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Prospects and Policies for Ensuring Public Debt Sustainability in Africa

22-09-2014

Ncube, M., Brixiová, Z. 2014. Prospects and policies for ensuring public debt sustainability in Africa. GREAT insights Magazine, Volume 3, Issue 8. September 2014.

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Shortly after being hit by the global financial crisis in 2009, Africa staged a robust economic recovery and was one of the fastest growing regions in the world. The continent’s performance is projected to remain strong despite the fragile and tepid global recovery. As several studies and scholars have now pointed out, Africa has the potential to become a global growth pole over the longer term. However, vast infrastructure and human capital gaps constrain Africa’s development. Balancing the need to scale up growth-enhancing public outlays and debt sustainability is therefore a key policy challenge ahead. 

What constitutes sustainable levels of public debt may need to be reconsidered in the context of Africa’s high economic growth rates, reduced risk premia, low interest rates, and strengthened debt management capacity. During the past decade, debt sustainability has improved markedly and Africa’s debt-to-GDP today is lower than in decades. Still, the global financial crisis has left some countries with looming fiscal challenges and deteriorating public debt sustainability.

The fiscal legacy of the global financial crisis in Africa

African countries – which entered the global financial crisis with overall low debt levels, adequate foreign exchange reserves, and moderate inflation – experienced the crisis shock mostly through cuts in external demand and liquidity shortages. Where policy buffers allowed, governments adopted counter-cyclical responses to the crisis, usually in the form of increased capital outlays and/or monetary easing.(1)Overall, the global financial crisis has left African countries with weakened fiscal (and current account) balances. Specifically, four years after the crisis, fiscal balances remain lower than before the crisis in about two-thirds of African countries. While the magnitude of the continent’s fiscal deterioration is similar to that in other developing and emerging market countries, its drivers differ. Unlike in richer countries where the increased deficits were caused mostly by stimulus policies, in Africa external shocks played an important role. Figure 1 shows how key pre- and post-crisis fiscal indicators of African countries compare to other global groupings, as well as key differences within African groupings.

In general, countries with stronger fiscal positions at the outset of the crisis implemented more decisive counter-cyclical measures and experienced larger deterioration of their fiscal balances. Most of the other countries, especially fragile states, could not adopt counter-cyclical measures during the crisis, due to limited fiscal policy buffers and access to borrowing. Their fiscal balances have thus weakened less than those of the frontier markets. These countries have posted current account deficits in double digits, raising concerns about vulnerability to external shocks.

As indicated in Figure 1, Africa’s public debt-to-GDP ratio declined during the 2008 – 2012 period, as widened primary fiscal deficits (i.e. deficits net of interest payments) were offset by factors such as low or negative real interest rates, high growth, and debt relief in some low-income countries. 

Figure 1. Pre- and post-crisis fiscal indicators 

ncube figure 1

Source: Ncube and Brixiová (2013), ‘Public Debt Sustainability in Africa: Building Resilience and Challenges Ahead’, William Davidson Institute Working Paper No. 1053. Note: Results are medians for the world regions and averages for African-country groups.

Grouping the countries by income shows that the total public debt increased in middle-income countries and declined in low-income countries. Two observations stand out. First, albeit rising, the overall debt level in middle-income countries is still markedly lower than that in low-income countries. Second, the current African debt is the lowest in decades, with the fastest decline posted by the most indebted countries thanks to debt relief and accompanying prudent policies that made the relief possible. As the composition of public debt has shifted from external to domestic (and from official to unofficial) creditors since 2000 while external reserves rose, countries’ vulnerability to external shocks has subsided.

While the relatively low overall public debt levels and declining trend are positive signs, they do not leave room for policymakers’ complacency. Vast differences among countries prevail. Further, there is no predetermined debt threshold that would indicate that fiscal (solvency) crisis is about to occur. While it is clear that higher public debt makes a country more vulnerable to a crisis (other factors being equal), it is not possible to determine the specific tipping point. Moreover, widening fiscal deficits indicate shorter-term fiscal vulnerabilities (including to liquidity crisis) and reduced fiscal space.

Key characteristics and patterns of continent’s public debt during 2003 – 2012 include a strong positive relationship between nominal public debt and GDP. This highlights that those African countries with a greater capacity to contract debt (measured by GDP) have done so. 

