Africa: Avoiding Sovereign Debt Crisis
Africa: Avoiding Sovereign Debt Crisis
Africa: Avoiding Sovereign Debt Crisis
Charles Malize
When governments demonstrate inability to repay debt or default on their loan agreement the outcome is a trigger of a financial meltdown in their capital markets. A depressed economic growth and a weak stock market, make it harder to raise capital in the international markets and even more challenging to satisfy outstanding loans.
In light of the euro zone crisis, some African countries in the 1980s and 90s have been down this road before with similar severity if not worse. South African and Nigerian foreign trade and investments were affected by sanctions and boycotts during this period.
In the case of South Africa, the most effective sanctions measured during the apartheid era were the withdrawal of short-term credits in 1985 by a group of international financial institutions. Many foreign corporations sold off their South African investments and left hence immediate loan repayments proved challenging to meet. This negatively impacted its external debt and the economy.
In the case of Nigeria, the military coup by Rtd. General Ibrahim Babangida and Rtd. General Sani Abacha led to foreign investors withdrawing their investments amid international pressure to return the country to a democratic system. The outcome was a ballooned budget deficit that necessitated their seeking a lifeline from international donors the International Monetary Fund (IMF) and the World Bank. This led to a number of austerity measures by these agencies popularly known as SAP (Structural Adjustment Program).
South Africa recovered following the end of the apartheid era. Nigeria avoided financial collapse following a change to a much needed democratic structure that resulted in debt forgiveness by international donors.
What is SAP?
Structural Adjustment Program are economic policies which countries must follow in order to qualify for new World Bank and IMF loans and help them make debt repayments on the older debts owed to commercial banks, governments and the World Bank.
SAPs' generally require countries to devalue their currencies against the dollar; lift import and export restrictions; balance their budgets and not overspend; and remove price controls and state subsidies.
Devaluation makes their goods cheaper for foreigners to buy and theoretically makes foreign imports more expensive.
Balancing national budgets can be done by raising taxes, which the IMF frowns upon, or by cutting government spending, which it definitely recommends. As a result, SAPs' often result in deep cuts in program like education, health and social care, and the removal of subsidies designed to control the price of basics such as food and milk. So SAPs' hurt the poor most, because they depend heavily on these services and subsidies. Source: The Whirled Bank Group
Africas' Sovereign Debt
Amid the current financial crisis in the euro zone, African governments' sovereign debt is increasingly being seen as less risky and more attractive than that of advanced economies. It is hard to underestimate the appeal of some of the emerging African countries, as financial institutions invest assertively for their securities, revealing a shift. The old status quo where these countries were considered a risky environment in part due to their troubling Debt to Gross Domestic Product ratio has changed. Today, it is the industrialized governments that are accumulating the biggest debts, not emerging market countries, and revealing a big change from previous sovereign debt crisis.
The diminutive sovereign debt in some of these emerging African countries has benefited them. A large part of debts were reduced as a result of debt forgiveness by donors. This aided them to record fast growth while restraining government spending. It helped their Debt to Gross Domestic Product (GDP) ratio contract sharply.
Note: As any nation's debt level advances towards 100 percent of their GDP, it increases the country's sovereign risks enormously. The obvious is that most of the country's earnings from taxes and other sources have to be spent on interest payments to satisfy debt. The end result is one having their hat in hand to donors such as the World Bank and International Monetary Fund for help that is usually accompanied with punitive measure to qualify.
Although public finances in the emerging market countries appear somewhat strong, much needed attention is required and should focus on management of their sovereign risks. Assuming these countries find themselves in the same demise as their European neighbors the outcome is the risk of being denied access to raising new capital in the international markets. The ones that can raise funding will have to do so at a painful cost.
The interest rate for long term financing charged to developing countries in the international capital markets comes at a price and in some cases could be as high as 12 percent compared to the United States that is financing its own debt for less than 3 percent. This restricts economic growth and could lead to a cavernous recession as cost for a lifeline will have a profound impact on the revenue the government can raise. This will certainly make it challenging for the country to meet the needed targets for cutting the fiscal deficit. The outcome; a default as debtors are forced to repay every dollar owed.
Institutional Investors in Africa
While much of the distress today is confined to the euro zone, unsustainable government debt has become a global concern. As the debt crisis rages out of control the fear with investors is a threat that could cripple euro zone governments and spread to other regions around the globe including Africa. This will impede global economic growth going forward. With such a scenario, investors become self-protective with their investments.
Some of the European and American institutional investors that are exposed to the sovereign risks in the euro zone have operations in Africa. Muddling through the current mess in Europe is creating panic with investors as they dry up. They are fast disappearing as they become defensive in the market place. This is not conducive for global financial markets. The ones that are invested in Africa where markets has somewhat been less volatile are looking to raise cash. Their withdrawal of investments could threaten the stability of some of their African affiliates and the capital markets in the process. This could prove disastrous for the region that is trying to recover from decades of neglect and abuse. For this reason, containing the crisis requires euro zone policy makers to strengthen control and management of their fiscal position to avoid further financial mayhem from spreading.
Currency
In summary, beneficiaries of the current euro zone crisis have been the emerging markets, especially those seen as having well managed fiscal policies and reasonable growth prospects. These markets have seen strong capital inflows as investors choose their bonds and equities over those of the industrialized countries. This generally translates into stronger currency for the countries issuing those bonds. Although this appears good in the interim it does come with its own headache as there is a risk, exports could diminish leading to elevated budget deficits and creating more problems that it was suppose to solve.
Hence it is central that policy makers shadow the current euro zone fallout of the debt crisis carefully, and develop strategies to assist them manage their risks effectively.
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