Africa’s COVID-19 Sovereign Debt Relief Package: Placebo or Panacea?
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Africa’s COVID-19 Sovereign Debt Relief Package: Placebo or Panacea?
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By Bathsheba Asati, Research Associate, Botho Emerging Markets Group
September 27, 2020
In recent months, African finance ministers and economists have lobbied for sovereign debt relief due to the fiscal pressures caused by COVID-19. As a result, the G20 issued a moratorium on debt payments, and the Chinese government also indicated that they would ease Africa’s debt burden. Nonetheless, these solutions only offer temporary relief and are nowhere close to addressing one of the core issues in Africa’s impending debt crisis: overindebtedness. Some reports even find that the solutions offered may worsen the situation, making it costlier for countries to access debt in the future. COVID-19 has strained on African governments’ resources, and efforts to ease the pressure are a step in the right direction. But the opportunity cost of each solution must be taken into account to avoid compounding the existing debt burden. Moreover, governments should advocate for sustainable, long-term solutions, overhauling the current practices to positively influence African countries’ position as borrowers.
Sovereign Debt Issues Across Emerging Markets Existed Before Covid-19
Changes to the sovereign debt landscape, marked by access to lenders outside the Paris and London Clubs, create more opportunities for sovereigns to access funds but also present a new set of challenges. First, borrowing outside of the Paris and London Clubs makes it harder to convene and coordinate restructuring discussions among creditors. Secondly, due to reduced restrictions on access to debt, countries often overborrow even at unsustainable rates. The increasing popularity of sovereign bonds and the emergence of bilateral lenders such as China has led to a steep increase in the debt burden of emerging countries. The debt owed to China is at $1.5 billion globally, making China the world’s largest creditor. China is also the largest lender to developing countries that owe over $350 billion, second to China, is the World Bank whose debt to developing countries currently amounts to $300 billion. According to the Institute of International Finance, the debt burden of small and vulnerable frontier markets grew in the last decade from less than $1 trillion in 2005 to $3.2 trillion, equal to 114% of these countries’ GDP.
In Africa, sovereign debt is a longstanding problem, not a pandemic-induced issue. There were a total of 317 debt restructurings in the continent between 1980 and 2012 — far more than any other region. Pre-pandemic, over 40% of Sub-Saharan African countries were projected to be facing an impending debt crisis. Nearly 22 countries had debt-to-GDP ratios exceeding the 60% recommended by economists, and more than half recorded fiscal deficits of over 3%. Africa’s debt burden is further exacerbated by issues such as unstable oil and commodity prices, corruption, foreign-currency risks, and high borrowing costs.
Some critics argue that African countries don’t borrow too much—the problem is they pay too much. These high borrowing costs arise from inflated perceptions of risk in the continent. The research supports this view: African countries incur up to $300 million of higher debt servicing costs arising from unjustified interests often called the “‘African Premium”. In the last decade, debt servicing costs in Africa doubled, from an average of 5% in 2012 to 10% in 2017. By 2019, major African economies such as Kenya, Nigeria, and South Africa paid over 10% on 10-year bonds when markets in Vietnam, India, and Indonesia had yields of between 3% to 8%. While one can rightly argue that these markets are not comparable in terms of economic diversification, GDP, debt profile, and revenue sources, still the significant difference in yield can be used as a basis to investigate the rates at which African countries borrow and identify pathways to reduced costs.
Covid-19 Debt Relief Solutions Do Not Address Africa’s Core Sovereign Debt Issues
Based on the overview of Africa’s sovereign debt issues, why are the solutions proposed by G20 governments, China, and multilateral organizations unsuitable? First, they do not address the core issues faced by African borrowers. Suspending debt payments gives African governments much-needed breathing room, but it does not lessen the debt burden that these countries face. Secondly, the moratorium issued is conditional: countries that access the relief package can only use the funds saved on critical public services and the shocks of the pandemic. Moreover, the countries under the debt relief program face additional restrictions around accessing funds from other creditors, which means that states cannot use the funds saved from the moratorium to generate revenues or bolster their debt repayment capacities.
