Otaviano Canuto, Hinh T. Dinh, Karim El Aynaoui, Hafez Ghanem, and Badr Mandri
Cape Town Chronicles, ORF – Observer Research Foundation
Africa’s Current Exposure to Debt
The history of debt in Africa is a long and painful one. It began in the 1980s, when the public finances of most developing countries deteriorated following two episodes of oil shocks, leading to a “lost decade” of low growth, increased poverty, and political instability. The recovery from the debt crisis only became possible following initiatives in favour of heavily indebted poor countries (HIPC) and the Multilateral Debt Relief Initiative (MDRI).[1] Owing to these two initiatives, the average debt-to-GDP ratio in Africa decreased from over 65.9 percent in 2000 to 32.6 percent in 2010. In sub-Saharan Africa, the IMF estimated a reduction of nearly US$100 billion in debt during this period.[2] This gave some breathing room to African countries to stabilise their current and future financial situation and promote development spending in the region.
However, due to the stagnation of official development aid following the global financial crisis, and the challenges faced by African countries in mobilising domestic resources to finance their massive needs for infrastructure and socio-economic development, a re-accumulation of debt in the region began in 2011. The trend was also facilitated by expanded and easy access to international financial markets at affordable interest rates. This accumulation has been more significant after 2013 and the commodity price shock. At the time, the economic situation caused cumulative currency depreciations, widened deficits, and a general deterioration of macroeconomic conditions in African countries in various ways. Indeed, between 2012 and 2017, real GDP growth in Africa fell from an average of 6.2 percent to 4 percent, while the average fiscal deficit increased from 2.1 percent of GDP to 5.5 percent. As a result, over this period more than two-thirds of sub-Saharan African countries have seen their public debt as a percentage of GDP increase by more than 10 percentage points , while a third of countries have experienced an increase in the debt-to-GDP ratio of more than 20 percentage points.[3]
The COVID-19 crisis, which had a significant impact on the public finances of countries across the continent, has worsened the challenge. The health emergency pushed the gross financing needs as a percentage of GDP[4] above the critical threshold of 15 percent for most countries in the continent, leading to an additional increase in debt levels of 10 to 15 percent.[5] The average debt-to-GDP ratio in Africa has recently exceeded 70 percent.[6] The immediate needs for public health and stimulus spending, combined with the drastic reduction in tax revenues following the global economic slowdown, and a similar drop in export revenues for resource-rich countries, have exerted an unbearable external pressure on the most vulnerable countries in the continent, which are now struggling to keep up with their interest payments. In 2020, debt service payments in more than 20 African countries comprised over 14 percent of public revenues, and in five of these countries, the ratio was a far 30 percent.[7]
These higher debt levels across Africa have begun to raise concerns about a return to unsustainable debt levels, especially given the limited ability of countries to generate the necessary budgetary resources. Since 2016, the IMF and the World Bank have been sounding the alarm that the debt levels of some African countries are approaching pre-HIPC ratios, and that signs of a possible new debt crisis are becoming apparent. The source of these concerns is not only the rapid accumulation of debt, but also the changing structure of African debt and, in particular, the profile of creditors.
Indeed, Africa is no longer dealing with the same creditors as before. At the turn of the century, most of Africa’s public debt was owed to multilateral institutions and some bilateral creditors of the Paris Club. As explained earlier, as a result of debt relief initiatives, these countries had been able to rebuild their debt capacity, giving them better access to market-based debt instruments. Thus, about 19 African countries entered the Eurobond market, taking advantage of the prolonged period of low interest rates that followed, and the strong demand from private investors.[8] Private investors, seeking alternative low rates from developed countries, were attracted by the yield prospects offered by African sovereign bonds. This interest in commercial debt increased the share of private creditors from 20 percent in 2010 to more than 41.3 percent in 2020.
Along with the increase in private creditors in Africa, the profile of bilateral creditors has also changed. The share of external debt held bilateral lenders, mostly by traditional Paris Club members, declined from 52 percent in 2000 to 10.3 percent between 2000 and 2020, while China has strengthened its position as the largest lender to Africa. According to data from the Global Development Policy Center, China loaned about US$160 billion to African countries between 2000 and 2020. This lending has accelerated since 2010, from an average of US$2.5 billion between 2000 and 2009 to about US$12.3 billion per year over the past decade.[9] In 2020, it was estimated that 17 percent of the total external debt of the sub-Saharan region is owed to China.
