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Economic Insight: Africa

The ICAEW Economic Insight: Africa, is a quarterly economic forecast for the region prepared directly for the finance profession.

Macro dynamics and debt in Africa in 2018: Q2 summary

  • Higher oil prices are boosting the fortunes of hydrocarbon-dependent economies.
  • Impressive growth in larger economies like Egypt and Ethiopia is driven by public investment, which can may  give rise to fears over debt.
  • Fears of over-indebtedness in Africa are mostly overblown.

East Africa will again be the fastest-growing region in Africa, as it has been in every year since 2012: the region’s GDP is forecast to grow by 6.1% in 2018, mainly thanks to Ethiopia, where real GDP growth of 8.1% is forecast to result from continued public investment, although this state-driven model presents certain risks. The same kind of capital spending in Egypt, made possible by compliance with reforms proposed by the International Monetary Fund (IMF), will boost growth to 5.0%, and that will be the main driver behind 3.9% growth in North Africa’s GDP this year. 

The picture in the franc zone is slightly more positive than in 2017, with regional GDP growth forecast at 4.5%. Most of the region’s growth, however, will be provided by the two economies that are not dependent on oil: Ivory Coast, where real GDP growth of 7.0% is forecast to result from continued government spending on infrastructure and ongoing improvements to the business environment, and Senegal (6.7% growth), on the same drivers. 

In Central and West Africa growth is forecast to increase substantially: to 3.6% in 2018 from 2.3% in 2017. The outperforming standout economy in that region will be Ghana, where real GDP growth of 7.2% in 2018 is forecast to come partly from increased public investment, and the resulting boost to the construction and manufacturing sectors.
Southern Africa’s growth will remain constrained by modest growth in South Africa. The region’s GDP is forecast to grow 2.3% in 2018, the slowest regional growth rate on the continent.

It is apparent that economic growth in most places in Africa depends on debt-financed capital spending by governments. Is this a concern? In recent months, there has been a flurry of coverage of the question of public debt in Africa, and the speed at which it has grown.

The good news is that, overall, fears of over-indebtedness in Africa are largely overblown. The growth recovery that commenced started in 2017 will support a decline in the real debt burden over the medium term, meaning that the debt burden will tend to become more sustainable over time. At the same time the profile of public debt is changing as tailored fittings replace off-the-rack offerings, allowing governments to take on external debt on more favourable conditions than before.

The bad news is that debt will become a problem in certain countries. A number of African countries remain at risk of debt distress because of fragmented structural adjustment and indiscriminate borrowing. Populist governments look uncommitted to reforms. These factors are reason enough to be nervous about debt, especially in countries that are vulnerable to swings in commodity prices.

Focus: Zambia

There has been some improvement in Zambia’s macroeconomic conditions this year. As the impact of successive supply-side shocks has receded, monetary conditions have loosened further and external conditions have improved. Economic weaknesses include lower agricultural output projections, the absence of a formal agreement with the IMF and some underlying structural fragilities. Among the most important of those, especially as Africa-watchers increasingly discuss debt levels as a danger to the continent’s economic health, is Zambia’s track record of weak fiscal discipline since 2013: underperformance of domestic revenues, delays in implementation of restorative measures, and vulnerability to budgetary overruns that are ascribed to unforeseen expenses. Domestic revenue capacity remains constrained, at around 18% of GDP. This implies that expenditure cuts are needed for fiscal consolidation, which looks irreconcilable with the policies and programmes of President Edgar Lungu and his Patriotic Front (PF) government.  

At the moment, a robust global appetite for risk assets – especially sovereign debt – has fostered some complacency in markets. But many countries remain at elevated risk of debt distress, and a number of them are in Southern Africa, where governments have implemented patchy structural adjustments and borrowed indiscriminately. Their commitment to reform agendas is in question while political incentives promote populist policies. The rise of protectionism may dampen appetite for frontier market debt, especially in countries exposed to international commodity prices, such as Zambia via the risk-sensitive copper price. 

In Zambia there already seems to be some misalignment between country risk and borrowing costs, especially considering the opacity surrounding the depth of its indebtedness – as with Angola and Mozambique, it has long been speculated that Zambia has been borrowing off balance sheet. This introduces considerable scope for excessive volatility. 

The sustainability of Zambia’s debt depends on growth, suggesting that the fledgling recovery that started last year on the back of improving external conditions, more favourable weather and the unwinding of tight monetary policy will support a decline in the real debt burden over the medium term. However, owing to more recent adverse weather conditions and a pest outbreak, harvest projections now warn of a decline of 34% y-o-y in maize output over the 2018/19 season. The resulting lower growth and pressure on the kwacha will inflate the real debt burden this year – we project that public debt will again breach the 60% of GDP threshold. On the other hand, while Zambian growth momentum will be carried over to 2018, Oxford Economics has revised its projection for this year lower to 4.1% from a previous forecast of 4.4% (which is still an improvement from an estimated expansion of around 3.7% in 2017). 