How sustainable is Africa’s public debt path?

The two main approaches to the debt sustainability are: (i) the approach of the International Monetary Fund and the World Bank, which looks at debt path projections and how they relate to thresholds; and (ii) the debt-stabilising primary balance approach, which looks for the primary balances to achieve a chosen debt path, given the assumptions about the evolution of the real interest rate and growth. We consider the sustainability of African debt dynamics using the debt-stabilising primary balance approach. This approach has the advantage of being relatively simple, transparent and having low data requirements.

We look into what factors – growth, real interest rates, primary balance or other factors (including debt relief) – drove public debt changes in Africa and its groups. On the continent and in all groups, high growth and negative real interests contributed to decline in debt burden.

While growth played an important role across Africa, the negative interest rates helped lower debt especially in low-income countries (including fragile states), reflecting the concessional terms of their loans. In contrast, in frontier markets where governments often borrow on market terms – either on domestics markets as in Kenya, or on international bond markets as in Ghana and Namibia – the contribution of real interest to cutting the debt burden has been lower. Except for oil exporters, fiscal policies led to debt accumulation in all Africa’s sub-groups. Finally, low-income countries saw their debt levels fall due to debt relief.

From our detailed analysis of African countries(2), we find that in more than half of the countries studied the primary balance was above that required to keep the public debt-to-GDP ratio at its 2007 level. Taking this perspective would then suggest that fiscal stance of the majority of the countries in this group was sustainable at the end of 2012. Still, in some of these countries the public debt-to-GDP ratio was above 40%, pointing to a need for fiscal adjustment.(3)Policy discussion

Africa’s public debt-to-GDP is lower today than it has been in decades and the overall fiscal policies are sustainable. The debt level is also comparable to other developing countries and below that of advanced economies. The debt-to-GDP ratio decline was to a large extent due to favourable differential between real interest rates and growth. In contrast, fiscal policy contributed to decline of debt only in oil exporting economies. At the same time, as oversubscriptions and favourable terms of Africa’s sovereign bonds have shown, a number of countries have gained attention from international investors which has opened up their borrowing space.

There is, therefore, scope for debt management strategies to emphasise growth. For countries with borrowing space, this includes prudent borrowing for growth-enhancing outlays. The heightened interest of international investors combined with favourable terms has created a window of opportunity for African countries to embark on inclusive growth also through prudent borrowing, provided the funds are well utilised for growth-enhancing outlays. However, the interest-rate-to-growth differential is subject to shocks: while Africa’s growth prospects are promising, the real interest is likely to be rising in the future. With the anaemic global recovery, some downside risks to growth remain, Africa’s increased linkages with Southern partners notwithstanding.

In the framework utilised in this article, policymakers can reduce public debt-to-GDP ratio by:

(i)             accelerating growth;

(ii)           improving primary balances through revenue mobilisation and optimising of outlays;

(iii)          reducing the real interest (also by raising inflation), and

(iv)          defaulting.

Since inflation and defaulting undermine other goals that the government is likely to pursue (notably, rising living standards of the population and improved access to capital markets), we discuss growth and fiscal policies.

Given that the interest-rate-to-growth differential has been the main driver of prudent public debt dynamics in recent years, African countries may like to aim at high growth as a key element of their debt sustainability strategy. Even though Africa’s growth recovery from the crisis’ shock has been fast, growth rates remain below trend in a number of countries, suggesting space to grow. Further, for Africa to become a global growth pole in the next two to three decades and keep pace with rising populations, growth in most African countries needs to accelerate beyond the pre-crisis rates.

