African perspectives on the current debt situation and ways to move forward

Posted on March 27, 2023September 5, 2023 by Aurore Sokpoh

The 4^th virtual meeting of the “Amplifying Africa Voices Initiative”, a group of African policy institutes co-convened by the African Center for Economic Transformation (ACET) and the Finance for Development Lab (FDL), reflected on the current debt situation in African countries. The previous two meetings covered climate finance and the reform of Multilateral Development Banks.

Discussions focused on structural questions, including why and how many African countries went back to debt distress situations. Reasons are both internal and external. At the same time, the fragmented creditor landscape and the high cost of borrowing could create an unnecessary crisis, for which global institutions and existing mechanisms, in particular the Common Framework, are not sufficiently equipped to manage.

Debt in Africa: How did we get there again?

In the 2000s and 2010s, high growth in developing countries allowed to ignore emerging debt challenges following a successful HIPC initiative. Since 2016, however, a decline of trend growth and a series of major economic crises have brought debt challenges to the fore.

INCREASING DEBT LEVELS, BUT STILL BELOW HISTORICAL HIGHS

Since the first large scale debt restructuring process (HIPC and MDRI), public debt in African countries has escalated, reaching $645bn in 2021 compared to $233bn in 2010. Its structure has also changed, with domestic debt playing a much more prominent role than in the past – though with wide variations across countries.

Nonetheless, compared to the HIPC period, public debt remains relatively low. From an external point of view, it is also far from the main determinant of flows: in 2019, debt accounted to around 30% of capital flows to African countries ($24bn), but FDIs ($32bn) and grants ($30bn) actually dominated.

Figure 1 - Public debt in Sub-Saharan Africa

Participants in the Amplifying Africa’s Voice dialogue noted an internal lack of governance to explain some of this debt accumulation. These include a deterioration of public financial management systems, a lack of transparency, and poor returns on investment. But “push factors” have also played an important role, such as Chinese loans driving large infrastructure investment of variable quality, a low rate environment and a stagnation of concessional finance. All this led some countries with access to markets to issue expensive Eurobonds while commodity price volatility exposed them to boom and bust dynamics.

The case of Zambia, presented by the Zambian Institute of Policy Analysis and Research (ZIPAR), illustrated those “pull” and “push” factors, including the issuance of expensive Eurobonds whose use of proceeds were opaque, large loans by Chinese finance institutions, all this happening amid declining growth. Those flows were financing investments, sometimes with poor returns, but also a growing civil service workforce, with no increase in tax revenues. ZIPAR presented key factors behind the dramatic accumulation of debt between 2010 and 2020, leading to a default in 2020. A summary of a forthcoming paper is available here.

The consequences of the case of Zambia are also important and should worry other countries: the deal has been too slow and contentious. The delayed publication of the IMF Staff-Level Agreement led to frustration among creditors, both official and private. In the end, it relies on austerity and provides little on renewing the growth model. It has become more urgent than ever to find compromises that are specific to Zambia, and to draw the lessons of past delays to catalyse broader reforms.

VULNERABILITIES ARE CLEARLY SHOWING

Recent macroeconomic shocks have exacerbated fiscal and external vulnerabilities for many emerging and frontier economies, namely the COVID-19 crisis, the Russian war in Ukraine, and fuel and food price shocks.

Experts in the Amplifying Africa’s Voice dialogue suggested that liquidity more than solvency has been the main concern. Debt to GDP remains low compared to other regions, as do other metrics such as debt to revenues. However, debt service has been increasing rapidly, and private as well as official sources of finance of the past decade are drying up. Since 2020, net transfers have been decreasing. For some creditors such as China and commercial lenders, net transfers are negative, i.e., more money is leaving Africa as debt service than money coming into Africa as loans. This is due to the types of financing raised by African countries in the 2010s, with a turn to Eurobonds that had shorter maturities and no concessionality. The problem lies in the refinancing risk it is creating. For many countries, yields are above 10%, implying a de facto lack of market access. Repayments walls under the form of large payments appeared and often lead to defaults.

Table 1: A simple typology of debt problems

A NEW APPROACH TO DEBT RESTRUCTURING PROCESS IS NEEDED

In addition, increasing financing needs for developmental purposes, and investment in climate mitigation and adaptation are stretching an already limited fiscal space in many African countries. Climate financing alone requires $2 trillion per year, notwithstanding financing needs for developmental purposes, or to absorb inflationary shocks.

