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Africa’s debt nightmare

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By Donasius Pathera:

Malawi joins the bandwagon of African countries with increasing debts hovering around the continent.

The country has seen debts rising above the 60 percent threshold, with an anticipation of getting closer to the 70 percent mark.

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As this is a concern for a poor country like Malawi, the worry is a renewed concern about the sustainability of rising debt levels in many African countries. Much of this debt is being incurred through foreign currency denominated Eurobonds issued on international financial markets.

According to IMF data, the total value of Eurobonds issued between 2018 and 2019 was more than the value of all bonds sold between 2003 and 2016; this shows an increase in appetite to borrow by African countries.

African governments are issuing and listing their Eurobonds on established international debt markets – usually London and Irish Stock Exchanges. African governments would venture into offshore a lot less if domestic bond markets were active and liquid.

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African bond markets are largely underdeveloped with inactive and illiquid secondary markets. This makes it difficult to attract international investor participation locally.

The International Monetary Fund (IMF) believes that African countries are on a Eurobond issuing spree and half of them are near or at distressed levels. It argues that African governments are piling on debt without evaluating the exchange rate risks and the real costs of repaying the debts.

According to Misheck Mutize, lecturer in finance at the University of Cape Town, the debt alarm being set off by international debt management organisations is exaggerated. The problem is not that African countries are borrowing too much but, rather, they are paying too much interest.

There are a number of reasons for this, including badly informed ratings by rating agencies, as well as the behaviour of issuers. However, it is evident for Malawi that lately it has been borrowing too much, as well as paying high interests rates that are crippling the economy of the country.

Unfortunately, if countries borrow too much, there are several consequences; the first one is the payment of higher interest rate and, secondly, countries are forced to raise taxes or introduce new taxes to cover up the fiscal gap, the third effect could be inflationary pressures, the chances of experiencing inflation are high.

On the fourth spot, countries may experience crowding out, as the government borrows from the private sector by selling bonds, it gets money from the private sector, so the private sector has less money to spend and invest, therefore government spending increases and the private sector spending falls-thus results into a decline of output by the private sector.

Another dangerous scenario is the capital flight, if the Government finances its deficit by borrowing from abroad there is potential for the economy to suffer capital flight, the investors fear investing in that country and they may decide to invest elsewhere because they fear they may lose out to devaluation.

Despite the threats that African countries are facing including Malawi, there are solutions that can be taken aboard. But these require African governments to stand up and take action.

There are two key elements that are taken into account in assessing a country’s debt burden. One is the level of debt based on the ratio of debt to gross domestic product (GDP). The other is the cost of servicing the debt, namely interest payments.

Debt levels on most countries in Africa are on average way below the 100 percent debt-to- GDP ratio mark. The premiums African countries are paying are much higher than those paid by other countries. In my view these are not justified by the risk profile of African countries.

Save for four countries; Cape Verde, Djibouti, Congo and Mozambique, all the other African countries have debt-to-GDP ratio averaging 60 percent. A debt-to- GDP ratio of 60 percent is the IMF’s and African Monetary Co-operation Program’s threshold for prudent debt levels.

The scale of debt issuances in Africa amounts to only 1percent of the continent’s total GDP annually, whose average annual growth rate is 4 percent. In simple terms, this means the value of income generation is higher than the rate of government debt accumulation. The ratios give a snapshot of the country’s fiscal sustainability.

On the contrary, the amount of interest expenditure has been disproportionate to the debt-to-GDP ratio. Studies show that in developed economies, an increase of 1percent in debt-to-GDP ratio is associated with an increase of between 0.02 percent and 0.03percent in interest rates.

African governments are paying interest of 5 percent to 16percent on 10 year government bonds, compared to near zero to negative rates in Europe and America. On average, the interest repayment is the highest expenditure portion and remains the fastest growth expenditure in sub- Saharan Africa’s fiscal budgets.

The rising interest rates on Africa’s debt should be of major concern. African countries are shortchanging themselves by accepting high yield curves in their Eurobond Initial Public Offerings. This unjustifiably cements the perception that they are high-risk issuers.

The high interest rates are driven by several key factors. First, the mismatch between the short-term duration of the debt those African governments have taken on by issuing Eurobonds compared to the long-term nature of the infrastructure projects they propose to fund with the money raised through Eurobonds. The excessive need to attract investors is forcing African governments to borrow short term to finance long-term projects.

Second, fungibility of Eurobonds proceeds, flexibility to be utilised for purposes other than the ones they were raised for, exposes the funds to the downside vulnerabilities of misappropriation and nonproductive expenditures. Third, poor credit ratings as the majority of countries are in junk status. Credit ratings are pivotal in determination of both interest rates and the demand for bonds.

The weaknesses of rating agencies’ risk assessments have widely been criticised. According to sovereign credit methodologies of the big three rating agencies, economic growth is a decisive factor in past sovereign credit events.

There is a strong positive correlation between economic strength and credit worthiness. But in Africa high economic growth has not translated into better sovereign ratings.

Take Ethiopia for example. It has a current economic growth of 8.5 percent and has been hovering between 8 percent to 11percentfor over 10 years. But it has not had a single upgrade activity from any of the three international rating agencies.

Senegal, one of Africa’s most stable countries, experiencing three peaceful political transitions since its independence in 1960, has maintained an economic growth averaging 6percent over the past 10 years. It still remains in junk status rating.

African countries can act to address the rising interest burden, and to avert falling into a debt trap through the following mechanisms: Governments should use the money raised to fund profitable projects and use the profits from these projects to repay interest owed, Governments must take control of the bond issuance process during the bond structuring stage.

Countries should manage lead issuance advisors to negotiate for the lowest interests possible to be saved from unnecessary costs. Governments should bargain for competitive interest rates and accept only favourable bids.

Governments should borrow for productive expenditure and manage proceeds from international bonds more prudently with integrity and transparency. African countries should establish a continental position, adopt international standards and guidelines to establish lines of accountability in rating agencies.

This will create a platform to enforce adherence to scientific rating methodology, rating appeals, regulating rating agencies and sufficient involvement of rated countries in the rating process.

Another important factor is domestic resource mobilisation, for African countries such as Malawi to wake up and shy away from debts, it is important for Malawi to start thinking in upgrading resource mobilization. Bringing the informal sector into the tax base and ensuring that revenue collection has its roots strengthen by quality institutionalism and professionalism.

Every Malawian has the responsibility to contribute to the development of the country. At the same time, the Government of Malawi should ensure that public finance management is up to standard so that the citizens have trust in the system.

*The author is an economist

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