If you haven’t heard what investors call the “Africa Story”, here it is. Africa south of the Sahara is on a roll. The once debt-ridden disaster zone of the world economy is back on its feet, and fighting. Sub-Saharan Africa is now growing faster than any other region of the world: from bankruptcy to boom in the space of less than a generation. The only bad news is that Africa is back in debt. And for some African economies, debt will turn to disaster. Soon.
The last two decades have seen explosive growth in the world’s emerging economies – those parts of the world where poverty once seemed endemic, where physical isolation from the rich developed world and self-destructive patterns of government seemed to ensure that the future would always be a repeat of the past. But a revolution in technology and the breaking of barriers to the flow of capital changed everything.
Africa came late to the emerging economy party. As investment began to flow into Asia and Eastern Europe in the 1990s, Africa remained clapped up in the debtor’s prison. The commodities that make up most of Africa’s exports were in a long down-cycle, governments were running ever bigger budget and trade deficits. By 2001 sub-Saharan Africa as a whole had government debts equivalent to over 70% of GDP – an impossible ratio for a poor and undeveloped region to sustain. Africa was reduced to borrowing money just to pay the interest on earlier borrowings.
Then came the change. From 2002, Africa’s sovereign debt as a proportion of GDP started falling. The international programme of debt reduction for the world’s most heavily indebted poor countries certainly helped, but many countries did not begin to benefit from full debt cancellation until after 2005. Yet the African debt-to-GDP ratio fell sharply even before that, finally reaching a low of less than 30% of GDP by 2008. What had actually happened was that from the end of the 1990s Africa’s economies had started to grow faster than the global average. During the first decade of the millennium sub-Saharan Africa grew by almost 6%, compared to global growth of 3.6%.
Debt relief helped Africa, but it was not the most important factor in the recovery. More important was a change in policy, away from state intervention and ownership and towards open channels for capital investment, together with the boom in commodity prices that began in the late 1990s. Donor countries agreed to ‘debt forgiveness’ because they really had no choice, but the unstated terms of the deal were clear enough. ‘The days of bilateral, government-to-government lending are over. There is no more money where that came from. From now on it’s the private sector, or China.’
The private sector is where Africa has turned for its government and corporate finance (Chinese lending is significant, but it is strictly project-specific, and usually secured on commodities that are in the ground). From the investor point of view, Africa has until recently looked like a very good bet: low government debt, strong domestic finances (by 2006 sub-Saharan Africa was running a regional budget surplus of almost 6%), and above all the favourable demographics that are always associated with high growth.
And Africa had a good crisis. After the financial economies of the developed world ground to a halt after 2007, Africa suddenly looked like a terrific place to put money in what was otherwise a zero-return world. African government bonds were paying 7% plus while US treasuries pay next to nothing; African corporate bonds can pay even more.
In fact it is African corporate debt that has been the favoured destination for international capital. Sub-Saharan economies are still growing relatively fast (about 4.5% this year forecasts the IMF) and the region’s big companies are growing comparably. But buying into companies either through shares or direct investment is usually not the best way to benefit from growth. Fast-growing companies may increase their sales rapidly but their profits rarely match, because their investment needs are so high. Corporate debt which is traded just like shares but which pays a set interest rate is more attractive.
Today, the global financial environment that was so friendly to Africa has changed again. China is in slowdown, cutting demand and prices for African commodities. The ultra-loose monetary policy of the US and Europe which has unintentionally helped pump money into high-return Africa is now on the turn. The US dollar is rising, making any borrowings denominated in dollars more expensive to service. Oil, the mainstay of several African economies, is cheap. No surprise that African government finances are back in deficit, and that the region’s government debt-to-GDP ratio is creeping back up towards 70%.
But government debt is not the main worry – governments tend not to go bankrupt, and sovereign debt can be restructured almost indefinitely, even if private lenders are less forgiving than than multilateral institutions. It is the debt of the private sector that is making for nervousness – for example the IMF started warning about excessive private sector borrowing last year, and this year said the risks had increased further.
The signs of what is to come have already been posted. In March one very large African company defaulted on its debt (Afren, the London-listed African energy group). The prospect of more defaults is one reason why international investors withdrew record amounts from emerging economy debt and equity markets last month – a reminder that the capital flowing into Africa is really hot money that can flow out as quickly as it flowed in. Longer-term investors like sovereign wealth funds have tended to steer clear of the African boom (their mandates often prevent them from buying into things like the infrastructure-related securities that are important in Africa).
What happens next? Sub-Saharan Africa is a region of wildly contrasting countries and economies, and the stories will be different. Countries with overvalued currencies and big foreign-currency borrowings that are not properly hedged against a rising dollar will see some turmoil. That means trouble in Nigeria, and Zambia, and Ghana, among others. Zambia in particular has been propping up its currency with borrowed dollars, which is like taking out a payday loan to pay your credit card. Banks will be vulnerable – Nigerian banks have the biggest biggest bank exposure to non-financial corporate debt and the smallest loan-to-deposit ratio of any emerging market in the world. And Ghana, an investor favourite, is now running a domestic deficit of over 10% of GDP and has one of the highest government debt-to-GDP ratios in Africa at 72%. Its government will find it very difficult to finance itself in the near future.
These countries and their backers are about to pay the price of the coming recovery in the developed world. Investment will fall (by around 80% according to the World Bank), government spending will have to be cut cruelly, and more than one African country will be back knocking on the doors of the IMF and World Bank. A lot of private investors will lose a lot of money. The African renaissance will be seriously delayed.