Repeated crises have led to an increased involvement of the IMF, which has been increasing its programs in Africa. Twenty-six countries have an IMF program, in addition to a program of lending to Rwanda under the Resilience and Sustainability Trust. MDBs have also expanded lending.

But the sustainability of such surges is uncertain. Ethiopia, Zambia and Ghana are in the midst of a debt restructuring, whilst many others are under high risk of debt distress. As of March 2023, 24 countries were at risk. The complexity induced by the changing composition of creditors has undermined current debt restructuring processes. New debt restructuring and management processes are needed to provide African economies with the necessary fiscal and policy spaces.

THE WORLD SHOULD PAY ATTENTION

The Amplifying Africa’s Voice discussion on debt focused on the reforms needed to avoid another wave of debt. Three topics were highlighted:

The “productivity of debt”

An influential view from Ndulu and O’Connell, 2021 is that debt accumulation also contributed to a more productive economy for African economies since the 2000s. Large financing needs to fund infrastructure and developmental purposes as well as the rising costs of climate vulnerability will not disappear, and a significant share will remain on governments’ balance sheet. However, growth effects have sometimes disappointed, or were not translated into government revenues or exports. Some countries in debt distress suffer from chronic public financial mismanagement and corruption. In other cases, security spending is a large, unavoidable cost which bears heavily on public finances. How to make debt more productive and for international organisations to recognize the burden of conflict, are important agendas for the future.

Transparency and debt management need to improve.

Governments need to improve control on spending and borrowing. More frequent and accurate data is necessary, including contingent liabilities or PPP-linked debt. Opaque loans sometimes lead to more costs down the line. More research should go into what works to strengthen debt management capacity.

Finally, governments and international organisations need to improve their surveillance frameworks.

There is a broad confusion between the different types of debt risks, and indicators. Debt to GDP ratios may be less useful in today’s complex world and need to better include factors such as exports or public revenues. Growth assumptions are often unrealistic. A broad review of the risks is necessary, both narrowly focusing on reforming Debt Sustainability Analyses (DSAs) and a broader understanding of the risks. The search for an “optimal” level of debt and domestic/external balance is also important, especially for countries with large domestic markets like Nigeria or Kenya.

At the same time, participants in the Amplifying Africa’s Voice dialogue noted that short-term tensions require the full attention of policymakers. While the topic of debt in African countries is a key concern for policymakers, both in the region and globally, with frequent mentions in G20 communiqués, there have been few concrete advances recently. The World Bank and the IMF themselves have suggested reforming the Common Framework by clarifying timelines and offering a single definition of “Comparability of Treatment”. Those reforms would allow more transparency in the process and give more agency to debtors. At the same time, the IMF could lean more on its ability to lend into arrears – private or official.

The fact that tensions on debt remain mainly due to the lack of liquidity is important too. The need for liquidity is urgent, but its sources so far have been drying up: SDR reallocation has been disappointing, multilateral development banks have reached the limit of their capacity, barring important reforms to their financial models. In addition, if debt rescheduling is necessary, are IMF tools adapted to such cases? How to prevent the diversity of creditor groups from stopping deals which could benefit everyone? Those questions should be treated at the highest level.

Yet, the “Summit for a New Global Financial Pact” announced by French President Emmanuel Macron to be held June 2023 does not have a separate track, or objectives, on debt reduction. Amidst concerns on climate financing, the debt agenda risks being forgotten. There are economic and geopolitical reasons for this as debt forgiveness is expensive for lenders and it creates geopolitical tensions across OECD countries and non-traditional lenders such as China. But ignoring debt would be a grave error. Countries in Africa need a stable debt framework to make progress on the SDGs and address global public goods such as climate. Advocacy and inventive policy solutions to this short-term challenge are required.

Amplifying Africa Voice is an initiative of the African Center for Economic Transformation (ACET) and Finance for Development Lab (FDL) to improve knowledge sharing and joint analysis among African economic policy institutes on the global financial architecture agenda. The fourth technical session on African perspectives on the debt crisis was held on March 15, 2023 and gathered nearly 20 African policy institutes from across all the regions and several experts of development finance.

Reforming the Multilateral Development Banks (MDBs)

Posted on February 25, 2023September 5, 2023 by Aurore Sokpoh

This blogpost was written in collaboration with participating think tanks from the Amplifying African Voices Initiative and jointly published

Now is the time to build momentum for meaningful MDB reforms that address Africa’s needs

Co-convened by the African Center for Economic Transformation (ACET) and the Finance for Development Lab (FDL), the third meeting of African think-tanks, under the Amplifying Africa Voices Initiative, specifically focused on MDB reforms (January 31).

