Broadly, the core mandates of central banks around the world are twofold: maintaining price stability and oversight of the financial system. There are nuances of course. Famously, the US Fed, for example, also has the responsibility to promote employment, in addition to price stability.
In the context of our countries, by and large, the formal and core mandate of central banks are similar.
But operating as they do in a hugely complex and dynamic environment, central banks in our countries also have at least two more factors—even if informally—that they consider as core mandates.
Fostering financial sector development—going well beyond the typical role of central banks, as elsewhere, needing to supervise and regulating banks and financial markets. In most African countries, financial deepening remains a major challenge.
For one, access to banking services remains far from universal, even with the advent of fintech. And beyond basic banking services financial intermediation still has ways to go.
Central banks in the region are also implicated in governments’ quest for financing, both internally and externally. The extent of this varies from country to country, of course. But with domestic financial markets rather shallow in most of the region, some governments borrow directly from central banks. And even where that is not the case, in the region rare is the central bank that does not keep a keen eye on the cost of financing its fiscal authority is facing.
To be clear, I am not arguing that these two considerations are the responsibility, much less part of central banks’ mandates in the region. Rather, inevitably and unavoidably, they feature prominently as central banks pursue their core functions in most developing countries.
How then have central banks fared in the pursuit of these responsibilities over the years?
Increasing price stability
The journey of central banking in sub-Sahara has been one marked by resilience and transformation. Emerging from the shadows of colonial legacy, central banks in sub-Sahara started their journey in the early post-colonial era rigid fixed exchange rate and rule-based regimes, including currency boards.
Through the course of the 1970s and early 1980s though, countries found themselves facing severe oil price shocks, floating exchange rates internationally, tight financing conditions and considerable political turmoil. Central banks were struggling to achieve multiple objectives. This included the onerous task of financing government deficits, precipitating rampant inflation and economic instability.
The 1990s heralded a new era of reforms geared towards more discretionary arrangements. Many countries initiated bold reforms to shift towards more flexible exchange rate systems and to reduce dependence on central bank financing of fiscal deficits. This pivotal shift wasn’t just about new monetary policies to curb deficit financing; it was about reshaping the economic landscape and laying the groundwork for stability and growth.
During this period and into the 2000s, financial sector reforms took centre stage, with many countries modernising and liberalising their banking systems. Market-based interest rates were introduced, and independent regulatory agencies established. Moreover, regional integration initiatives, such as Ecowas, EAC, and SADC, spurred efforts to harmonise financial regulations and promoted cross-border banking supervision.
Engendering financial sector development
Despite the region historically lagging in credit-to-GDP ratios, reforms since the 2000s have spurred gradual increases, supported by regulatory enhancements and competition promotion. These efforts yielded notable benefits, including enhanced banking sector performance and stability, deeper financial intermediation, and improved financial literacy.
However, there is still ample room for growth, particularly in the realm of financial markets where progress has been less pronounced.
To further gauge progress in financial deepening, it is also useful to examine regional money multiplier trends. Higher multipliers in more developed financial systems signify banks' increased ability to lend efficiently, thus expanding the money supply.
Evidence across sub-Sahara suggests varying effectiveness in supporting economic development, influenced by factors like banking competition, financial innovation, monetary policy frameworks, fiscal-monetary policy interactions, and exposure to global conditions.
Despite recent strides, there remains substantial room for enhanced financial intermediation in the region, as median money multipliers lag those of emerging and advanced economies.
What is quite remarkable, on the other hand, is that the region is leading the world in innovative financial services based on mobile telephony. Mobile-based systems such as digital payments, digital savings, micro-insurance, peer-to-peer lending have boosted financial inclusion, especially in East Africa.
Yet, there is a significant untapped potential in other countries, offering solutions to infrastructure and other shortcomings.
Microfinance has also grown in some countries in SSA, aiding lower-income individuals.
Conditional on solid regulatory frameworks, such innovations could cut costs, lessen cash dependence, and boost financial development in SSA economies.
Financing the government
I would be remiss without touching on the issue of central bank lending to the government for fiscal purposes, something that many (but by no means all) central banks in the region have had to be involved in. Its appropriateness has been an issue of much debate over the years.
And recent economic developments have brought the matter once again to the fore. I am here talking about the funding squeeze many countries have been experiencing, as external financing conditions have tightened, domestic ones have followed, official development assistance declined, and tax revenue collection has been weak.
Excessive fiscal dominance has exacted a heavy toll in the region over the years, notably causing episodes of high inflation, heightened economic uncertainty, and undermining investment and growth. Examples include DRC (1991-92, 1993-94, and 1998), Angola (1994-97), and Zimbabwe (2007-08, 2019-20).
And short of three-digit and/or hyperinflation levels, there are many other episodes of inflation accelerating to the 30-50 percent range in countries around the region—recent cases include Ethiopia, Ghana, and Nigeria.
