peak of 6.6% of GDP in 1990 to around 2.5% of GDP today. Despite this decrease, aid remains essential, particularly for low-income countries, supporting various developmental projects and humanitarian needs. The United States and Europe are the primary donors, though China's influence is growing.
Africa is increasingly focusing on mobilizing domestic resources and attracting private capital for development projects. The African Continental Free Trade Area (AfCFTA) and global collaborations, such as those with the G20, aim to create an environment conducive to green financing and sustainable investments. These initiatives are crucial for bridging the financing gap in infrastructure, healthcare, and education.
While remittances, FDI, and ODA are essential for Africa's development, their full potential is not being realized
High Costs of Remittances: While remittances are vital for household incomes, the cost of sending money to Africa remains prohibitively high, averaging 7.9% for $200. This reduces the effective amount received by families and limits the overall economic benefit.
Low FDI Levels: Despite high growth potential and abundant natural resources, Africa attracts far less investment per capita than Asia or Latin America. Contributing factors include political instability, economic uncertainty, underdeveloped financial markets, poor infrastructure, and weak regulatory frameworks.
Declining Aid: Although still crucial, especially for low-income countries, the decline in aid has not kept pace with Africa's growing needs. The growing influence of China as a donor adds complexity to the traditional aid dynamics, potentially leading to debt sustainability issues due to non-concessional loan terms.
Illicit Financial Flows: Africa loses between $50 billion and $80 billion annually due to illicit financial flows, including tax evasion, corruption, and illegal transactions. These outflows drain resources that could be invested domestically.
Aid, remittances, and FDI each have distinct impacts on Africa's socio-economic development.
Remittances: Remittances can boost growth by providing resources for investment and consumption. However, their positive impact is limited by factors like spending on imports, real exchange rate appreciation, and the potential 'brain drain' of skilled workers.
FDI: FDI is crucial for capital accumulation, technology transfer, and managerial skills. It directly reduces poverty by creating jobs and enabling further job creation through knowledge transfer. Labor-intensive manufacturing FDI, similar to the Asian model, is particularly effective in reducing poverty.
Aid: To be effective in reducing poverty, aid should be targeted at specific programs and objectives, such as health and education.
FDI has the most significant positive effect on GDP per capita and poverty reduction compared to other financial flows
FDI has the most significant impact on poverty reduction in upper-middle- and lower-middle-income groups. For low-income groups, aid remains crucial for poverty reduction, closely followed by FDI.
By 2043, increased FDI could raise Africa's GDP per capita by $142 above the current path forecast. While aid and remittances would have much smaller effects ($20 and $4, respectively).
Increased FDI could reduce the number of poor people in Africa to 383 million by 2043, 15.5 million fewer than the current path forecast.
Sources to learn more:
Remitscope - The global platform for remittance related data
Investment flows to Africa dropped to $45 billion in 2022 by UN Trade & Development
False economy: Why Europeans should stop slashing development aid to Africa by ECFR
AidFlows - Flows of aid around the world by country and organization
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Disclaimer: All information provided is not intended to serve as investment advice. Any mention of industries or countries should not be taken as an endorsement.