How to navigate the African debt dilemma
Debt has been a prominent topic of discussion for weeks, except during the period when SVB and CS experienced a crash, which had a spill-over effect on developing markets. However, these discussions have overlooked critical issues such as capital management and return on investment on infrastructure such as ports, roads, and railways. Despite significant spending on these projects in countries like Mozambique, Zambia, Senegal, Nigeria, and Kenya to turbo charge export-led growth, they have yet to yield tangible results, as noted by Carnegie. The recurring nature of Africa’s debt crisis raises the question of how governments on the continent find themselves in this predicament. Rather than getting sidetracked by debates about ulterior motives, it is crucial to examine the underlying factors contributing to the problem. Below are some insights.
Infrastructure needs: The need for funding to develop Africa’s infrastructure has been met by China, which offers more options and fewer conditions than Western donors. China’s interest in securing access to African resources and markets, along with their comparative advantage in delivering infrastructure projects quickly and cheaply, are reasons for African governments to reach out to Chinese banks for financing. The World Bank and China have different approaches to development assistance, with the former offering aid with conditions of political freedom and human rights, and the latter prioritizing stability for investment. This means that some countries may prefer Chinese terms over World Bank terms if they value sovereignty, non-interference, and pragmatism over democracy, accountability, and transparency.
While some countries may prefer Chinese terms over World Bank terms, both actors may have different motivations depending on the context and project. Sluggishness in investing by Western institutions has caused delays in critical infrastructure projects, leading to frustration and alternative funding sources such as a Chinese EPC entity and French partner financing the LFZ deep-sea port in Lagos, Nigeria. This indicates an opportunity for Americans to de-risk their investments by embracing a similar model.
No voice: Africa is caught in the middle of competing global powers seeking its attention, either for political influence or financial gain. Russia’s influence in the region is limited, given its comparatively low GDP and social development. However, African governments, including the African Union, have struggled to present a unified voice and articulate their needs in the face of these global pressures.
Risk: Africa needs investments in its infrastructure sector and in the past two decades China has been the big brother to developing nations, lending over $1.5 trillion to 150 countries with interest rates charged at commercial rates. The assumption was that growth would set up a gear making future repayment easy.
The makes the issue of risk paramount, as China has slowed down its investments in Africa, primarily due to defaults and a focus on its domestic economy. However, many African nations have not adequately managed their finances, made sound decisions, or developed proper plans for growth. Corruption and illegitimate government practices, such as hiding debt from the public, also pose a significant risk, as seen in Mozambique. Some countries have taken loans for projects that will not yield near-future returns, while others have rent-seeking institutions, such as South Africa’s energy crisis.
Western institutions and the private sector have not been effective in implementing governance measures, either because they prioritize high returns or do not want to bear the cost of implementing such measures. Although it would be beneficial if China placed as much importance on governance as the US and EU, it would send a positive message to African leaders to prioritize good governance and fiscal management practices.
Lopsided trade agreements: In the event many recipient countries of China One Belt One Road (OBOR) loans ended up saddled with unsustainable debts, and with limited growth or export earning potential to meet now seemingly exorbitant debt service costs. Problems were accentuated by often onerous market access conditions — China often negotiated preferential trade access terms into these low-income country markets, which on occasion destroyed competitor domestic industries, crimping their ability to earn foreign exchange revenues to pay back loans. A case in point is the Pakistan shoe industry, with the country now swamped with cheap Chinese shoe imports.
Debt restructuring and forgiveness dilemma: The issue at hand is not simply China versus the IMF/World Bank, as there are calls for reform from both sides. China has specifically called for Western Financial Institutions to reform their debt restructuring and forgiveness policies. However, there are two main points of contention with China: Beijing’s insistence that local debt owned by foreign investors be included, and that multilateral development banks also take a haircut. Both of these points have been rejected by the United States, Zambia, and other countries.
In typical sovereign debt restructurings, multilateral lenders are usually exempted from haircuts due to their special status as providers of concessional financing as lenders of last resort. Furthermore, treating bondholders differently based on their geographic location could prove difficult and potentially unworkable. The World Bank and IMF are not able to grant debt relief as they are seen as lenders of last resort and borrow at exceptionally low rates, which helps maintain their credit rating. Debt relief would drastically impact the lending practices of the IMF and World Bank.
