By Steve Kayizzi-Mugerwa and Dawit Birhanu
As African countries seek today to consolidate their growth through increased foreign borrowing, the words “deja vu” are frequently cited, with experts’ eyes on the implications for debt distress. Some thirty five years ago, the Latin American economies had enjoyed similarly high growth levels buttressed by large inflows from US private banks, at sub-prime rates. While the latter helped close the region’s current account deficits, following the oil-price shocks of the 1970s, they also escalated the debt overhang. In the first half of the 1980s, Latin American debt had increased tenfold from the previous decade to 320 billion dollars. Subsequent external economic shocks and increases in US benchmark interest rates sucked capital out of the region, leading to a string of sovereign defaults.
Although African economies have enjoyed a decade of high growth, increased foreign and domestic investment and strong domestic consumption, analysts see the recent evolution of the debt burden as similar to that of Latin America in the 1980s. African countries are now more integrated in international financial markets, while risk profiles have improved as shown by increases in investor appetite for Africa’s sovereign debt issues in recent years, at historically low rates.
Compared to the past, when countries were confined to borrowing from bilateral and multilateral public lenders, many countries have today direct access to financial markets. But as growth rates begin to taper off in Asia, there are concerns over the medium-long term sustainability of Africa’s recent borrowing activity, although, it must be remarked, the continent’s debt levels are nowhere near those of the much bigger economies of Latin America at the height of their crises in the 1980s.
That the US Fed will raise rates before the end of 2015 is almost a foregone conclusion, although the exact date and amounts are still unknown. Inevitably, speculative bets with potentially detrimental effects for emerging economies have resulted – notably the premium between emerging-market debt and US Treasury’s had widened to 330 basis points by June 2015. Likewise, the US dollar has appreciated by some 10pc against major currencies and by much more against those of emerging markets. The strengthening dollar has encouraged investors to liquidate commodity contracts in favour of US Treasury bills, with important implications for natural resource exports from Africa.
Looking ahead, foreign portfolio investment in Africa will likely rebalance in response to the strong dollar. Lower US dollar adjusted returns might force the fickle investors to seek better returns elsewhere – a form of flight to safety. The outflow could be sizeable, nevertheless, given the rather large proportion of foreign portfolio investment in Africa’s stock markets. For countries like South Africa, this would not be the first time. In November 2013, in the earlier days of Fed tapering, the country saw outflows estimated at some 1.65 billion dollars.
Africa’s external debt has remained low in the past decade thanks to Highly Indebted Poor Countries (HIPC) Initiative and higher levels of growth in past decade. Nevertheless, Africa’s sovereign bond issues now make up about four percent of developing country debt compared to less than one percent over a decade ago. Elevated levels of foreign currency borrowing have the potential to cause currency mismatches when speculative shocks occur.
Today, a third of African countries have debt to gross domestic product (GDP) ratios in excess of 40pc. The outstanding sovereign debt for Africa as a whole increased 2.6 times between 2009 and 2015. In contrast, total debt in developing countries rose 2.3 times over the same period. The appreciation of the dollar has raised the nominal currency values of dollar denominated debts. Thus Africa’s outstanding bond debt is already 29pc higher today in real terms than it would have been had the dollar remained at its March 2011 level.
The increase in debt is also true of many emerging market economies that have contracted dollar denominated debt over the past five years. However, not all debtor countries in Africa face the same risk of indebtedness, as fundamentals are country specific. Africa has undoubtedly experienced a concurrence of global economic headwinds in recent years, including declining global demand, unfavourable commodity prices and the likelihood of further dollar appreciation, that have increased the risk of debt distress. Declining gold and cocoa prices and rising fiscal and trade deficits prompted Ghana, for example, to request a bridge loan from the International Monetary Fund (IMF). Zambia is facing similar headwinds. Copper prices have declined by 19pc year-on-year and the government budget is under stress from obligations related to fuel and agricultural subsidies.
The notion that governments can spend on growth inducing infrastructure projects is now well ingrained in Africa’s development debate. It will, nevertheless, be important to put in place a good institutional framework for debt management to prevent the risk of debt distress. In strategic terms, the absence of such a mechanism was as much to blame for the debt distress of the past as the size of country indebtedness.
Debt distress will become a serious issue, if funds for infrastructure investment are used to bridge the fiscal deficit of the government and for public consumption, as was the case with Latin America in the 1980s. However, the surprise is how well other African countries have generally managed to contain external shocks, and to embark once again on building reserves and related fiscal buffers.
In the medium-term, African countries should seriously assess the benefits of international sovereign bond issuance as compared to other forms of finance. Recent developments have shown that the threats of foreign and domestic currency denominated debt mismatches are real.
Kenya and other countries have shown, on the other hand, that there is potential for Africa’s local currency bond market to raise funds for capital projects, although the volume of issues is still limited. Here is a source that could provide a robust and sustainable means of domestic capital financing, while not subjecting countries to the same risk of debt distress.
Steve Kayizzi-Mugerwa (PhD), Acting Chief Economist of the African Development Bank (AfDB), and Dawit Birhanu, an expert at the Bank.