Africa’s Quest to Deleverage!

Africa continues to be plagued by high, and possibly unsustainable, debt levels, even after some have had their debt forgiven by lenders. Better taxing policies, greater transparency and new forms of payments through mutually beneficial projects are likely to garner a substantial social dividend. Austerity is unlikely to emerge as a lasting solution.

Majority of Financing comes from Foreign investors

The multilateral debt relief given to African countries saw a dramatic decline in debt stocks, but unlike the early 2000s where most of the debt was held by the IMF, World Bank and members of the Paris Club; foreign investors now constitute the majority of the continent’s lenders.

Source: Economist, IMF

This shift in investor profile over the past decade has complicated the already fraught relationship between debt restructuring and growth. If African countries default, the consequences would be wide-ranging, but capital flight would likely ensue at the very least, followed closely by a spike in bond yields.

The need for bespoke financing is reaching a pivotal moment. It would be ill-timed to restrain financing, as growth-dependent infrastructure projects are well underway in frontier economies such as Nigeria and Kenya. As the multilateral underpinnings of financing become less important, this will exacerbate credit crunches and the obstacles in access to finance. As such, African countries must deleverage in an effort to safeguard sustainable growth and ensure lasting prosperity.

Higher taxes or better taxing?

If higher taxes are a remote prospect, better taxation policies are necessary to deleverage in a sustainable manner. As developed market central banks turn away risk-free interest and normalize monetary policy, borrowing cost will undoubtedly rise for emerging market economies. Absent the repayment of concessional loans from known lenders such as the World Bank, EMs will have to contend with yield-hungry investors, a stronger dollar and rising trade protectionism and risk premiums reflecting political and economic uncertainty. As the informal sector shrinks, tax bases will increase, which should be reflected in government revenues. This will prevent a significant deterioration of fiscal buffers and support repayment during periods of crisis.

Greater transparency will reduce loopholes and increase tax receipts in the long-run. A more straightforward way to achieve this will be through automation, which is very much needed but largely undeveloped in some EM countries. Greater regulatory alignment between governments will lessen tax evasion and increase the capital available for repayment.

Economic Vs Social Dividend

A less straightforward, but perhaps more beneficial, way of deleveraging would be to ensure that the social dividend from new projects outweighs financial gain in the long term. If stakeholders’ payments are linked to specific outcomes, institutions will be inclined to lend more responsibly. This could undoubtedly restrain capital flows in the near term, but the country’s finances and productivity will likely benefit in the long run. This could allow countries to capitalise on global development projects such as China’s belt and road initiative, without significant deterioration in external balances.

Higher Oil Prices not here to stay for ever

Targeted investments would allow faster repayment of debt. Geopolitical uncertainty will provide tailwinds for oil and commodity prices going forward, even as risks of a global slowdown remain. As such, EMs must utilise current access to financial markets to improve oil industry infrastructure, and possibly seek to address global output lost to sanctions and trade wars. It remains to be seen how China responds to continued U.S. trade pressure, but they could significantly reduce imports of U.S. crude, for instance. This provides a unique opportunity for EMs, as OPEC spare capacity is unlikely to address global supply disruptions adequately. Increased revenue during a cyclical upswing will provide more ammunition to Ems, as monetary policy normalisation continues in DMs and borrowing costs rise as a result.

Finance should take other forms

Policy inertia is not a thing of the past, and despite continuous talk of greener and more sustainable energy sources, very few countries have made progress on reducing emissions to the extent that Norway and Sweden have. While Germany facilitates access to Russian gas, solar panels could facilitate greener energy around the globe. This represents a considerable opportunity for Africa in its deleveraging. Such projects could yield a double dividend, both for foreign investors and the countries receiving such finance. It is not outlandish to push for other sustainable means to repay debt. The question of how is more difficult, but one must try to diverge from traditional financing if true sustainability is sought. Energy security and global economic stability need not be mutually exclusive.

Austerity, at great social cost

Austerity is not a sustainable way for African countries to shed their debt.. Even as some economies have transitioned to “frontier” status, it remains unclear how many emerging economies will avoid the “middle income” trap that Chile has fallen into. Should this occur, it will be against a backdrop of DM normalisation as policymakers seek to “fix the roof while the sun shines”. In the context of rising protectionism and (not altogether unjustified) policies of crisis prevention could mean that debt repayment comes at greater social cost. So if developed economies must rethink their policy tools in the event of a financial crisis, emerging markets must think even harder.

Dealing with a prosperous developed world is one thing, dealing with the shockwaves of another crisis is another. Africa needs a new way of approaching economic challenges, if it is ever to achieve long-lasting growth.