By no means am I arguing that central government borrowing is the only reason for the spike in inflation. Rather, it is a predominant factor, with other, often exogenous shocks—for example, food price increases—and accommodative monetary conditions also contributing.
Over the years, legal constraints on central bank financing of fiscal debt have been implemented worldwide, including in our region, to address the risks of fiscal dominance. Despite this, central bank lending to governments remains a pressure point in sub-Saharan Africa.
Recourse to central bank financing had started to drift to levels seen outside the region between 2000 and the global financial crisis—from four to two percent of GDP.
But since then, borrowing from central banks has been trending upwards, and jumped a notch with the onset of the Covid pandemic bringing the median level of borrowing back to the four percent mark for the region as of 2023. This is about double the level of other developing regions.
Challenges going forward
Overall, central banks in the region have been instrumental in the progress countries have made over the years. All the more so given the hugely challenging circumstances that central banks operate in, weak policy transmission mechanism, the still shallow financial markets and underdeveloped regulatory frameworks.
What makes our region so fascinating and working on issues affecting our countries so fascinating and demanding are the hours one could spend considering the difference in outcomes, say for inflation and growth, between and within countries with fixed and flexible exchange rate regimes.
Take just countries in the eastern part of the continent: was inflation higher in Ethiopia because of or despite the higher levels of growth observed over the years? How has Uganda been able to keep inflation consistently low?
In a more forward-looking vein, I have to say the context for macroeconomic policy formulation is a hugely challenging one. The progress that has been made is now being severely tested. The region faces hurdles from a decidedly difficult external environment—something that could get more difficult still if ongoing geopolitical tensions continue to further disrupt trade and investment flows.
More domestic policy challenges facing central bankers include the huge development financing needs countries face, persistent current account deficits and exchange rate pressures. All these constrain the scope for monetary policy manoeuvre. Decreasing international reserve buffers have also heightened vulnerability to external shocks.
In this difficult environment, safeguarding stability to foster the growth that countries need and the immiserating consequences of high inflation on the poor will be a challenging undertaking.
In this dynamic landscape, policymakers must adopt careful strategies, leveraging insights to calibrate monetary policy responses effectively, safeguarding against risks and nurturing resilience in the face of uncertainty. With this in mind, I would like to emphasise four key policy areas, which in my opinion have become increasingly important for central bankers today: exchange rate flexibility, contending with high public debt, financial sector risk management, and the growing importance of financial innovations.
Exchange rate flexibility
In sub-Sahara, the prevalence of fixed exchange rate regimes reflects a widespread "fear of floating," driven by concerns about exchange rate volatility's impact on inflation, balance sheets, and socio-political stability. This highlights the intricate balancing act policymakers face, especially amid current global volatility. However, relying on fixed exchange rates limits policy flexibility and risks sudden adjustments, necessitating a more adaptable monetary strategy.
Globally, more central banks are turning to inflation targeting, prioritising price stability while retaining the capacity to respond to economic shocks. Increasing monetary policy credibility is the antidote to the fear of floating.
Monetary policy credibility, which takes time to acquire, is like a three-legged stool: saying clearly what you do, consistently doing what you say, and having the policy independency to do. Once policy credibility is achieved, the degree of exchange rate pass-through declines.
Contending with high public debt
Even when central banks stay clear of direct financing of the government, the pressure to ensure that there is adequate liquidity in the system and for the government’s borrowing costs to remain contained has been an age-old challenge in our countries and elsewhere. And in our region now with public debt levels quite elevated and domestic debt quite high, this challenge is set to be more acute still. Specifically, domestic debt now accounts for around half of public debt.
The pressure for monetary policy to accommodate fiscal financing pressures has in the past been and going forward will be a clear threat to the central bank’s ability to control inflation. The primary responsibility in dealing with this challenge of course remain firmly the responsibility of fiscal authorities.
Financial risk management
Prudent financial sector risk management is paramount, especially in countries where pan-African banks play a pivotal role. The emergence of such banks has been a welcome feature of the economic landscape in recent years and will help foster economic integration, competition, and financial inclusion.
But it comes with some risks that need to be managed carefully, notably weaker oversight from home country supervision or openings to exploit regulatory asymmetry.
To tackle this, we must carefully manage rapid credit growth, uphold prudent underwriting standards, monitor concentrated exposures, utilize macroprudential tools effectively, bolster bank resolution frameworks, enhance regional supervisory coordination, and strengthen anti-money laundering/countering the financing of terrorism frameworks.
Financial innovations
With the proliferation of mobile money providers in Sub-Saharan Africa, central banks must upgrade their digital capabilities to ensure payments efficiency and manage risks, including those from crypto assets, cybersecurity, and illicit financial flows.
Selassie is the director of the IMF's African Department.
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