Corona Virus and Debt Dynamics in CEMAC region; Placing debt on a downward path
Synopsis: The Coronavirus (COVID-19) has caused a retrenchment in global economic activity, exacerbated by lockdowns that have disrupted sectors spanning tourism, manufacturing, and the energy sector. The abrupt increase in inflation outcomes and weaker currencies have exacerbated debt sustainability worries. The latter, driven by resource-backed loans, non-concessional and opaque concessional loans from multilateral institutions, development banks, and private investors. Placing debt on a sustainable trajectory consist of broadening the tax base by increasing the domestic employment share of debt-driven spending, invoicing intra-African trade in African currencies, and increasing the domestic content on said projects.
The Coronavirus (COVID-19) has caused a retrenchment in global economic activity, exacerbated by lockdowns that have disrupted sectors spanning tourism, manufacturing, and the energy sector. Whilst the economic fallout continues to loom, CEMAC member countries are increasingly exposed to spillovers from falling commodity prices and economic activity in advanced economies.
Falling commodity and a synchronized cyclical prompted by the virus has exacerbated capital flows from developing economies, caused currencies to depreciate, and raised debt servicing costs. This paper investigates the debt dynamics in CEMAC member countries, whose low value-added exports comprise commodities. The findings conclude with policy recommendations to lessen the adverse effects of falling debt levels. The paper employs a data-driven approach to ensure the debt is placed on a sustainable path, with actionable policy proposals to that regard.
The CEMAC region at a glance
The CEMAC region comprises Cameroon, Chad, Central African Republic, Republic of Congo, and Gabon. The majority of whom are commodity exporters with marginally diversified economies and a single currency. According to the IMF, the average annual economic growth currently stands at 2.5%, with a population of 52 million people. The region did, however, see noticeable improvements in real GDP growth, with the latter averaging 4.06% during the period 2014–2019 and forecast to reach 5.02% by 2024.
The region appears to industrialize at a very gradual pace, with huge sections of the workforce still employed in the formal sector. Additionally, the non-oil balance improved from 5.3% of GDP to 2.9% in the same period, while public debt is expected to rise to 38.04% from 36% in 2016–2019.
Oil exports are indispensable to economic growth in the region, contributing between 20–25% of overall GDP (IMF, 2020). As such, COVID-19 related stress and low oil prices will have a profound, if not, lasting impact on the domestic economy.
The region is particularly exposed to rising risks of protectionism or the regionalization of supply chains due to COVID-19, decelerating growth in China, and low commodity prices. Meanwhile, Congo, Cameroon, Chad, and Equatorial Guinea are currently under IMF extended credit facility programs, designed to address structural vulnerabilities and improve their external balance. The latter is, however, contingent on diversifying the economy away from fossil fuels, digitizing the public sector, and improving the value-added of exports. There is no shortage of findings positing said recommendations (Adeleye and Eboagu (2019) and Batuo (2015), Alege and Ogundipe (2013), Bahrini and Qaffas (2018) and (Chavula (2013) and Asongu and Le Roux (2017)), but underinvestment in high-growth sectors spanning renewable energy, manufacturing, and a seemingly opaque regulatory infrastructure have impeded economic convergence in said countries.
The service sector has seen significant improvements in recent years but remains limited due to power outages, low teledensity, and an ill-digitized workforce. Domestically, dynamic construction, forestry, and financial services could help support non-oil activity, but that absence of sufficiently adapted infrastructure could lessen internet penetration and growth effects associated with increased internet connectivity.
Debt dynamics tell an all too familiar story
The current debt trajectory in the CEMAC region is unsustainable, driven by uncertain commodity prices, fluctuation in the exchange rate, and increased infrastructure loans on opaque and highly concessional terms. As illustrated in Figure 1, the downtrend in the public-debt-to-GDP ratio between 2004–2008 is reminiscent of higher oil prices, while the collapse in global trade following the 2008 GFC caused a reversal in this trend. The sustainability of debt is contingent on the pace of economic growth, but CEMAC members are commodity exporters, who depend on the levels of global manufacturing and industrial activity. The Coronavirus has halted manufacturing supply chains, interrupted travel, and caused a resounding fall in oil prices.
More worrying is the fact that some loans were gotten in exchange for oil at a specific price. For example, country A takes a loan and promises to repay oil worth $100. At $50/bl, they’ll pay two barrels. At $10/bl, they’ll have to pay 10 barrels. Furthermore, production in Cameroon is strained after an accident in 2019, while most CEMAC countries cannot suddenly ramp up production to pay for “resource-backed loans”. Meanwhile, the increasing reliance on market-based sources of finance suggests that CEMAC member countries have to borrow from international debt markets with an additional premium, which increases concerns of debt sustainability.
