Although the pandemic strained debt repayments, the G20’s Debt Service Suspension Initiative, led by the World Bank and the International Monetary Fund (IMF), eased Africa’s debt sustainability struggles.
- Over the past decade, African countries have accumulated external debt at a faster pace.
- African nations have had to deal with exchange rate pressures caused by inflation, rising global interest rates and growing uncertainty caused by currency vulnerability.
- Reducing currency vulnerability can reduce the dependence on foreign currency loans and promote sustainable economic growth.
Debt accumulation
Over the past decade, African countries have accumulated external debt at a faster pace. The countries have capitalized on abundant, low-cost international credit for fiscal and balance-of-payments funding to help drive development plans.
Africa’s total external debt, accrued by both the private and public sectors, owed to foreign lenders, has surpassed $1 trillion. The related annual debt servicing costs broke through the $100 billion threshold for the first time in 2021.
Although the pandemic strained debt repayments, the G20’s Debt Service Suspension Initiative, led by the World Bank and the International Monetary Fund (IMF), eased Africa’s debt sustainability struggles. However, the war in Ukraine in early 2022 delivered another economic shock. Surging energy and food prices have led to sharply increasing interest rates as central banks struggle to contain inflation globally.
Rising borrowing costs, inflation and currency depreciation
For Africa, this means that the cost of borrowing is rapidly increasing. International markets have already given a flavour of what this means; Yields in secondary markets – which indicate the extent of refinancing costs – have approximately doubled, with an average increase of 600 basis points and some countries seeing an increase of up to 1800 basis points.
With $140 billion worth of Eurobonds and an average maturity of 10 years, the 6 per cent interest costs amount to $8.4 billion annually or $84 billion in total over the life of the bonds. This represents 0.3 per cent of Africa’s annual GDP and given that Eurobonds average 30 per cent of total debt, the overall cost of increased debt servicing will be a strenuous 1 per cent of GDP each year.
For instance, before the pandemic, Ghana’s heavy borrowing included $13.2 billion in Eurobonds – representing 17 per cent of its GDP. International investors piled in, with a 2020 Eurobond issue being five times oversubscribed.
By August 2022, however, inflation stood at 31 per cent, and the Ghanaian cedi had lost 36 per cent of its value. The rating agencies downgraded Ghana’s Eurobonds to ‘junk’ – effectively shutting the West African nation out of international credit markets. The Central Bank responded by hiking interest rates by more than 850 basis points between November 2021 and August 2022, resulting in Ghana seeking an IMF bailout in December.
In Kenya, the government paid US$43 million more in external debt repayment in 2022 due to a weakening shilling which had lost 9.25 per cent of its value against the dollar in the 2021/22 financial year. In November, foreign exchange reserves fell to US$7.4 billion, breaching the four-month import cover target for the first time since October 2015.
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The effect of currency vulnerability
While currency depreciation may be a beneficial shock absorber for nations with flexible arrangements, it can complicate the prospects for those with foreign-currency-denominated debt when depreciation rapidly flows through to domestic inflation. Contrasting monetary and fiscal policy on domestic goals allows currencies to adapt. The adaptation benefits countries with managed or free-floating exchange rate regimes.
Foreign exchange to reduce currency vulnerability intervention may assist African nations in countering excessive exchange rate fluctuations in this respect. However, low international reserves have frequently limited the scope for intervention. In certain instances, monetary tightening may help to sustain the currency, even where economic activity remains sluggish. However, the peculiarities and vulnerabilities of African nations with floating exchange rate regimes have restricted the advantages of entirely flexible rates. For instance, dominant currency pricing (i.e., fixed export prices in US dollar terms) has disadvantaged trade adjustments associated with flexible rates.
Many African nations have shallow foreign exchange markets, as shown by significant gaps between ask and bid prices. Thus, with insufficient liquidity, these markets have accentuated exchange rate swings translating to excessive currency volatility.
