Africa spends more on servicing debt than on healthcare. Few would argue such imbalances demand radical change. But with no global consensus on how to relieve this debt burden in the face of the coronavirus pandemic and its economic toll, Africa is at yet another crossroads.
AZA, delved into some of the most critical aspects of Africa’s debt relief implementation in a transcript of the recent webinar Africa’s Debt: Freeze, Forgive, or Forget? hosted by AZA, Africa’s biggest non-bank currency broker.
In his closing remarks, former Central Bank of Nigeria Governor and the 14th Emir of Kano Muhammad Sanusi II, said unifying exchange rate will lead to further devaluation of the naira. He also kicked against spending cut and raising taxes.
Muhammad Sanusi II comments :
In most African countries, you’ve got a fiscal deficit problem. You also have balance of payments problems. But this is not the time to look at how you can reduce the deficit, this is not the time for consolidation.
Any attempt at cutting spending is going to throw many households into deeper poverty. You can’t increase taxes on the private sector heavily at this point because that is going to affect private investment and you’ll go into a self-fulfilling cycle of economic regress.
What is also clear is that we must do something about the level of debt service obligations. We must provide relief to the countries’ balance sheets to free up cash flow and maintain the momentum to go through this period. I think this is something that’s well understood. That’s what the IMF and World Bank have done, that’s what the DSSI is about, and private creditors also need to look at this. I don’t think the countries are going to ask for a moratorium on private debt but I know the African Union is looking at some instruments that will provide liquidity to the countries, while making sure that debt obligations have been met with private creditors.
How did we get to this point? I spent most of my life in banking as a risk manager and I must say I am absolutely appalled by the kind of risk management that is shown by international creditors when lending to African countries. It seems very easy to just invest in a bond if it’s giving a return of 10 or 11% because you’ve got all these negative yielding instruments in the international markets and you’re relying on the fact that countries cannot afford to default. You’re not looking at where the money is going; you’re not looking at the financial condition of these countries.
I hear these numbers about debt-to-GDP ratios. As a credit officer, a debt-to-GDP ratio means nothing. A debt-to-GDP ratio of 30% for a country where tax revenues are only 6% of GDP is not the same as 30% debt-to-GDP for a country that has 60% tax-to-GDP ratios. All these signals and alarm bells have been going on for a long time: countries spending a high percentage of their revenue on debt service and then piling on more debt. Now, if I was sitting as a risk manager in lending, I would look at these numbers.
The second point is that COVID is a black swan event, and we all understand what it has done. But the reality is, I don’t think there is anything that Africa is facing now that was not known or predicted. After HIPC we had this story of ‘Africa Rising,’ and the Africa Rising story was driven by two things. In the first phase, it was driven by rapidly rising commodity prices, basically on the back of China and India growth.
After that, African growth was fueled by debt. As far back as 2015/ 2016, most African countries had gone back to debt-to-GDP ratios and debt service-to-revenue ratios that were much worse than they were pre-HIPC. So, with or without COVID, something was going to happen. Questions that were supposed to be asked were not being asked. Countries were just piling on debt.
Some of that debt is domestic, which means that, at least for now, those countries don’t have a risk of insolvency because they are the issuers of their currency. However, there is the risk of inflation, risk of devaluation, and they have got to be careful with printing too much money.
What we see today is that, yes, COVID is a wake up call, but for the last five or six years, if you were looking at the balance sheets of African countries, you would have seen that we were already back to where we were before 2000, and somebody should have been asking these questions, and these questions were not being asked.
When I was governor of the central bank in 2012, I wrote an op-ed for the Financial Times where I raised an alarm about the nature of the relationship between China and Africa. It was very controversial. But, again, I’m not surprised that we are at this point now. It is something that everybody could see. There was too much debt going into projects that had no connection to economic growth and development.
We were in this world where, as long as you had GDP growth of five or six percent, nobody looked at where the growth was coming from. Was it coming from just debt that was going into revenue expenditure, overheads and consumer spending, or was it going into real productive capacity?