One reason for the calls to restructure how the World Bank provides development finance loans is due to the COVID-19 pandemic, which has caused a surge in nonperforming loans and bankruptcies among households and businesses in many countries. Some critics argue that the World Bank’s current development policy financing does not adequately address this issue and needs to be more flexible and responsive to the needs of different countries.
Another issue causing a standoff is that China does not disclose all its lending activities to other creditors or international organizations, making it difficult to assess the true debt situation of some countries and coordinate a comprehensive solution. Additionally, some private creditors refuse to join the DSSI, fearing that they would lose money or face legal challenges from bondholders. Some bondholders may be reluctant to accept voluntary debt relief because they fear losing money or their reputation in the market. Finally, some countries may not have clear legal frameworks or institutions to deal with debt restructuring or litigation, making them vulnerable to aggressive lawsuits by bondholders who seek full repayment plus interest and penalties. Some bondholders may also use legal tactics such as injunctions or asset seizures to pressure countries into paying their debts.
Social and environmental Challenges: For example, the early and unusually heavy rains of 2022 led to devastating floods that washed away homes and farmland in 34 of 36 states, displaced 2 million people, and fuelled food inflation. A study by researchers with the World Weather Attribution initiative concluded that climate change had made such flooding events across West Africa more likely and intense. Similarly, extreme heat and erratic rainfall, both consequences of climate change, have intensified resource competition between farmers and herders and shifted traditional migratory patterns. Due to deep-rooted ethnic and religious tensions, agrarian-based competition has escalated into communal clashes and armed conflict.
Workable solutions
Debt forgiveness with conditionalities: The liquidity constraint arises naturally from the overhang, as new lenders are discouraged from providing loans because they expect to be “taxed” by the old creditors, who stand to gain disproportionately. Furthermore, even if new funds are available, debtor governments cannot commit credibly to not spend the additional resources on consumption, thereby preventing profitable investments from being exploited. While financing these viable projects is necessary, it is not enough in this context. Conditionality is also essential to prevent the debtor country from squandering the new loans on consumption.
However, in the absence of debt reduction, new lending by IFIs would result in losses, as they would have to join the extensive list of debt claimants. Hence, the role of debt reduction is to create the “headroom” required for the IFIs to lend without subsidizing the old creditors. Therefore, the overhang necessitates a three-sided bargain: The debtor government can only undertake adjustment policies and invest in growth opportunities that yield returns in the future if additional resources are provided. The IFIs can safely lend those resources only if the old creditors undertake debt (and debt-service) reduction. In turn, the old creditors will provide debt reduction only if the IFIs can enforce effective conditionality on debtor governments to ensure appropriate growth policies are implemented. The gains from such a package can be shared among all parties involved.
Public debt management: African leaders have shown poor public finance management practices. For instance, Ghana, despite its fiscal crisis has hedged on with the white elephant project based on religious sentiments and hopes to attract tourists. The project is projected to cost $1bn but experts say it will cost nothing more than $350 million. The project has also been beset by allegations of misappropriation of funds. This goes to show that accountability is low and private sector representation is lagging in various facets of African Governments financial institutions. Ken Opalo and David Stasavage have shared magnificent views on how creditors stand to benefit from serving in public institutions be it the legislature or on the board of central banks to drive the quality of governance and enforcements of debt repayments. This could remedy the dependence on multilateral debt restructuring processes. The Chinese also use these tactics. For instance, the debtor’s government revenues remain outside the borrowing country and beyond the sovereign borrower’s control.
Re-prioritization: The policy of investing in mega-infrastructure projects in Africa has not yielded the desired economic growth and has contributed to the continent’s incipient debt distress, according to a Carnegie report. The author, David Ndii, suggests that financing agricultural productivity would require a fraction of the commercial infrastructure financing already available but unlikely to be absorbed due to the fiscal consolidation imperative brought about by the debt crisis. The claim that infrastructure is a key factor in economic growth lacks theoretical foundation or empirical evidence, as evidenced by the success of export-led manufacturing in infrastructure-deficient Asian countries such as Bangladesh, Cambodia, and Vietnam. These countries have leapfrogged African countries in terms of per capita income, even though they have similarly deficient infrastructure. For instance, Bangladesh’s infrastructure was ranked last on electricity and well below that of all African countries. See chart below.