The absence of African voices in the conversation on global financial architecture issues increases the urgency of this initiative.

The number and frequency of crises of all sorts (climate change, COVID-19 pandemic, geopolitical conflicts) has increased in recent years and underlines the urgency to find ways to overcome some of the most pressing global challenges of our time. International responses so far have been disappointing and lessons from the past have not yet been properly assimilated.

The G20, the international development community, and CSOs have repeatedly called for in-depth reforms of Multilateral Development Banks (MDBs). Indeed, whilst the latter may be uniquely qualified to address today’s crises with strong country-specific programmes, their approaches and fiscal impact need to be improved and concessionary funding has to be scaled up in order to effectively address the development challenges ahead.

MDBs play a unique role in tackling today’s global development challenges while maintaining vital country-level programmes.

The estimated needs to respond to shocks, finance development and the SDGs, and address to climate challenge run in the trillions. It is estimated that the new global challenges will require a tripling of financing from the MDBs, a doubling of bilateral aid, and a massive rise in the flow of private capital.

To succeed on all of these challenges, it is perceived that the role of MDBs is central. They have a financial model whereby all member countries – even developing economies - are shareholders. Contrary to many developing countries to which the markets have currently closed their doors, MDBs are able to borrow from capital markets. This leverage effect has allowed the World Bank Group’s International Bank for Reconstruction and Development (IBRD) to lend over $750 billion in loans from 1944 to 2020 with a capital of $18 billion provided by the 189 member countries.

Given the scale of today’s new global challenges, MDB financing will need to be increased significantly.

Concessional financing represents around $200bn a year, which is clearly insufficient considering that climate financing alone requires $2 trillion per year. There is a view that MDBs are overly constrained constrained by mandates and are too focused on protecting their capital base. Over time, a push by MDB non-borrower shareholders has led MDBs to focus on low-income countries (LICs) and to withdraw middle-income countries (MICs) from MDB concessional lending. This was due in part to the fact that MICs economies were growing, providing them access to international capital markets. In particular, during the Covid-19 pandemic, concessional lending to LICs rose sharply while the rise in non-concessional finance for MICs was much lower. MDB lending is seen by many as not aligned with the priorities of emerging economies, and it comes with high costs related to policy conditionalities, rigid safeguards, and lengthy processes.

THE INDEPENDENT REVIEW OF MDBS’ CAPITAL ADEQUACY FRAMEWORKS (CAF)

To address pressing financing needs, the G20 called in July 2021, for an Independent Review of MDBs’ Capital Adequacy Frameworks (CAF). The question is whether MDBs could leverage its capital even more. The panel’s view is that it does.

To do so, it recommended strategic shifts in five areas of the capital adequacy frameworks to maximise the impact of MDBs capital. These included adopting more efficient management of capital and risk, defining risk tolerance more precisely, relying more on callable capital, increasing the rate of financial innovations, and engaging in a closer dialogue with credit rating agencies. They further recommended creating an enabling environment for reform through greater transparency and information. The CAF report suggests that these actions could allow MDBs to substantially increase available funding by $1 trillion while protecting the World Bank’s AAA credit ratings.

Following the CAF Report, shareholders during the 2022 WB/IMF Annual meetings called on the World Bank to produce an “Evolution Roadmap”. In December 2022, the World Bank released its roadmap with a focus on the need to broaden and redefine poverty appropriately, while also revisiting the “shared prosperity goal”. The roadmap broadly accepted to deepen engagement with Middle-Income Countries, increase financial capacity, and work harder to catalyse private capital and raise domestic resource mobilization. It also warned that such reforms cannot lead to much more financing in the absence of a capital increase.

During the discussion, think tanks and experts stressed that the report lacked ambition and innovation. It also failed to focus sufficiently on the need for a parallel scaling up of finance to poor countries. This is reflected in insufficient stress on finding the right balance between financing global public good investments related to mitigation, and resilience enhancement – in particular with regards to food security. Higher level of disbursements will require major changes in safeguards, legislation, governance and human capacity. Capacities for national planning and donor coordination as well as learning and evaluation will also need to be enhanced. But equally, to ensure new financing is effectively used, Nationally Determined Contributions (NDCs) need to become more disciplined and more ambitious.