I think we’re not looking at the right levers for growth. If you’re looking at development long term, you don’t need 7% growth. If your economy grows at 2.5% year after year, the law of cumulative growth says you’ll double your GDP in 30 years. In a hundred years, you’ll have multiplied GDP by 11.8 times. Now, that is enough to transform nations radically. But we get carried away by these 5-6 percent growth rates over 2 to 3 years, and you have these boom-bust cycles, and you’re back to where you started, rather than looking at what you’re actually doing to improve the productivity of your human capital, which should be important, and the productivity of your economy.
If you take Nigeria, if we just focused on increasing the supply of electricity per capita, looked at bandwidth, and invested more in education and healthcare, you would have stable growth of three to four percent every year, and that is more than enough to transform the economy over a 10 to 20 year period. But if you continue relying on government spending that’s fueled by debt, and commodity prices that are unpredictable, you’ll be going up and down. Nigeria is just one example but there are many across Africa.
The situation as I see it today is that the DSSI being worked out by the AU is a great thing. I think the idea of setting up some mechanism where you can pay private creditors while keeping governments afloat by giving them money is also excellent. But we must also ask what we need to do going forward, and how we should attack the balance of payments deficit.
The Central Bank of Nigeria has said it will move toward a convergence of exchange rates. I don’t think there is much risk in Nigeria of not getting capital out. I think we will get to that convergence, and when we get to that convergence, there will be a devaluation but that’s a price we have to pay.
I think that would be a very good signal for reducing the current account deficit because the reality is that if you have a weaker currency today – if you look at the tradables, look at rice imports, how much is spent importing food, for example, which is also produced locally; how much we spend in the tradables sector importing textile products, we import shoes, we import bags from China, and we are a big leather producing country – there’s no reason why Nigeria should not be producing its own shoes, its own bags, textiles, garments, food, and that is going to bring a major improvement to the balance of payments situation. That is the route, I think, to also reducing the fiscal deficit, rather than hitting the household and private sector balance sheets.
We also have to look at some of the more inelastic areas of demand – take petroleum products for example. The Dangote Refinery would be good news, I don’t know how long it would take for it to come on stream. But we do have four refineries. What does it take to get those refineries producing and reduce dependence on petroleum imports? Now, with a flexible exchange rate regime to improve the tradables sector, if you can reduce dependence on imported petroleum products then, hopefully, with stable oil prices, you should move back to a balance of payments surplus, and that should then be the route towards redressing the weakness in the government balance sheet.
The final point I’d like to make – and Von and Elizabeth made this point – is that we lend money and we don’t know where this money is going to. From a risk management perspective, if I were a bondholder going to put in $1 billion in an African country, I’d be interested in knowing where that money is going. And if I understood that there was an execution risk, I would ask what structures I needed to put in place to follow up and make sure there is actually execution and completion of this particular project. You don’t just simply put in the money and wait. We all understand that when you’re dealing with a counter party, you look at the risks you are running with that counter party.
For some counter-parties, if you’re a bank and you lend to Shell or MTN, you don’t necessarily need to follow up, but if you’re lending to a middle market or SME, you know you have to put in extra effort to ensure that your loan does not turn bad. That is why you’re entitled to charge a higher rate of interest. So, given the rates of return creditors are making on Africa, a little bit less laziness, a little more effort in following up the money, making sure it goes into the sectors, helping see that these projects are actually executed, would be very helpful to avert a reoccurrence of this situation.
Certainly, for anyone at this point to say you won’t do a debt standstill or won’t give any debt relief, you’re basically sentencing many of these countries to death. It’s simply not possible. They will default anyway. Plus, with the levels of poverty, with the amount of people thrown out of work, with SMEs suffering already, if you hit the governments’ balance sheets today, without looking at the external balance sheet, what you are going to do is impose all that cost on the household and private sector, and that would throw us into a recession that we cannot come out of.