The increase in borrowing from non-Club de Paris creditors and commercial lenders has resulted in shorter maturity periods and higher refinancing risks. The significant rise since 2014 in the issuance of 10- and 15-year Eurobonds by many African countries, as well as non-Club de Paris loans with shorter maturities than traditional long-term concessional multilateral loans, has led to a concentration of sovereign debt maturities between 2024 and 2028.[10] Consequently, it has forced debtor countries to refinance these loans under tight international financial conditions just as they were recovering from the COVID period legacy and are dealing with the new inflationary shock resulting from the war in Ukraine. This concentration of maturities increases the risk of debt distress for some countries in the continent; others, such as Zambia and Ghana, have already announced payment defaults.[11]
What the International Community is Offering Africa
The international community has taken steps to address a new debt crisis in Africa. One notable initiative is the allocation of Special Drawing Rights (SDRs) by the International Monetary Fund (IMF). The IMF has distributed around US$29 billion to African countries as part of the new SDR allocation. For the continent, this represented up to 4.5 percent of external debt and could cover up to 10 percent of country-level GDP, as in the case of Liberia.
In addition, during the pandemic, the G20 introduced the Debt Service Suspension Initiative (DSSI), whose primary aim was to defer debt repayments. This freed up financial resources that enabled African countries to combat COVID-19 and make essential investments in sectors such as healthcare and education. A common framework for debt restructuring has also been put in place to facilitate negotiations between debtors and creditors.[12]
However, these initiatives are not without their challenges. First, their scale may not align adequately with the enormity of the challenge at hand. While the funds provided are substantial, the debt burdens facing many developing countries remain staggering, necessitating a more comprehensive approach. Second, implementing these programs can prove to be complicated, with administrative obstacles and delays impeding their effectiveness. Lastly, the participation of various stakeholders, including multilateral development banks and bilateral creditors, often results in intricate negotiations that are ripe with disagreements.
A prime illustration of these challenges is in the handling of debt restructuring requests from countries such as Zambia, Ethiopia, and Chad. These nations have confronted economic hardships that were exacerbated by the pandemic, compelling them to seek debt relief. Nonetheless, finding common ground among creditors, each with differing interests and priorities, has proven to be an arduous task.[13]
Adaptation Needs and Holistic Solutions
To effectively tackle the massive challenges, it is imperative to contemplate a reconfiguration and expansion of existing debt relief programmes. The present-day circumstances and issues confronting the developing world, including the African continent, demand an approach that is more adaptable and all-encompassing. Rather than viewing debt-related difficulties solely as matters of short-term liquidity, it is essential to acknowledge the underlying solvency problems that necessitate long-term remedies.
Moreover, the global landscape has undergone significant transformations, with a multitude of crises diverting international attention. Factors such as the COVID-19 pandemic, geopolitical rivalries, the conflict in Ukraine, and the specter of stagflation have all contributed to this shift in focus. Nevertheless, it remains crucial not to disregard the immediate concerns surrounding development challenges and climate change. These issues are intricately interconnected and it is crucial to integrate them into the debt relief process for heavily indebted nations.
One promising avenue for addressing these multifaceted challenges is the incorporation of environmental considerations into the debt relief process. Climate change is a global crisis that disproportionately impacts developing nations, including many in Africa. These countries frequently lack the necessary resources and infrastructure to effectively adapt to and mitigate the repercussions of climate change.
The introduction of a fresh climate-centric initiative for debt relief could offer a comprehensive solution to these predicaments. This initiative would entail the active participation of the international community, multilateral platforms like the G20, multilateral development banks, and bilateral creditors—all of them working in tandem to provide debt relief while simultaneously addressing pressing environmental concerns.
Africa Relies on Africa
Critics of the international community and the mechanisms deployed to prevent a new systemic debt crisis in developing countries, including those in Africa, might sound as if they are seeking to divert blame from Africans. To be sure, debt distress is a result of multidimensional factors, including mismanagement of financial resources at the domestic level. Some countries accumulate debt with the expectation that it would feed the economic system and lead eventually to growth. Africa is urged to mark a new paradigm in its governance model and, in this case, its economic policy design.
A starting point for African countries is to conduct a sound macroeconomic policy with proper use of capital flow management to limit the negative effects. Fiscal and monetary policies should play their roles fully in mitigating the implications of the global financial cycle, the fluctuation of commodity prices, and the domestic shocks affecting the African economy. For resource-intensive economies, managing the flow of related export revenues will enable them to shield their growth from commodity prices volatility. Although those classic recommendations have been documented, this challenge remains on top of the agenda for the continent.