Currently, the dialogue on how to leverage MDB capital is mostly a G20 political dialogue and there are three key issues to be resolved:

How to ensure the LIC agenda continues to advance as the unit cost of development increases, particularly considering climate change adaptation and mitigation.
With regards to MICs, how to ensure that climate lending does not come at the cost of other development goals.
Even if it gets expanded, how can climate financing match the borrowing needs.

In all of this, it is critical to ensure that African voices are influencing the design of the reforms

It is time for a new institution with equal participation or a new African-led and focused financing instrument. A proposal for the creation of a new climate finance institution was discussed. It would bring together governments, the private sector, and civil society representatives and where the Global South would have an equal voice to the Global North. Some policy institutes have noted there might not be a need for new organisations, but rather closing down some existing ones with overlapping mandates could be more effective. That said, attracting funding from the private sector remain a big challenge. Establishing a new instrument focused on climate may more easily attract funding from the private sector, provide incentives for carbon credits, elicit political will and create a channel to sell green bonds.

The discussion highlighted the political economy of how to affect the international financial architecture for development. Unprecedented global financial resources were spent on the Covid-19 response and now Russia’s war in Ukraine. But many in Africa feel insufficient resources have been allocated to the continent, which is leading to dissatisfaction and anger. Some policy institutes felt that reforming the international financial institutes is an impossible task as it is a zero-sum game. If one party gains more voice or voting rights, then another party loses its voice or voting rights. Others are more optimistic. But all agree that for African perspectives to have a chance of influencing these debates, there is need for a much stronger effort at articulating what Africa collectively wants to see out of this reform.

Given that G20 members India, Brazil and South Africa are/will serve as presidents of the G20 in the next three years, there is an opportunity for African think-tanks to build momentum on the financing agenda by deepening and filling the void of African voices on these topics. Concrete proposals need to be advanced to inform African leaders. This is even more urgent given the African Union (AU) is seeking a seat at the G20.

Two tracks of ways forward

Workable solutions for global financial architecture reforms need to come from the continent. It will come down to strategies combining public goods and national development plans. The challenge is how to structure new instruments to address the current crises and provide solutions where governments fail to do so.

The African economic policy institutes have discussed two tracks of research.

The first relates to proposals for structuring a new instrument.
The second focuses on leveraging what is already happening on the ground in Africa. In this way, and with a strong African voice in global fora, the new global financial architecture can reflect on Africa’s priorities.

Amplifying Africa Voice is an initiative of the African Center for Economic Transformation (ACET) and Finance for Development Lab (FDL) to improve knowledge sharing and joint analysis among African economic policy institutes on the global financial architecture agenda. The second technical session on African perspectives on the MDB reform was held on January 31, 2023.

How to move from trillions to people ?

Posted on January 24, 2023September 5, 2023 by Aurore Sokpoh

This blogpost was written in collaboration with participating think tanks from the Amplifying African Voices Initiative and jointly published

Climate finance has emerged as a major concern not just for African countries, but for the developing world at large.

A recent meeting of African think-tanks, under the Amplifying African Voices Initiative co-convened by the African Center for Economic Transformation (ACET) and the Finance for Development Lab (FDL), discussed existing knowledge on the pressing topic of climate finance and highlighted the need for further work to advance the cause of an effective and fair green transition on the African continent.

Climate finance has emerged as a major concern not just for African countries, but for the developing world at large. Global warming is estimated to generate a median loss of 1.5 percent of annual GDP in developing countries and in SSA (IPCC, 2022). At the same time, there is a rising occurrence of catastrophic events – droughts, floods, pandemics – that lead to the loss of years of development at once. It is poor people, women, and children that are the least able to protect themselves and bear the brunt of these shocks.

A recent meeting of African think-tanks, under the Amplifying Africa Voices Initiative co-convened by the African Center for Economic Transformation (ACET) and the Finance for Development Lab (FDL), discussed existing knowledge on the pressing topic of climate finance and highlighted the need for further work to advance the cause of an effective and fair green transition on the African continent.

The key tensions between development and climate needs were not resolved at COP27. We are still very far from a credible agenda for a fair transition to a de-carbonated world. From a fairness perspective, Africa needs to be compensated for the emission gap (AfDB 2022). The continent generates 3% of global emissions, and yet it suffers most from climate change. North Americans emit 14 tons of CO2 per person annually; Chinese and Europeans 7 tons, and Africans emit just 1.1 tons. The African Development Bank estimates that climate debt requires a transfer from the rich world to Africa of more than $150b/year until 2050. But, as the world aims to net zero by 2050, Africa’s aspiration is not just to be compensated for damages but also use green development pathways to its comparative advantages, including renewable energy, green hydrogen production and credible carbon offsets.

