Tuesday, 1 December 2015

FfD3 Hopes Meet EM Slowdown in Africa

Just a little while ago (last July), they were so hopeful when adopting the Addis Ababa Action Agenda of the Third International Conference on Financing for Development (FfD3):

“We, the Heads of State and Government and High Representatives, gathered in Addis Ababa from 13 to 16 July 2015, affirm our strong political commitment to address the challenge of financing and creating an enabling environment at all levels for sustainable development in the spirit of global partnership and solidarity. We reaffirm and build on the 2002 Monterrey Consensus and the 2008 Doha Declaration.”

… and so on…  The SDG tanker had been set on course, and little attention seems to have been  given to the slowdown in most large emerging economies (EM) nor to the risk that ample liquidity driven by OECD monetary policy will not last forever. Poor countries´ challenging economic backdrop dominated by falling commodity prices, lower demand from China and the prospects of the Fed eventually hiking rates, all that was largely ignored in the official FfD3 documents

But consider the prospects of mobilizing foreign and domestic resources in Africa, which has become increasingly China centric over the last 15 years. According to the IMF latest (October 2015) Regional Economic Outlook on Sub-Saharan Africa, aptly subtitled “Dealing with the Gathering Clouds”, Africa´s recent good macro performance has rested on three pillars: high commodity prices; associated capital inflows; and better policies and institutions. Wasn´t the Fund consulted during the FfD process? Or was it simply ignored?

Figure 1: Commodity Prices August 2015, 2016 Projections
% change since January 2013

Source: IMF (2015), “Dealing with the Gathering Clouds”, October.

The first pillar, commodity prices, has broken over the last three years (Figure 1). Sub-Saharan Africa counts 8 net oil exporters and 15 net nonrenewable exporters. The prices of their main export staple - fossil fuels and metals - have crashed by between more than 60 and 30 percent during that period. Oil exporters are hard hit: If oil exports constitute 40 percent of a country´s GDP, an annual drop in oil prices by 25 percent translates into an income effect of minus ten percent. To be sure, commodity prices may fall even further; they may stagnate from now on; and they may rise again. Only the rise of commodity prices would alleviate African producers. Don´t bet on it, says Carmen Reinhard (2015)[1]: price declines typically retain downward momentum. By the end of the boom, many commodity exporters had already initiated investment projects to expand production. As these investments bear fruit, the increased supply will sustain downward pressure on prices. For minerals, short-term supply is price-inelastic: a result of near-insurmountable barriers to exit and a significant proportion of fixed costs.

The second pillar, net capital inflows, is so far surprisingly unaffected prima facie. The IMF WEO, released last October, still projects a small surplus (0.4% of GDP) in the capital account for Sub-Saharan Africa. DB Research[2] produces fresh evidence that Eurobond issuance by Sub-Saharan African frontier sovereigns (excluding South Africa) has held up remarkably well in 2015.

Figure 2: Change in Debt Service Cost, Sub-Saharan Africa 2015

However, issuers had to offer significantly higher yields than previously and yields on secondary markets jumped to multi-year highs (Figure 2):
·         While Emerging Market Bond Index Global (EMBIG) spreads have moved up since October 2014 by less than 100 basis points (bp), sub-Saharan sovereign bond spreads have risen by between 120 bp (South Africa) and almost 500 bp in Zambia.
·         As all outstanding sovereign Eurobonds in SSA are denominated in USD, any depreciation will have a direct effect on the local currency value of debt service payments. This is potentially even more harmful for interest burdens than rising spreads. The drop since summer 2014 against the USD has been most severe for the Zambian kwacha, the Angolan kwanza, the Namibian dollar, the Ugandan shilling and the Tanzanian shilling which lost between 51% and 20% yoy against the USD, as of November 2015. Zambia has been hit hardest: debt service cost rose in 2015 by 18 percentage points of GDP (left hand scale in Fig. 2) and by 106% in local currency terms (right hand scale).

The difference between rising local currency cost of Eurobonds – around 20% on average in SSA - and the drop in growth rates to low single digits makes for terrible debt dynamics, which is unlikely to be compensated by a corresponding surplus in the non-interest account.[3]

This leaves us with the third pillar, better policies. In the realm of development finance, this translates above all into improved tax collection. Recent IMF analysis (“Dealing with the Gathering Clouds”) suggests that the median country in sub-Saharan Africa might have a potential for another 3 to 6.5 percentage points increase in tax revenue. AID spel

[1] Reinhard, Carmen (2015), “The Commodity Roller Coaster”, Project Syndicate, 9 November.
[2] Masetti, Oliver (2015), „African Eurobonds: Will the Boom Continue?“, Deutsche Bank Research, Research Briefing, 16th November, Frankfurt/Main.
[3] Debt dynamics for a country´s local currency debt-GDP ratio eD/Y are driven by e(r-n)D + (G-T), with e the real exchange rate, r real interest cost, n real growth rate, D/Y the debt-GDP ratio and (G-T) the non-interest deficit. The same debt-dynamics equation can be applied to public finance.

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