I think that this is a great opportunity for us in Africa to look at how we got here. Subsidies that we have been paying that we should not have been paying – not going into cost-reflective tariffs, for example, in the electricity sector, borrowing long term and not following up on infrastructure projects. What have we learned from the mistakes of the past so that we do not repeat them going forward? Also for the creditors themselves to step back and say, did they ask the right questions?
The relationship between China and Africa is one that is filled with great opportunity, but also fraught with risk. At the end of the day, we Africans have to decide what we want from China. We ask the Chinese to give us loans to build roads from nowhere to nowhere. The Chinese loans are commercial but not in the sense of other loans.
The Chinese will give you a loan to build a road, and it will be done by Chinese construction companies, it will be done by Chinese labour, so even if they have a loss on the loan, they probably have made a lot of money on the construction and supply of equipment side. They probably have made more money in profits than they’re going to lose on the loan. So they’re very smart in that sense. For a typical bank, if you lose the money, you lose the money. Which is why I think the Chinese need to be far more flexible and accommodating than they have been so far, and they need to sign up to the DSSI.
Other speakers at the event are:
Elizabeth Rossiello, Co-Founder and CEO of AZA
Joseph Rohm, Managing Director of Adventis
Von Kemedi, Co-Founder and Managing Director of Alluvial Agriculture
How do you balance the need for debt payments relief against a history of a moral hazard on debt for a number of African states?
Elizabeth Rossiello: It’s interesting to compare perception against reality. Take a country like Angola compared with, say, Argentina. Argentina reneged on its debt nine times and yet three years ago became the first junk-rated country to sell bonds with no repayment required for a century. Angola hasn’t defaulted since the end of its civil war in 2002 and yet bondholders charged a higher rate of over nine per cent for shorter-dated bonds. So is there some sort of truth in bad behavior, or is it more of a bias against African markets? The real question is what will happen if we don’t cancel the debt? I think the mountain is too high to climb. There is no other option.
What are the lessons from previous experience of debt cancellation?
Joseph Rohm: First, just to say, I agree with Elizabeth. I think there is enormous bias around how Africa’s debt is treated. But you asked about lessons from history. I think one of the things one must be aware of is that the situation is very different now. The reality is that Africa’s credit market is much more complicated than it was in the early 2000s when HIPC and the Paris Club granted debt relief. Effectively Africa at that time owed money to wealthy countries. It’s not just the arrival of China. Private lenders now own more than 30% of Africa’s debt so that’s been a huge shift. Getting disperate lenders to agree on debt relief is much more complicated, particularly bondholders.
Clearly, there are also huge differences from country to country in terms of their performance and their need for debt relief, so I would argue you need to look firstly on a sovereign by sovereign basis. Some countries desperately need debt relief and you can see which ones they are – the IMF has provided rapid finance facilities at very short notice.
But others are doing relatively well. I don’t think anybody would argue that Africa doesn’t need short-term debt relief but I think long-term debt relief is unlikely and inadvisable. What are the implications of long-term debt relief? Is it actually the best way to attack poverty and development going forward? I would say ‘no.’ One of the risks of debt relief is damage to the growth of capital markets in Africa and to those Africans desperate for capital to feed companies. The Eurobond market has been an enormous success for Africa, but local currency funding from international investors and public equity markets have grown at a dismally low rate. One of the dangers of talking about a blanket debt relief is you damage the potential growth of capital markets at a time when African corporates in particular need access to capital probably more than ever before, and that’s partly because the African continent is performing much more strongly than it did 20 years ago. Africa is one of the few parts of the world that has been delivering strong growth, following Southeast Asia, so there’s this huge need for development finance and capital to grow businesses.
How do we ensure debt responsibility during cycles, in particular for commodity-driven economies?
Von Kemedi: What’s important is to make sure that the economy is robust enough to manage. Bondholders and countries that extend debt or that relieve African countries must have an agreement with the government that the funds will be channeled strictly to specific projects that can support repayment rather than being used to supplement expansive government.
How can Africa’s debt negotiations be leveraged to bring lasting benefit to the people?