Think-tanks need to be much closer to the ground to start bringing this vision closer to reality.

Where is climate finance for Africa?

Climate funds mobilized for African countries still fall far short of the amount needed to avoid the worst impacts of climate change, support adaptation and the building up of resilience on the continent. Worse, some of what is raised crowds out traditional ODA, and much of what is spent is tilted towards mitigation. A recent report by ACET showed that for the period 2020-2030, the average annual climate funding needs for Africa are estimated at over $140bn per year - around $30bn for adaptation, $70bn for mitigation, and $40bn for loss and damage. This compares to current flows of only $20 bn per year.

It is not going to be easy to raise these large amounts in a world of tight budget constraints. Several initiatives on this front need to be supported – such as MDBs reform and SDR rechanneling. Moreover, different aspects of the problems require different types of financing:

Adaptation finance should be largely financed by MDBs, since it covers projects with public goods characteristics. Allocation criteria should be related to climatic vulnerability, not just to poverty.
Funding for climate mitigation should come largely from the private sector, and supported with instruments to mitigate country risk through FDI, PPPs, guarantees and other enhancements from MDBs.
Loss and damage funds should be grants-based and may require a new global tax instrument to be put in place – for example in the domain of transport, carbon, or capital flows.

To move from trillions to people, there is mostly a need to move from “back of the envelop” estimates to closer to the ground and to the identification of people’s needs. There are indications that rates of return on adaptation projects can be in the triple digits (see e.g. IMF 2022). But pipelines of actual projects ready to be financed remain hard to come by, especially for adaptation, but also for mitigation. To flow, climate finance needs to be irrigated by a pipeline of proposals. To get there requires work at the field-level to determine how to reduce vulnerability. It also requires large amounts of technical assistance funding to build up financeable proposals for desirable projects. AUDA-NEPAD has been a provider of such capacity building and project preparation.

Listening to people's voices

How can think-tanks and civil society be more involved? There are already models in the continent that can be emulated. Through a series of webinars called "What is the voice of Africa?", the Egyptian Center for Economic Studies (ECES) has explored solutions proposed by African countries’ speakers to address their concerns about climate change.

Africa’s youth need to play a fundamental role since they will be the primary bearers of climate change consequences: as the continent will be on the frontline of the consequences of climate change, and the current young generation will experience increasing impact.

The South African Institute of International Affairs (SAIIA) has been working on capacity-building programs with young scholars on climate. The Kenyan Institute from Public Policy Research and Analysis (KIPPRA) organized a Youth in Climate Change Action Symposium which informed policy briefs in preparation of COP27. But in Sharm-El-Sheikh, a big gap remained between closed-door negotiations and debates among civil society actors.

More pressure is needed to open up formal negotiations to demands emanating from citizens. At the national and global levels, we need mechanisms to hold leaders accountable, and for their pledges to be translated to concrete actions.

Defining climate change vulnerability

The newly approved Loss and Damage Fund was one of the successes of the COP27, as this has been an African priority in global climate negotiations for more than a decade (SAIIA, 2022). But central questions on the mechanism, its funding, and conditions of access remain wide open. Conversations took place during COP27 on the urgency of defining economic and non-economic impacts of climate change, including depending on social characteristics, such as gender or age. It was clear that a much better understanding is needed about the connection between efforts to improve adaptation to global warming and loss & damage. Adaptation includes projects to build defenses against sea-level rising, reduce the salinity intrusion and floods, make resilient road and bridge infrastructure, and increase water conservation. An important side-benefit is that adaptation will improve food security in a world with greater variability in food prices.

At the regional and local levels, work is needed to understand how efforts on adaptation can be better integrated to reduce the costs of natural disasters. In East Africa or the Sahel, the nexus between humanitarian or food insecurity needs is linked to efforts in adapting to climate change. Estimating needs and returns on certain investments could be a step forward in making the case for much more financing from the international community.

What is green growth?

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In the future, African economic growth will have to be green.

What constitutes green growth – sustainable, inclusive - remains to be imagined. Some elements are becoming clearer but need to be brought together into a coherent whole.

Solar and hydro can become a source of comparative advantage. With adapted technology transfers, economies could leapfrog to higher levels of productivity in many fields.