Table 1: Change in public debt to GDP ratio (%)
As increasingly indebted CEMAC countries were shunned from international markets, Chinese financing came to serve as an anchor for increased infrastructure spending spanning roads, energy infrastructure, schools, etc. The noticeable increase also reflects budget contributions from multilateral institutions, concessional healthcare spending, and weaker oil prices. Cameroon, the largest economy in the region also holds the smallest debt, despite recording a 41% increase in the last decade (Figure 1).
Figure 1: The noticeable increase in debt levels will stymie economic growth
Republic of Cong and CAR saw the largest declines in public debt levels
Additionally, Chad and Gabon saw a similar increase, despite having markedly smaller economies than Cameroon. The largest decline in public debt to GDP ratio was recorded in the Republic of Congo (-521%) and Central African Republic (-13%). Nevertheless, CEMAC economies are little diversified from primary products, which exacerbates the negative spillovers of higher debt levels on the potential growth rate.
Nevertheless, these economies remain prone to falling oil revenues, which lessens the pace of economic growth and government revenues. Furthermore, a majority of CEMAC countries hold a significant portion of increasingly indebted oil producers. A prime example includes Cameroon, whose state-owned oil producer — SONARA- has debt currently worth 3.5% GDP (IMF, 2020).
Similarly, oil in Gabon contributes 45% of GDP and 80% of its exports. As such, lower oil prices not only slow economic growth, they cause a resounding increase in public debt. Additionally, the government’s revenues are highly dependent on oil prices; at 60%, lower oil prices could cause a sovereign debt crisis and raise the cost of borrowing from international debt markets. This dependence on primary exports has had a lasting impact on sovereign debt ratings,
Table 2: Fitch Ratings downgraded all CEMAC member countries
Country ceiling capture foreign currency, which indicates the likelihood of currency-induced stress
It is important to note that Country Ceilings capture the risk of capital and exchange controls being imposed that would prevent or significantly impede the private sector’s ability to convert local currency into foreign currency and transfer the proceeds to non-resident creditors. As such, funding pressures and shortages of USD due to a global flight for safety and liquidity could cause financial frictions or lead to a banking crisis.
Dollar dependence: Trade invoicing, financing and FDI flows could
Admittedly, too-high public debt impedes sustainable development and increase the risk of a currency and banking crisis and cause the economy to grow at a slower pace. Furthermore, trade among CEMAC member countries continued to be cleared in dollars, which exacerbates the spillovers from lower oil prices. As public debt levels rise and exports fall, trade is nonetheless cleared in dollars, which is currently highly sought by developing and advanced economies. While gross external reserves increased more rapidly in 2019, also helped by a stronger implementation of CEMAC foreign exchange regulations, a sudden spike for USD dollars could increase the cost of servicing debt in commercial banks. This bode ill for banks such as Union Bank of Africa that have seen their rating downgraded to B/negative. Given trade in Sub-Saharan Africa is currently at 24%, clearing trade in currencies other than the dollar is a credible way to lessen banking and financial crisis. The latter causes high unemployment to reduce development gains and increases poverty in an already strained and commodity-dependent region.
In other to place debt levels on a sustainable path, policymakers should prioritize the following;
1) The majority of new loans in the CEMAC region were taken to fund infrastructure projects. Policymakers should ensure that 60% of the workforce from foreign-financed infrastructure loans are gotten from their domestic economies. Not only will this increase the tax base employed in the formal sector, but it will also create a great deal of employment capable of absorbing the CEMAC zone’s growing youth population. The other portion of the workforce can be imported from other countries to ensure technology and knowledge transfer on such projects.
2) Furthermore, policymakers should ensure between 50–60% of inputs for infrastructure projects financed by foreign countries are gotten from Cameroon. This will boost domestic demand for construction materials, consultancy services, creating jobs, raising tax revenues in a sustainable manner, and lessen dependence on oil exports.
3) Finally, CEMAC member countries should consider invoicing trade with sub-Saharan Africa in domestic currencies such as the Nigerian Naira, the South African Rand, and Ghanaian Cedes. Not only will this lessen the risk of a currency and banking crisis, but it will also place overall public debt on a more sustainable path. Furthermore, such an approach will reduce the cost of holding foreign currencies for BEAC, and increase the effectiveness of our foreign exchange reserves on our credit outlook.
4) CEMAC countries should ensure that all future debt is transparent and shared with stakeholders to allow for a more rigorous economic assessment of higher borrowing. Furthermore, prioritizing green investments such as off-grid solar plants and wind turbines will highly skilled green jobs and ensure sustainable economic development as countries around the world diversify away from oil.
COVID-19 has exacerbated structural vulnerabilities and bought the issue of debt sustainability to the fore. For CEMAC member countries, a majority of whom are commodity exporters, putting debt on a sustainable trajectory entails a rigorous FX regime, transparency in foreign lending, and a renewed emphasis on green projects that will stimulate economic development, raise tax revenues and place debt on a sustainable downward trajectory.
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