Last, and probably most importantly, while these relief packages offer short-term benefits, their opportunity cost and long-term effects may be more harmful than helpful to African borrowers. The explanation is simple: access to bond markets is largely based on the reputation, history, and integrity of the borrower. Relief packages may have a negative signaling effect on bond investors and bilateral lenders affecting the profile of the borrower. The credit ratings of Ethiopia, Côte d’Ivoire, and Senegal were already affected by their participation in the G-20 Debt Service Suspension Initiative. Kenya, citing the same reasons (the risk of a rating downgrade), made it clear that it will not seek a relief package but will instead explore alternative solutions such as directly engaging bilateral creditors.
Moving Forward, All Stakeholders Must Work Together to Enhance Debt Sustainability on the Continent
Resolving African countries over-indebtedness is a complex issue that requires a multi-pronged approach to address the exacerbating factors such as high borrowing costs and insufficient debt management structures. Addressing overindebtedness falls not just on African governments but also on lenders, credit rating agencies, and multilateral institutions to each do their part to improve debt sustainability on the continent. Reducing one’s debt burden, in particular, requires a range of solutions such as enhanced national debt management policies, a collective continental voice around strengthening the reputation and treatment of African borrowers, and better negotiations between African borrowers and creditors.
First, the lack of national debt management policies and structures aggravates the precarious situation that African borrowers find themselves in. An increase in debt levels is not necessarily bad if the funds are channeled into profitable projects that support repayment. Unfortunately, in many African countries, that does not appear to be the case. Even where debt is channeled into potentially lucrative projects, recording and managing debt obligations remains a challenge due to the fragmentation of the process across government entities. Adopting a centralized approach and appointing a designated office to manage and track all sovereign obligations will help African governments better manage and track their sovereign obligations. Additionally, sound debt management practices have a positive signaling effect and will boost investor confidence which would ultimately lead to lower debt servicing costs.
Second, African countries must also adopt a collective voice in advocating for the overhauling of practices that disadvantage them. For instance, African countries can collectively push for the revision of the methodologies used by credit rating agencies to ensure that rating agencies consult the relevant governments and disclose the formulas they have used to arrive at their decisions. The European Union and the United States both introduced policies and directives that require agencies to reveal the methodologies used in their ranking. Increased oversight over the credit rating agencies has two beneficial outcomes. First, rating agencies are more likely to be more conscientious in their approach as they will be open to scrutiny. Secondly, with more insights on the methodology, African governments will be armed with more information that they can use to challenge the rating process or even negotiate with potential investors.
Finally, all stakeholders must work together to facilitate better negotiations with lenders and the structuring of African bonds to create better terms. There is sustained, if not growing, interest in African sovereign bonds as was demonstrated by the oversubscription in Kenya's and Ghana’s listings. The continent has significant potential for growth, and creditors must be careful to balance immediate gratification from the promise of higher returns and the long-term benefits gained from lower and more realistic interest rates. Overcharging borrowers will create a vicious cycle of over-indebtedness where debtors borrow to repay and are unable to dedicate enough resources to development projects that generate returns. If the cycle continues, borrowers could default, a situation that borrowers and lenders alike would prefer to avoid. Therefore, it is in the lenders’ best interests to ensure that they offer terms to the debtor that ensure repayment remains a possibility and does not drive borrowers to default.
As Winston Churchill stated, “Don’t waste a good crisis.” African economists presented a powerful united front to lobby for debt relief however, current solutions will only yield promising short-term rewards. In the long-term, they will generate more harm than good. While no one solution is a cure-all, over-indebtedness can be addressed if countries collectively build on the existing momentum to advocate for more wholesome reconsiderations for African borrowers that lead to lower borrowing costs and debt sustainability.
References:
Devarajan S, Indermit G, and Karakülah K, Debt, growth, and stability in Africa: Speculative calculations and policy responses, Conference Paper, June 2019.