Progress in these areas requires large investment, technological transfers, and proper planning. In some cases, global reforms are needed. African initiatives to transform and strengthen carbon offsets markets could unlock large sources of financing: at $50/ton, $15b of annual revenue and 50 million jobs can be generated (Climate Action 2022). Those flows would compensate for global environmental services.

A tight connection between growth and Nationally Determined Contributions (NDC) needs to be achieved, which would help define the needs, chart green development pathways and link projects to funding sources. For instance, the Kenya Institute for Public Policy Research and Analysis (KIPPRA) has recently introduced a task force with the Kenyan government and World Bank representatives, as well as other think-tanks, which will look at the green initiatives in Kenya, their incentives, and outcomes. A national framework has been drafted and is awaiting approval for implementation. A further research and evaluation project will look at the integration of green economy in Kenya and determine the outcomes to be evaluated.

Amidst a growing number of initiatives, this meeting clarified important questions that remain to achieve green development pathways:

charting green growth with economic transformation and infrastructure investment,
connecting them to financing sources,
protecting vulnerable people and economic systems through adaptation,
compensating losses and rewarding global public goods contributions.

Ultimately, it also implies reforming institutions to provide more voice and accountability from decision makers.

The first technical session on African perspectives on climate finance was hold on January 10, 2023. It included the participation of nine African think tanks – African Center for Economic Transformation (ACET); African Economic Research Consortium (AERC); BIDPA (Botswana); AUDA-NEPAD Policy Bridge Tank; ECES (Egypt); KIPPRA (Kenya); Policy Center for the New South (PCNS); REPOA (Tanzania); and the South African Institute for International Affairs (SAIIA) – as well as several independent experts – Hafez Ghanem (FDL), Jean-Louis Sarbib (ACET Distinguished Fellow), and Lemma Senbet (University of Maryland).

The Development Finance Agenda Must Adapt to Africa’s Reality

Posted on November 24, 2022September 5, 2023 by Aurore Sokpoh

This blogpost was written in collaboration with Rob Floyd (ACET) and jointly published

The global financial architecture is no longer aligned with the economic, social and environmental needs of many African economies. But addressing this misalignment will require a strong African voice from leaders and policy institutes working together to determine what changes are needed.

To help address these issues and develop a more unified African perspective, a group of ten African think tanks and policy institutes gathered on November 15, 2022, to launch the Amplifying Africa’s Voice Initiative.

Two tracks of connected reflexions

African countries are being faced with twin challenges. On the one hand, financing has slowed down at a time when it is needed the most to recover from a succession of negative shocks - from COVID-19 to the current rise in food prices and interest rates. In parallel, ongoing global changes are reopening fundamental questions on the type of economic models that can effectively deliver growth convergence in the future. Africa’s leaders need to lead a "global wake-up call" for action in order to avert such serious interlocking challenges.

The recent series of negative shocks have put many African countries at risk of falling into a prolonged period of debt overhang with low growth. To make a bad situation worse, the recent rise in global interest rates and food and energy prices has reduced further access to foreign exchange, at a time when more than half of the countries that had borrowed on the Eurobond market have lost market access. Much needs to be done to prevent the current situation from deteriorating further, especially as countries are confronted with refinancing walls in the next few years. But so far, there are no credible plans that can avert a grave crisis:

The instrument to address debt distress, the Debt Service Suspension Initiative (DSSI) has ended,
the $100b pledge in green finance has not been delivered,
the prospect of $100b of Special Drawing Rights (SDRs) re-allocation remains unfulfilled,
International financial institutes continue to lend at a business-as-usual rate and,
Zambia, Ethiopia, and Chad have already been in a state of default for two years, without the G20-initiated Common Framework managing to find a resolution.

The challenges ahead are not limited to short-term recovery, but also to longer term growth. There was an early indication by 2015 that growth opportunities were faltering – which are now more evident: the export-led model has become less promising with the growth of automation of manufacturing; global growth is falling because of geo-political divergences and stagflation; and the economic drag exerted by climate warming is increasing.

Moreover, short- and medium-term issues interact as they are inextricably related, meaning that progress on all fronts is needed, even if execution is sequenced. Recovery cannot be built on austerity alone but needs to involve moving towards new growth opportunities. But new money to support a new growth path is unlikely to flow in the absence of adequate debt restructuring. The injection of new money to fund a new growth path also remains contingent on a better working of the Common Framework and closer collaboration with China, clearer agreements on climate finance, and multilateral development bank (MDB) reform.