Cross-asset default risk came into focus this semester as outstanding debt payments (the compensation paid for the Libyan stake in Zamtel nationalised in 2012) captured headlines. Even inclusive of domestic arrears, the sovereign balance sheet is dollar-heavy which presents asymmetric downside risks to adverse currency movements – the depreciation of the kwacha exchange rate will increase the debt level in local currency terms (and government raises taxes in kwacha), raising the risk of sovereign credit downgrades. The latter will present a negative feedback loop. 

Mindful of this structural vulnerability, authorities plan to re-profile public debt towards long-dated domestic debt. However, challenges are presented by the narrow capital base, and the domestic debt curve remains front-loaded, meaning most of the debt is short-term. This means the government is vulnerable to roll-over risk (banks choosing to cash out their bonds rather than keep lending) and interest rate risk (an increase in the rate the market demands to hold bonds).

Earlier this year, the market’s attention was captured by reports of debt restructuring. Authorities highlighted that this will take place on a voluntary basis and Eurobond holders will not be affected, with the focus rather falling on the renegotiation of the terms of commercial loans (primarily from China). In a bid to alleviate refinancing risk associated with maturing Eurobonds falling due in 2022 and 2024, Zambia may however seek to buy back debt using the proceeds of a new credit issuance and/or concessional debt. African issuers are embracing a trend towards the elongation of their dollar debt curves this year, with numerous SSA countries tapping credit markets for maturities extending to 30 years. Zambia may follow suit with an offering of between 15 and 30 years, although the lack of a guarantee from a multilateral organisation – such the World Bank or IMF – will severely undermine the success of such an undertaking.

Focus: Kenya

Kenya’s economic recovery is well under way. Real GDP growth came in at 4.9% last year, which is somewhat lower than the revised 2016 figure of 5.9%. In addition to a drought-related slowdown in agricultural sector growth in 2017, weaker economic performance can be attributed to political uncertainty surrounding the annulled August presidential poll and the controversial re-run election in October. The detrimental impact that the election had on business sentiment reflects in dismal readings in the country’s purchasing managers’ index (PMI, a leading indicator of private sector activity), which dropped to an all-time low in October. 

However, the political dust has settled and economic prospects have improved. The PMI jumped to 56.4 points in April 2018, marking its fifth-consecutive month in expansionary territory. In fact, the April reading is the highest since January 2016, indicative of a solid economic recovery. The agricultural, industrial and services sectors are all expected to record stronger growth this year relative to 2017, thanks to more favourable weather conditions (agriculture), stronger public investment (industry) and an improvement in business sentiment (services). Real GDP growth is projected to reach 5.7% this year before averaging just under 6% p.a. over the medium term, with the development of the domestic hydrocarbons sector gaining some momentum towards the end of the decade as construction of the required infrastructure commences.

One big concern is debt. The pace of public debt accumulation and the lack of a clear communication strategy regarding the government’s plan to address deficits have raised concerns about the sustainability of Kenya’s public finances. Total public debt amounted to around KSh4.6trn by the end of last year – $44.4bn, or nearly 60% of GDP. The amount increased by 19% in a single year, and has more than doubled (in local currency terms) since December 2013. Public debt has increasingly taken the form of commercial loans and the government issued the country’s second Eurobond earlier this year. The affordability of external loans will be determined by the yield demanded by investors, which, in turn, will be determined by perceptions of whether Kenya is able to keep its fiscal house in order. 

In turn, domestic borrowing costs have been contained due to the regulatory caps on interest rates, which have increased the attractiveness of government debt on a risk-weighted basis. Now, however, there are expectations that the regulation will be amended or scrapped before the commencement of the new fiscal year in July, so domestic debt refinancing costs will become an increasing concern going forward. 

Investors allowed for the distracting effect of elections when it comes to fiscal policy formulation and communication, but now that elections are over the government has to come up with, and clearly communicate, its fiscal game plan. One clear way to do this would be through deeper engagement with the International Monetary Fund (IMF). In March this year, the IMF approved a six-month extension of Kenya’s Stand-By Arrangement (SBA). The facility was due to expire on March 13, but Kenyan authorities requested an extension so that the Fund can complete programme reviews that were missed last year. The reviews were not completed on schedule as agreement could not be reached between the Fund and Kenyan authorities on corrective policies to address fiscal slippages, and further discussions were then postponed due to the prolonged election period. 

In exchange for the extension, Kenyan authorities have committed to policies that will enable them to achieve fiscal objectives while also modifying interest controls on commercial banks. The reviews are expected to be completed by September, which would then form the foundation for a follow-up support programme. 

The importance of continued IMF engagement is the signal it provides that the Fund is on board with Kenya’s fiscal consolidation strategy. The commencement of a new IMF programme will most likely be accompanied by greater austerity, while a nod from the Fund will also have a favourable impact on government borrowing costs. Discussions are ongoing and a new IMF programme has not yet been confirmed, but the announcement (and clear measures to meet the fiscal requirements) will go a long way in easing concerns regarding fiscal sustainability.

Economic Insight reports are produced with ICAEW's partner Oxford Economics, one of the world’s foremost advisory firms. Their analytical tools provide unparalleled ability to forecast economic trends.

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