On the monetary policy side, the central bank’s independence will allow the institution to set its objectives and prevent any intervention in its mandate that could undermine its fiscal policy orientation. The latest data from the World Bank’s Country Policy and Institutional Assessment on macroeconomic management in Africa comes with no surprises, pointing out low performance in the region compared to the rest of the world.[14] The macroeconomic management toolkit also includes macroprudential policies. These can indeed insulate the economy, or at least attenuate the disruptive consequences of capital flow volatility on the financial stability of the country.
The African Financial Stability Mechanism (AFSM) governed by the African Development Bank (AFDB) as Anchor
In March 2021, the president of the AfDB announced the institution’s proposal to create an African Financial Stability Mechanism, a pan-African platform that will have broader and more ambitious objectives.[15] It will support countries in their cyclical macroeconomic management, fund countries in deep stress to prevent defaults, provide a platform for debt restructuring, and mitigate further complications and side effects of a sovereign default. The mechanism seeks to complement the existing African Monetary Fund. It will help with the clean-up when an African economy fails to meet its obligations, but also to prevent such scenarios in the first place, by committing to support countries in their macro-management and handle the fluctuation along the cycle.
Accelerating the implementation of the platform will consolidate the toolkit to combat the various shocks threatening the financial stability of the continent. The Common Framework for Debt Restructuring should seek synergies with this regional platform to increase efficiency and credibility among African nations. The AfDB, which champions this initiative, is a well-established institution across the continent, and the stigma associated with soliciting foreign powers to address domestic issues in Africa can be overcome through greater involvement of the AFSM. An African platform established by these nations themselves will be more acceptable when intervening in local government decisions and ensuring that countries’ macroeconomic policies are on-track.
Deep and Liquid Local Currency Sovereign Debt Markets
A well-established sovereign bond market will enable African countries to mobilise extra financial resources for their increasing social and economic needs. The current context, marked by tightening financial conditions, especially for developing countries, has shown how favourable it would be to leverage a domestic and deep local-currency sovereign debt market. Beyond the role of the market in catalysing the development of the capital market in general, especially the fixed-income compartment, it will add a new funding option for countries and improve their bargaining power in international financial markets.
The steps needed to create or deepen the market have been widely documented. They include coordination among market regulators, such as central banks and finance ministries, and the creation of the market infrastructure and a central securities depository. An enabling, comprehensive, and transparent legal framework will give the system the credibility it requires to attract foreign and domestic investors. The African diaspora can see through these actions a call for their commitment to support their countries. In 2011, the World Bank estimated that the accumulated savings of the African diaspora reached US$53 billion a year, representing almost one-third of the continent’s infrastructure financing needs.[16]
A Sound Tax Policy
African economies, especially low-income and resource-intensive economies, have among the lowest tax-to-GDP ratios in the world. While the OECD average is 34 percent, and that Latin America and the Caribbean hovers around 23 percent, in Africa this ratio was 16.6 percent in 2019. Unless Africa adopts an ambitious tax policy, enabling authorities to raise the due amount of tax, the funding issue will remain unresolved. Indeed, tax revenues are more stable and predictable than external funding or revenues related to commodity exports. Increasing tax collection should not come at the expense of economic activity and not weigh down economic growth in the continent. Tax administration should strike the right balance between collecting the due tax revenues and catalysing economic growth.
The informal sector issue is complex and requires a thoughtful and full-fledged approach instead of a unique tax policy focus. Tax reform also brings into the spotlight tax expenditures policies in Africa. In African countries, estimates report that tax incentives on average amount to 2.8 percent of GDP and 17.8 percent of total tax revenue.[17] These can take the form of allowances, exemptions, rate relief, tax deferral, or even credits. In general, they represent postponed revenues for a set of sectors or economic agents relative to a benchmark tax. They are especially high in Senegal (7.8 percent), and Mauritania (58.4 percent).[18]
A systemic impact analysis to assess the effectiveness of those measures is crucial for the orientation of fiscal and tax policies. Empirical analysis suggests that tax expenditures often do not achieve their main objectives and end up disrupting the economic system and feeding into economic inequality, or even exacerbating climate change. Phasing out ineffective tax incentives is the right measure to limit the disruption and enable the tax administration to design the appropriate economic policy in the medium and long run.
Otaviano Canuto, Senior Fellow, Policy Center for the New South.
Hinh T. Dinh, Senior Fellow, Policy Center for the New South.
Karim El Aynaoui, Executive President, Policy Center for the New South.
Hafez Ghanem, Senior Fellow, Policy Center for the New South.
Badr Mandri, Economist, Policy Center for the New South.