Hidden debt: This is not peculiar to African countries but widely prevalent by Low Middle-Income Countries (LMICs) and Low-Income Countries (LICs). Why? Because it maximizes their ability to borrow while avoiding being penalized by rating agencies or multilateral agencies for rising debt burdens. In recent years, China has dolled out emergency loans to at-risk nations based on secrecy, collateral, No Paris Club clauses, (explicitly excluding the debts from being included as part of a broad international debt restructuring process) and aggressive cross-default clauses. According to Aid Data, half of Chinese loans in Sub-Saharan Africa are missing from sovereign debt records. This has unintended consequences to IFIs intervention in LICs. Nigeria, as a good example, has laws defining and guiding debt which ensures transparency. However, in countries like Zambia, the scope of debt is not defined comprehensively, and in Rwanda and Madagascar, the law does not define public debt at all. Such countries are likely to have issues in managing their public debt, as guidance on what constitutes public debt is missing. It is then critical for creditors to drive conditionalities on governance especially in debt restructuring talks.
Debt Overhang: Africa is experiencing a debt overhang — a phenomenon where the debt of a country exceeds its future capacity to pay it and as seen has reached out to People's Bank of China (PBOC) and IMF as last resorts in order not to default on its loans (this is overly critical for PBOC as Chinese-state- owned enterprises are in the balance — lent out countries/projects on the prospect of defaulting). Africa’s debt has not yielded the desired results be it Chinese development projects or debt financing. This could be due to the way African countries are structured — not trade integrated alongside its infrastructure — or domestic disjointed policies that has not yielded value to Africa’s major sector, Agriculture (Small-scale farming dominates African agriculture). Whatever the case, African leaders need to agree on what would drive productivity. African nations can agree on raising debt together to develop agreed and accurately assessed projects and make low interest payments into a central pot managed by an entity. This will create more fiscal space for countries and reduce the debt overhang.
Climate debt swaps: Debt swaps are a financial tool that can help countries reduce their debt burden and invest in climate action. They involve exchanging part of a country’s debt with creditors for a commitment to fund domestic projects that enhance climate resilience or reduce greenhouse gas emissions. Debt swaps can benefit both debtors and creditors, as well as the global environment. Debtors can free up fiscal space, lower their debt servicing costs, and access additional resources for climate action. Creditors can improve their debt recovery prospects, support global climate goals, and demonstrate social responsibility. The global environment can benefit from more investment in adaptation and mitigation measures that reduce the risks and impacts of climate change.
Debt swaps have been used since the 1980s for various purposes, such as biodiversity conservation, education, health, and social development. More recently, they have been proposed to address the twin challenges of debt distress and climate vulnerability that many developing countries face. For example, African finance ministers agreed to consider swapping debt for climate action at a meeting in Ethiopia in March 2023. Several multilateral development banks and international organizations have also expressed interest in supporting debt-for-climate swaps.
However, debt swaps are not a panacea for solving the debt and climate crises. They have some limitations and challenges, such as complex negotiations, high transaction costs, potential moral hazard, and limited scalability. They also require careful design and implementation to ensure that they are aligned with the country’s debt sustainability and climate objectives, and that they deliver measurable and verifiable results. Therefore, debt swaps should be seen as a complementary instrument to other forms of financial support, such as grants, concessional loans, and broad debt restructuring.
Debt swaps can be an innovative and effective way to mobilize more resources for climate action in developing countries, especially those that are highly indebted and vulnerable to climate change. By linking debt relief with climate investment, they can create a win-win situation for both creditors and debtors, as well as the planet. However, they need to be carefully designed and implemented to ensure that they achieve their intended goals and do not create unintended consequences.
In conclusion, Africa is currently faced with a complex debt situation involving both China and Western institutions, but countries that prioritize creating headroom for growth are likely to be the most effective in managing their debt. Moving forward, it is important to rethink debt policies and prioritize long-term sustainable growth over short-term gains. By doing so, both creditors and debtors can benefit from a more stable and prosperous economic environment.
