How to revive Africa’s growth and avoid the need for a future debt jubilee
In ancient times, debt jubilees were customary after wars or dramatic events. By writing off debts, these jubilees sought to avoid polarization and social tensions. Today, the massive upheavals caused by the COVID-19 pandemic justify the international community to tolerate such a debt jubilee, especially for the poorest countries, like many in Africa.
With the exception of a few hot spots, Africa has mostly been spared the type of disease and massive deaths from the pandemic experienced by millions of people in Asia, Europe and North and South America. Yet Africa risks suffering the most serious economic and social consequences of the pandemic.
Both International Monetary Fund (IMF) and the African development bank (AfDB) predicts a sharp decline in global growth due to the global health crisis. Africa is expected to experience its first recession in about two decades. When you take these aggregate forecasts apart and look at the individual sectors, it becomes clear why Africa is most at risk of losing. The economies of the continent are heavily dependent on external flows emanating from countries hard hit by the pandemic. These flows include trade in petroleum and other commodities, foreign direct investment, remittances, development assistance and tourism. The tourism sector has been devastated and countries that depend on it are expected to experience declines in growth in the two digits.
To avoid a lost decade similar to the one Latin America experienced following the debt crisis of the 1980s, the international community must help African countries avoid disorderly default and restart growth.
The new normal of low growth that appears to be setting in is propelling debt distress to the forefront of the continent’s political agenda. The recent zambia default has cast a shadow over the ability of several other African countries to manage their debt. A substantive calculation that assumes a halving of growth prospects for the next 10 years and a zero budget deficit throughout the period results in a 150% increase in the debt-to-GDP ratio. A widening of the budget deficit will lead to a further deterioration of this ratio.
Moreover, while the external debt-to-GDP ratio is an important indicator of sustainability, low ratios can be an illusion of economic health. A favorable debt-to-GDP ratio can hide substantial “below-baseline financing”. Governments that have a relatively low ratio can actually borrow forcibly from their economies. For example, a government engages in forced borrowing by not paying suppliers, which may reduce the government’s borrowing needs, but will damage the productive system and delay economic recovery. Domestic arrears have become a growing source of forced financing in sub-Saharan Africa. IMF analysis also shows that domestic arrears negatively impact growth through multiple channels, including hurting private sector profitability and straining the banking sector. By undermining trust in government, arrears can even reduce the effectiveness of fiscal policy. Recent African experience also shows that public liabilities may increase further when government guarantees are offered or when SOEs can accumulate debt without much control and transparency
Historically, debt resolution in Africa has been messy and protracted. There are many examples of such an extension of debt resolution. The Heavily Indebted Poor Countries Initiative took more than a decade to implement. There are also ongoing disputes with external creditors concerning the Republic of Congo and Angola.
Disorderly debt settlement frequently leads to significant and often permanent yield losses. Worse, these disorderly episodes also led to socio-economic instability. To avoid a lost decade similar to the one Latin America experienced following the debt crisis of the 1980s, the international community must help African countries avoid disorderly default and restart growth.
How? ‘Or’ What? The nature of sovereign debt contracts – which, unlike corporate debt contracts, do not have established bankruptcy procedures – helps explain why debt restructurings tend to be messy. The lack of a clear set of rules for resolving sovereign insolvency allows opportunistic investors, such as vulture funds, to delay the restructuring process and delay resolution of over-indebtedness. Tackling sovereign distress early can reduce the duration of the crisis and the associated production losses. Yet authorities in debtor countries are often reluctant to act early, fearing the potential effect on their reputation in international markets.
On November 22, the G-20 agreed to extend the freeze on public debt service payments until mid-2021 and urged private sector actors to participate on an equal footing. But there is still a long way to go to reduce the outstanding debt. This will likely include more in-depth debt restructuring and cancellation, which, in the absence of changes to the current framework, is likely to be contentious and difficult to achieve.
Guaranteeing an orderly debt settlement requires major adjustments to the international architecture. One of these solutions could be for the government lenders that make up the G-20 and the Paris Club adopt more stringent comparability of treatment (CTC) clauses that require them to ensure that a debtor country’s agreements with d he other private and public creditors are similar to those concluded with the G-20 and the Paris Club. The application of such clauses would make it easier and faster for official debt relief initiatives to translate into comparable relief from private creditors.
This mechanism could be particularly relevant for Africa, where the contribution of commercial creditors to Africa’s total external debt increased from 17% in 2000 to 40% at the end of 2019. China is the second largest creditor of the country. Africa since 2015, just behind bondholders. Bondholders alone accounted for 27% while China accounted for 13% of Africa’s debt at the end of 2019.
Countries cannot simply wait for public sector debt relief. They should firmly commit to a credible change in their governance structures, including regional fiscal rules to constrain regional budgets and fiscal councils to advise governments on fiscal and expenditure policies, and help countries coordinate their fiscal policies. The benefits of regional commitments to strengthen discipline and solidarity mechanisms are at least twofold. First, regionalization allows countries to rise above the complexities of domestic politics. Second, regionalization offers the advantage of sharing the risks.
In light of the emptying of government coffers, countries should consider aggressively eradicate leakage and curb capital flight to create fiscal space and boost growth. These policies will aim to ensure that government programs meet their objectives (e.g. more open governments and markets reduce waste and monopoly rents) and increase revenue mobilization from domestic resources to finance green energy and digitization infrastructure. Resource mobilization should not be limited to tax revenues, in part because tax increases would be procyclical. Resource mobilization should also focus on better allocation of savings to productive investments by shifting the incentives of the banking system so that it can perform its essential functions of payment, price discovery, information generation and intermediation– through a combination of better macroeconomic policies and greater competition in the financial system, including non-bank operators, who are advancing in payment systems on the continent.
Better public finance governance will not only help create short-term fiscal space for governments to finance public needs, but will also pave the way for more sustainable fiscal frameworks in the medium term, which will help boost growth. Strengthened competition policy frameworks—at regional and national level– will also help stimulate growth on the continent. Good governance and more vigorous and robust growth can pave the way for deeper changes in the way sovereigns obtain finance, potentially allowing African countries to use government-subordinated debt instruments which link repayment schedules to the ability to pay according to economic developments.
A more conducive international sovereign debt architecture coupled with a change in the governance system in Africa would not only help align the incentives of debtors and creditors to address debt problems. This can prevent any need to consider a debt jubilee later on.