Elizabeth Rossiello: Real mid-sized businesses have driven the economic boom in European markets, South American markets, East Asian markets – but these businesses have been crowded out of licensing, crowded out of government contracts, crowded out of available opportunities in Africa. Those that don’t have uncles and fathers in parliament still don’t win licenses. I think we would see a radical change in completion level and execution if we can increase competition and let smaller players in. We are really missing competition in this market.
The Nigerian electricity sector is one example: a lot of electricity is produced but transmission is the problem. While there are many solutions to that all over the world, companies are not being allowed to enter the market and give it a shot. So, I’d love to see international financiers and governments include SMEs and mid-size businesses in government contracts and really let’s see this as the necessary change and push forward transparency and also more competition.
Two CEOs of African banks, Ecobank and Equity Bank, said they are not in support of debt cancellation for Africa. What are your thoughts?
Elizabeth Rossiello: I think they’re speaking to the fear that debt forgiveness is used for inappropriate purposes, like supporting currencies that should be free-floating. Crowding out the private sector is a big problem, and Ecobank and Equity Bank are real champions of the continent, showing how private brands can grow their market. Some of these super brands have come in replacing the focus on international poverty debt with development debt, and it’s awesome to see Equity Bank and Ecobank move in and take some of those pipeline investments. Kenya has become a banking lion in last decade really.
What does China want to achieve with the Africa debt relief program?
Joseph Rohm: China now owns just over 20% of Africa’s external debt. In the last 10 years, it has become the major lender on the continent. But China has a very nimble and flexible approach, and has actually been renegotiating debt with Ghana, Zambia and Angola fairly recently. While we don’t have all the details around that, it’s clear that China has been very effective at restructuring loans, turning debts into 99-year port leases, for example. China will be saying, we are very happy to restructure again but we don’t want to be the only ones doing that and we would want to do it alongside multilateral and bilateral organisations. Why should we be the only ones restructuring?
Is the African debt cycle a blessing or a curse?
Von Kemedi: The African debt cycle is definitely not a blessing. What’s happening is that we are taking in too much debt and our economies are not robust enough to repay this debt, and so it becomes a question of going back to the creditors to appeal for rescheduling or cancellation. That shouldn’t be the case. We should be able to go to the table like anyone else and discuss business rather than coming to beg for debt forgiveness. For us to have strong economies that can manage this debt we need to have a more vibrant private sector and this happens in the small and medium size sector.
Elizabeth Rossiello: We need to have liquidity. We need to have people willing to buy and sell this debt. That means we need healthy capital markets, we need more competition, we need more brokers. In the small city of Zurich, in the small country of Switzerland, where I started my career, there are thousands of brokers making a market between the Swiss franc and the Euro, which never really moved anyway. And then you go to the city of Lagos, one of the most bustling and vibrant metropolitan areas on the planet and one of the fastest-growing populations, and you can count the number of brokers and market makers on your two hands. What we need to see is more people step in. The problem on the continent is is the fear that no one will be able to settle and everything will evaporate. If authorities simply gave out more licenses, we would see more players come into the space and some of this achieved.
Joseph Rohm: One of the big successes is the Eurobond market. Africa has raised $55 billion in the last two years alone from the Eurobond market. This is attractive financing because in dollar terms it’s quite cheap, but it’s not linked to specific projects and too few questions are asked around the use of funding.
What is the role of pan-African institutions in debt implementation?
Von Kemedi: Most credit from the African Development Bank has been going through governments to support projects and other state expenses. This is not sustainable. The African economy needs to generate more from the private sector to become more robust. Of course, the AfDB are doing very well in terms of credit ratings for the bank, which is really good for the continent, but what is required is for the African Union to work with the African Development Bank to address the unsustainable flows that we are now dealing with.
In Nigeria and Angola, for instance, the amount of money spent on just paying down interest not to mention even the capital is just too much. We must come together and convince the rest of the world that we seriously need to reduce our cost of government very, very drastically. What’s not going to work is continuing to run expensive governments and at the same time convincing people that debt rescheduling or debt cancellation will not simply go to subsidizing that very lifestyle.
