Africa Tax Summit 2021: Trade from a Tax Perspective

This growing institutional capacity is a by-product of the underlying gains in political stability – whilst democratic transitions are fresh and fragile in many countries on the continent, the drop in the number of coups and the rise of peacefully-conducted elections has freed civil servants across ministries and institutions to do their jobs. Preserving this political stability and building on governance gains will be crucial.

Investors have taken notice, and are also ready to act on another trend, and a notably durable one: Africa is the world’s youngest continent, and stands out in a world of aging and shrinking populations. In the coming decades Africa will be the world’s only source of growing labour forces and consumer bases. This narrative helps why extractives are no longer the primary source of FDI, and why the basic investment focus in Africa is shifting from resources to services. The majority of investors now aim to participate more deeply in African economies, rather than exporting local resources for use elsewhere. 

Many of the policies required to capitalize on today’s economic environment address both tax and trade, and the benefits will extend beyond what ACFTA promises. Simplifying tax rates and codes and broadening tax bases will deliver broad-based gains.

The ambitious trade pact commits the 54 signatory countries to removing 90 percent of tariff lines for goods as well as for services. Implementation was to begin just as the pandemic shut down the global economy in March 2020, and leaders opted for a short delay to take stock rather than putting the entire process on hold. At last year’s EY Africa Tax Summit, the discussion focused on political will: would there still be sufficient amounts of it during the challenging implementation stages? Panellists were concerned about the potential short-term loss of tariff revenue in order to achieve the long-term gains, and this apprehension remains paramount given the rising public debt in many African countries.

One way to measure political will is the speed at which leaders agreed on the deal: it took less than five years for trade negotiators and politicians to negotiate and ratify AFCTA, according to research from Olumide Abimbola, Executive Director of the Berlin-based Africa Policy Research Institute. In contrast, some African countries’ and regional organizations’ negotiations for Economic Partnership Agreements with the EU have dragged on without a deal for more than a decade, and some deals were agreed on but are not being implemented. The continent’s politicians have signalled that they would rather trade with each other.

Economic research supports that approach. When African countries trade with each other they are more likely to exchange value-added goods than raw materials, as they do in global trade, according to the United Nations’ Economic Commission for Africa. The process creates more value and knowledge exchange. A study by The World Bank anticipated ACTFTA will increase average wages in Africa by about 10 percent.

However, an effective AFCTA would also boost FDI from beyond the continent, in particular as global businesses realign their supply chains. The increased resilience multinationals seek will steer capital to Africa to create regional supply chains. Likely sources include European Union countries and China, as these are the most common destinations for current African exports.

For tax authorities, reforms to aid this process typically fall into two categories: simplification policies and base-broadening policies. Simplification of tax codes and rates can make them more uniform, providing taxpayers an easier path to compliance and tax authorities with a reduced need to audit and arbitrate. In both cases, digital tools are crucial solutions. 

As attention turns to the post-pandemic economy, the latest FDI data for Africa already indicate a return of the trends developing before the pandemic. The most important one is the growing interest in Africa from investors looking beyond the extractive industries, and in particular beyond oil, gas, and coal. From 2015 to 2020, the value of investment in those three commodities reached $2.97 billion. That made it the third-most popular sector for FDI. In contrast, communications attracted $8.48 billion in capital, the most of any sector, followed by renewable energy at $4.68 billion.

An EY study of FDI in Africa confirms that this trend is not new – it has been a slow transformation. From 2005 to 2011, extractives overall accounted for more than half of investment in all but one year in the period in sub-Saharan Africa. From 2011 to 2018, they accounted for less than half in each year save for one. The shift toward services has meant more job creation. Investments in the three most popular sectors created 10,625 new jobs from 2015 to 2020, with 87.2 percent of them from communications and renewables.

For 2019, the last year before the pandemic distorted figures, the value of FDI was $68.9 billion, with services sectors accounting for 24 percent and extractives just 4 percent. In addition to communications investments, the services sectors that were most popular included business services; food and beverages; and transportation and warehousing. 

This long-term, structural FDI shift away from extractives and toward services can be explained by both push and pull factors. Africa’s demographic, and long-term improvements in political stability and governance, pull in the new investors in services. Push factors for petroleum are speeding up the transition, as familiar investors are increasingly cautious of major new projects thanks to decarbonization, and considering the relative attractiveness of projects on other continents.

Investments in telecommunications and technology in particular, both in the private sector and public, create a positive feedback loop. In 2020, in the midst of the Covid-19 crisis, the countries with the greatest capacity to deliver digital services saw smaller declines in FDI investment, and economic recessions were either avoided or less severe. West Africa, for example, which lags East and Southern Africa in digitalization, received a smaller share of FDI.

Digital capacity led to economic resilience through governments’ ability to send digital cash transfers to people via electronic platforms, and from e-commerce services, which eliminated concerns about Covid contagion by offering contactless delivery and cashless payment. “The numbers tell us that countries and sectors that have adopted digital platforms were more resilient, and are attracting more investment now as a result,” said EY’s Sandile Hlophe, EY Africa Industry Leader for Government and Infrastructure.

In West Africa, the region’s largest economies in Ghana and Nigeria are closely linked to global trade and commodity prices. Both expect a rebound in 2021. However, Ghana’s plans to tap global capital markets will likely send its debt-to-GDP ratio above 80 percent, a reminder that debt distress is a significant risk to growth narratives across Africa.

East Africa’s economy remained the fastest growing on the continent in 2020, with the regional average GDP growth at 2.3 percent. Kenya’s economy contracted slightly for the first time in two decades, but rebounds in services-sector FDI should restore a GDP growth at a rate of at least 5 percent. In addition to debt levels, risks in the region also include political instability in Ethiopia and low vaccination rates.

In Southern Africa, South Africa led the continent in COVID cases and saw its GDP shrink by 7 percent, the most precipitous decline in more than a century. However, a global economic rebound is likely to boost export earnings. Risks in the southern region start with debt distress, in particular in Mozambique, one of six African countries with debts of at least 120 percent of GDP. Zambia’s efforts to restructure its debt could help set wider expectations, as it faces restructurings with Chinese lenders, global investors, and commercial banks.