African policymakers need to adopt appropriately sound fiscal policies and complementary monetary policies, while seizing opportunities for growth-enhancing investment, including through borrowing. Caution should be exercised however when approaching commercial debt markets given the borrowing cost and possibility of shifting sentiments of investors. With low revenue-to-GDP ratios, many low-income African countries can reduce their debt through domestic revenue mobilisation. They would also benefit from greater efficiency of public expenditures and medium-term perspective in budgeting. Reducing inefficient spending (for example, over-sized wage bills in Southern Africa and costly energy subsidies in North Africa) would create space for pro-growth outlays (support to small- and medium-sized enterprises and investments in infrastructure and ICT) and discretion against shocks. In general, we can make the following distinctions around policies that appear prudent at this stage for ensuring long-term debt sustainability in Africa:

  • Countries with high public debt and/or large fiscal deficits – Sudan among the oil exporters, Eritrea among fragile states, and Egypt, Ghana and Morocco among frontier markets – need to undertake fiscal adjustment. The scope and the speed should account for its likely impact on investment and growth, to avoid debt traps.
  • In frontier markets with more developed financial systems and monetary policy space (for example, Cape Verde and Mauritius), the government could try to ease the impact of fiscal adjustment on growth via less tight monetary policy. Further, in some countries, especially those with long-term domestic debt, slightly higher domestic inflation could in theory help ‘inflate the debt away’, even though this option would have other negative implications.

Beyond these near-term policies, a number of structural and institutional changes and reforms will also enhance debt sustainability in African countries. Efforts to regain fiscal policy space and manage debt would benefit from macroeconomic policies based on fiscal rules and medium-term expenditure frameworks. Such frameworks would also help countries transition gradually to counter-cyclical and growth-supporting fiscal policies. In countries where rapid debt accumulation is of concern, ‘debt breaks’ could be also useful. Taking a long-term view, fiscal policy buffers are needed for emerging challenges such as creation of social protection schemes. African countries also need to strengthen their capacity to carry out independent debt sustainability analysis and apply it to their borrowing activities. Together with improved debt management capacity, such changes would allow frontier markets to access additional (non-concessional) funds, while maintaining fiscal sustainability.

Changes in the international financial institutions’ debt sustainability frameworks, and in particular better links between investment and growth, may be needed to reflect the phenomenon of ‘rising Africa’. A key question in this regard is: given the current high economic growth rates, lower risk premia, and lower global interest rates, what should be the new sustainable debt levels (and thresholds) in various African countries, especially frontier markets? Besides changes to the debt sustainability frameworks, reaching the objectives of enhanced borrowing space and fiscal sustainability hinges critically on increased transparency and improved communication. While progress has been made, most countries could do much more in utilising technology for sharing information on key fiscal and macroeconomic developments. Similarly, communicating countries’ fiscal stance and changes to it early on (and delivering on the announcements) can help raise the credibility of fiscal policy. 


This article has been condensed from Ncube and Brixiová (2013), ‘Public Debt Sustainability in Africa: Building Resilience and Challenges Ahead’, William Davidson Institute Working Paper No. 1053. The full working paper can be consulted for more detail on each of the debt sustainability issues discussed.


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Prof. Mthuli Ncube is Chief Economist and Vice President at the African Development Bank (AfDB) and Zuzana Brixiová is his Advisor.

Notes

Blanchard, O. 1990. Suggestions for a New Set of Fiscal Indicators. OECD Working Paper, No. 79, OECD: Paris.

Buiter, W. 1985. Guide to Public Debt and Deficits. Economic Policy, Vol. 1(1).

Contessi, S. 2012. An Application of Conventional Sovereign Debt Sustainability Analysis to the Current Debt Crisis. Federal Reserve Bank of St. Louis Review, Vol. 94(3).

Escolano, J. 2010. Practical Guide to Public Debt Dynamics, Fiscal Sustainability, and Cyclical Adjustment of Budgetary Aggregates. IMF Fiscal Affairs Department Technical Notes and Manuals, IMF: Washington, DC.

Footnotes 

[1] Kasekende, L., Brixiová, Z. and Ndikumana, L. 2010. Africa: Africa’s Counter-cyclical Response to the Crisis, Journal of Globalization and Development, Vol. 1(1).

[2] For full discussion, see Ncube, and Brixiová, 2013.

[3] In fiscal consolidation debates, 40% public debt-to-GDP ratio is often recommended as prudent limit that developing and emerging market countries should not exceed on a long-term basis.  

 

This article was published in GREAT insights Volume 3, Issue 8 (September 2014).

Economic Transformation and TradeDevelopment Finance and TaxationDevelopment FinanceAfrica

External authors

Mthuli Ncube

Zuzana Brixiová