The cost-raising monetary tightening
Western central banks have stepped up monetary policy tightening to handle the threat posed by inflation. This has raised the cost of borrowing and reduced access to finance for some African states. Expectedly, the US Federal Reserve raised its benchmark policy target rate by 250 basis points in 2022. Expectedly, the policy will tighten further to push the primary target rate to 3.1 per cent by the end of 2023.
The Fed also reduced its enormous balance sheet mid-2022 and will accelerate the process this year. The European Central Bank (ECB) began its tightening cycle by halting its asset purchases in end-June and raised rates three times in the second half of 2022. Further interest-rate hikes will follow in 2023.
Many African states have adjusted their policy rates at a domestic level with a tightening bias. For instance, African monetary unions followed the lead and raised their policy interest rates in 2022. The Common Monetary Area (CMA) countries of Namibia, Lesotho, South Africa, and Eswatini raised their domestic interest rates, steered by the South African Reserve Bank (SAB), seeking to support the rand and hedge against large outflows of foreign portfolio investment.
Meanwhile, the 14 member states of the two CFA Franc Zones pegging their currency to the euro—the West African Economic and Monetary Union and the Central African Economic and Monetary Union—continued to follow ECB’s lead and raised their policy interest rates in late 2022 and should take it up in 2023.
The appreciation of the dollar – the highest since 2000 – has been problematic across the globe, increasing the cost of international trade and finance. But the low-income countries have borne the brunt of a stronger dollar. The International Monetary Fund (IMF) reported that several countries resulted to foreign exchange interventions.
“Total foreign reserves held by emerging market and developing economies fell by more than 6 per cent in the first seven months of this year (2022)”, noted the IMF.
Addressing Africa’s debt sustainability struggles
External debts have provided the much-needed resource for development in Africa. However, the loans have accumulated faster in the last decade. The accompanying monetary and fiscal tightening has put many African economies at risk of debt distress.
Countries at medium or high risk of debt distress require additional financial support. The $23 billion of IMF special drawing rights (SDRs) issued in 2021 and a G20 input of $100 billion to vulnerable countries provided critical support and eased Africa’s debt sustainability struggles. Still, more is needed – and on a medium-term basis, not a short-term one. Additionally, countries already in, or are very close to, debt distress need help with debt restructuring. Ghana and Zambia have already benefited from debt restructuring arrangements from the IMF.
Strengthening local currencies
One proper long-term solution to Africa’s debt sustainability struggles is strengthening local currencies. Reducing currency vulnerability can reduce the dependence on foreign currency loans and promote sustainable economic growth.
One way to strengthen local currencies is to increase the use of domestic currencies in international trade. This can be done by encouraging businesses to use domestic currencies when trading with other countries. Countries can also encourage the use of domestic currencies in international financial transactions. This will increase the demand for domestic currencies, which will, in turn, increase their value.
Another way to strengthen local currencies is to increase the amount of foreign currency reserves held by the central bank. This can be done by encouraging foreign investment and exports. As the demand for domestic currencies increases, their value will also increase. This will make it more attractive to foreign investors and make it easier for the country to obtain foreign loans.
The IMF suggests that countries should preserve crucial foreign reserves to cushion potential adverse outflows in the future.
“Countries with large foreign-currency debts should reduce foreign-exchange mismatches by using capital-flow management or macroprudential policies, in addition to debt management operations to smooth repayment profiles.”
In addition, African countries could also focus on developing their domestic markets. This can happen by boosting small and medium-sized enterprises (SMEs) and the informal sector. These sectors have the potential to create jobs, increase productivity and improve income distribution, thus reducing poverty and inequality. By boosting domestic production, countries will decrease their reliance on imported goods and services, decreasing their need for foreign currency. Furthermore, implementing sound macroeconomic policies such as fiscal discipline and monetary stability will also contribute to maintaining a stable currency.
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