To help address these issues and develop a more unified African perspective, a group of ten African think tanks and policy institutes gathered on November 15, 2022, to launch the Amplifying Africa's Voice Initiative.[1]

This is a project which goal is to inject more forcefully African voices, ideas, and interests in the ongoing global debates on the urgent reforms needed in the international system to advance the cause of sustainable development. To amplify Africa’s voice, the policy institutes will join forces to raise awareness, build technical knowledge, and undertake joint analysis and research reflecting African perspectives and positions. The analysis and research will be used in advocacy efforts and to inform African leaders so they can engage in international negotiations more effectively.

A meeting of minds

In their first meeting, participants described the ongoing global and regional conversations in which they participate. They agreed that they could have a more formidable impact in all these instances as a collective. The ongoing global conversations include a large range of issues, from how to finance the Sustainable Development Goals (SDGs) and the climate goals; to the evolution of financial relations with the capital market, China, and MDBs. It also addresses the needed reforms in the international financial architecture, including the re-allocation of SDRs, MDBs capital increase, and how to make the Common Framework for debt-restructuring work. While a few new initiatives are starting to address some of the failures of the global financial architecture, most notably the G20 Independent Review of MDBs’ Capital Adequacy Frameworks, much more will be needed to renew the development framework, as suggested by the recent Bridgetown Agenda initiative championed by Barbados Prime Minister Mottley.

The way forward

While the issues that affect Africa are global, the drivers behind them have an outsized impact on African economies.

To participate in international discussions on reforming the global financial architecture, the group of African policy institutes emphasized that an important task is to figure out “what Africa needs and what it wants”. Introspective efforts are needed to figure out why African countries have fallen again into a debt crisis, and what safeguards can work in the future to avoid yet another repeat.

Equally, a recovery process must be inscribed in longer term plans, and supported by country-defined commitments.. They have a role to play in supporting MDB reforms, whereby those institutions are able to fund adaptation at scale and to simplify their business model. The methods to enhancements of private flows must also be reviewed to make them work at scale and the Common Framework requires a deeper participation of China, which an African think tank collective could elicit by organizing a structured discussion on reformed win-win rules of debt restructuring adapted to current circumstances.

Besides good ideas, communication will be key. Beyond a small group of Ministers of Finance and a few Heads of State, Africa’s voice is inaudible amongst ongoing global conversations. To convince world powers to implement changes that are in Africa’s interests, good ideas won’t be sufficient - the volume needs to be turned up. In this regard, the group stressed the need for Africa, including heads of states and core institutions such as the African Union and the African Development Bank, to have more voice in international discussions, to be able to influence fora such at the United Nations, the G7, G20, MDB boards, and important bilateral instances. Both efforts must proceed in parallel. In the coming months, the policy institutes engaged in the process will start addressing key technical issues to figure out what Africa needs in terms of international and regional reforms, and how to make this happen.

Authors: Ishac Diwan is Research Director at the Finance for Development Lab. Rob Floyd is Director for Innovation and Digital Policy at the African Center for Economic Transformation.

[1] The initial group included: the African Center for Economic Transformation (ACET), the African Economic Research Consortium (AERC), AUDA-NEPAD Policy Bridge Tank, the Centre for the Study of the Economies of Africa (CSEA), the Institute for Strategic Studies (ISS), the Policy Center for the New South (PCNS), the South African Institute for International Affairs (SAIIA), the Laboratoire de Finances pour le Développement (LAFIDEV) and the Kenya Institute for Public Policy Research and Analysis (KIPPRA). The Finance for Development Lab, a co-sponsor of the initiative, also participated.

African Liquidity and Stability Mechanism

Posted on June 30, 2022September 5, 2023 by Brendan Harnoys-Vannier

The financing challenge

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While solvency issues must be dealt with adequate restructuring, there are dangers these claims will come at the expense of tackling liquidity-related issues, such as excessive risk-premiums during crises. Indeed, risk premiums tendto be too high, on average, in Africa for three reasons.

The COVID-19 pandemic and the war in Ukraine have put African countries under severe financial pressure, with high debt, declining financial flows and slowing growth. This coincides with rising needs to meet challenges to adapt to climate change, as well as to ensure access to health, education and sustainable infrastructure for all.

The financial constraint is central to those challenges. With stagnating official development assistance, African countries have turned to bond markets, at high costs and exposure to global liquidity flows. Low creditworthiness and liquidity risks raise the cost of finance and can turn into solvency concerns. With a new era of tapering unravelling, headlines predict waves of debt crises upon Africa.