Endnotes
[1] International Monetary Fund. “Debt Relief Under the Heavily Indebted Poor Countries Initiative (HIPC).” IMF. Accessed October 10, 2023. https://www.imf.org/en/About/Factsheets/Sheets/2023/Debt-relief-under-the-heavily-indebted-poor-countries-initiative-HIPC.
[2] International Monetary Fund (IMF). “Heavily Indebted Poor Countries (HIPC) Initiative and Multilateral Debt Relief Initiative (MDRI)—Statistical Update.” September 2019. https://www.imf.org/en/Publications/Policy-Papers/Issues/2017/09/15/pp090117hipc-mdri-statistical-update.
[3] World Bank. “Africa’s Pulse.” No. 17, April 2018. Washington, DC: World Bank, 2018. https://openknowledge.worldbank.org/entities/publication/0288f5d8-a2ed-56d6-8704-51b7d748d176.
[4] Gross Financing Needs are the amount of borrowed funds required to cover all expenditures and amortizations not covered by revenues.
[5] African Development Bank. “African Economic Outlook 2021. From Debt Resolution to Growth: The Road Ahead for Africa.” March 2021. https://www.afdb.org/en/documents/african-economic-outlook-2021.
[6] ibid.
[7] OECD/AUC/ATAF. “Revenue Statistics in Africa 2021.” OECD Publishing, Paris, 2021. https://www.oecd-ilibrary.org/docserver/c511aa1e-en-fr.pdf?expires=1680783214&id=id&accname=guest&checksum=E81B836129313F404F98F541F76716AD.
[8] Hinh T. Dinh. “COVID-19 & Developing Countries—the Road to Recovery.” 2022. https://www.policycenter.ma/publications/covid-19-developing-countries%E2%80%94-road-recovery.
[9] Boston University Global Development Policy Center. “Chinese Loans to Africa Database.” Accessed October 10, 2023. https://www.bu.edu/gdp/chinese-loans-to-africa-database/.
[10] Moody’s Investors Service. “Sovereigns – Africa: Rollover Risk Increases amid Tighter Financial Conditions and Upcoming Maturity Wall.” June 28, 2022. https://www.afsic.net/wp-content/uploads/2022/08/Sovereigns-%E2%80%93-Africa-Rollover-risk-increases-amid-tighter-financial-conditions-and-upcoming-maturity-wall.pdf.
[11] Project Syndicate. “Human Costs of African Countries’ Efforts to Avoid Debt Default by Masood Ahmed.” June 1, 2023. https://www.project-syndicate.org/commentary/human-costs-of-african-countries-efforts-to-avoid-debt-default-by-masood-ahmed-1-2023-06.
[12] The Common Framework for Debt Treatments beyond the DSSI was initiated by the G20 in October 2020. It requires bilateral creditors to disclose their outstanding debts from highly indebted countries and engage in joint negotiations for debt rescheduling. The debtor country is also required to participate in an IMF program. Only four countries, namely Chad, Ethiopia, Ghana, and Zambia, have applied for the Common Framework. By July 2023, Chad and Zambia have reached agreements with creditors, primarily involving debt restructuring rather than debt cancellation.
[13] Baqir, Reza, Ishac Diwan, and Dani Rodrik. “A Framework to Evaluate Economic Adjustment cum-Debt Restructuring Packages.” Finance for Development Lab. Working Paper 2, January 2023. https://findevlab.org/wp-content/uploads/2023/01/FDL_Working-Paper-2_A-Framework-to-Evaluate-Economic-Adjustment-cum-Debt-Restructuring-Packages.pdf.
[14] World Bank. “Country Policy and Institutional Assessment (CPIA) – Macroeconomic Management Rating.” Accessed October 22, 2023. https://datacatalog.worldbank.org/indicator/baf7c97c-56cf-eb11-bacc-000d3a596ff0/CPIA-macroeconomic-management-rating–1-low-to-6-high-.
[15] African Development Bank. “African Development Bank President Adesina Calls African Financial Stabilization Mechanism.” Accessed October 22, 2023. https://www.afdb.org/fr/news-and-events/press-releases/african-development-bank-president-adesina-calls-african-financial-stabilization-mechanism-42719.
[16] World Bank. “Harnessing the Diaspora’s Resources to Boost African Development.” June 2011.
[17] Redonda, Agustin A., C. von Haldenwang, and Flurim Aliu. “Tax Expenditure Reporting and Domestic Revenue Mobilization in Africa.” German Institute of Development and Sustainability, 2011.
[18] Ibid.