First, African financial markets remain exposed to contagion due to the lack of a backstop. Second, while there is a need to raise creditworthiness by increasing revenue mobilisation and spending efficacy, perception of the African risk is exaggerated: at equivalent fundamentals, markets tend to require higher interest rates. Third, exports remain concentrated in commodities and subject to high volatility. Hedging those risks is expensive and has left commodity exporters struggling with the ups-and-downs of global demand.

This should not distract from the existence of low savings, fiscal profligacy and low revenue mobilization. Countries should also strengthen governance systems, in some cases by adopting and better implementing fiscal rules. At the same time, for countries with strong fundamentals, shielding countries’ liquidity vulnerabilities is necessary to expand these countries’ policy space. The support of the International Monetary Fund has been important but remains attached with political stigma which deters countries from requesting assistance. In contrast with other regions, the African continent does not have a Regional Financial Arrangement. It has been a long-standing project but has not been achieved. Political leaders in the continent are renewing the impetus, and the goal of this proposal is to provide possible concrete tools for such an arrangement.

A regional financial arrangement adapted to the specificities of the continent

In our first report, joint with the Economic Research Forum, we advocate for the creation of four facilities, which grouped together would form a fund called the “African Liquidity and Stability Mechanism”:

(1) To address illiquidity of African bond markets, UNECA’s Liquidity and Sustainability Facility, a special purpose vehicle which provides repo (short-term loans) in exchange for African sovereign debt collateral. The LSF aims at introducing greater liquidity and reduce government borrowing costs across the continent. This facility would help bring depth and liquidity to the market by allowing investors to generate liquidity against sustainable investments.

(2) A Commodity Hedging Facility which would allow countries to protect against the gyrations of global commodity markets. Usually, producers of commodities would lock-in high prices by selling at a given price on the markets for future. This comes at a price: buyers of future request deposits of capital, called margin calls, when prices rise, to ensure that the merchandise can be delivered. For illiquid countries, those margin calls can be prohibitively expensive. We therefore suggest that the facility guarantees margin calls by making use of its AAA rating, and thus allow a forward rolling insurance against price decreases.

(3) A Credit Enhancement Facility whose role would be to stabilize the existing debt stock. It would do that by offering rolling interest payment guarantees (following the example of the Brady Bonds in Latin America in the 1980s and 1990s). This would reduce market financing costs on the guaranteed bonds, as well as ensuring a homogenous asset class with high liquidity. With preferred creditor status, the ALSM would limit its risk of losses.

(4) A Debt Restructuring Facilitation Facility which would facilitate debt restructuring negotiations by providing cash ‘sweeteners’ in the event of debt restructuring and secure higher private investor participation. By buying out marginal creditors at a set price (fixed in advance to avoid so-called “buyback boondoggle”, or gaming by the market), this liquidity line would reduce the length and the costs of restructuring negotiations.

Ensuring sustainability

The African Liquidity & Stability Mechanism would need to be financially sustainable, which requires several pre-conditions.

First, it should not underestimate the extent of solvency risks. To avoid losses, it should ensure that countries are on a sustainable fiscal path, by defining a set of criteria for solvency in collaboration with other international institutions. It would also develop its own monitoring capacity, akin to the ASEAN+3 Macroeconomic Research Office (AMRO) function of the Chang-Mai Initiative Multilateralization in Asia. This is especially the case for the Credit Enhancement Facility, where the facility would be exposed to country risk. This facility could also request commitments to raise revenue mobilization capacity when it is too low, including with strong reforms.
Second, it would be mitigated by being set-up under the form of a trust-fund hosted by an institution, preferably pan-African, benefitting both from preferred creditor status. The seniority of the ALSM’s lending would ensure that, should a default occur, the institution be reimbursed. As a result, a guarantee would not be a bail-out of private creditors.
Third, it should be subscribed by African countries as well as external donors, including with on-lent SDRs. Actual rechannelling efforts by developed countries still trail commitments, and such an instrument would be an efficient conduit, provided it would be hosted by a SDR prescribed holder, or, with a longer-term horizon, gain this status. To ensure proper accountability and independence, the ALSM should be governed by a board of directors representing member countries and international official financial contributors.

The ALSM would not be a silver bullet, but it would protect African sovereigns against major market movements and misperceptions of risks. In addition, it could be an important tool to assist countries in improving their fiscal governance and revenue mobilization. As the world becomes increasingly uncertain, and investment needs are likely to rise in concomitance with interest rates, an institution to foster deeper and more stable financial markets is essential.

Thématique générale: Africa