The debt situation in many African countries has escalated again at a critical juncture. Twenty are in or at risk of debt.
Three key elements contribute significantly to this.
First, the rules governing the international banking system favor developed countries and work against the interests of African countries.
Second, multilateral financial institutions such as the International Monetary Fund (IMF) and the World Bank focus on poverty reduction. This is commendable. But it does not address the liquidity crisis that countries face. Many do not have the necessary readily available funds in their coffers to meet urgent development priorities due to their dependence on volatile commodity exports. As a result, governments are turning to increasing public debt under conditions that are among the most unfavorable on the planet.
This perpetuates a cycle of debt dependence rather than encouraging sustainable economic growth.
Third, there is the significant influence of biased credit rating agencies. These unfairly punish African countries. In turn, this hinders their ability to attract investment on favorable terms.
The convergence of these three factors underscores the imperative to implement effective strategies aimed at mitigating the overwhelming debt burden affecting African nations. These strategies must address the immediate economic challenges that countries face. They must also lay the foundations for long-term economic sustainability and equitable development across the continent.
By tackling these issues head on, an economic environment can be created that fosters growth, strengthens local economies and ensures that African countries have access to the resources they need to thrive.
The rules of the banking game
The Bank for International Settlements often called the “central bank for central banks”. It sets the regulations and standards for the global banking system.
But its rules disproportionately favor developed economies, leading to unfavorable conditions for African countries. For example, capital adequacy requirements – the amount of money banks must hold relative to their assets – and other prudential rules may be disproportionately strict for African markets. This limits lending to stimulate economic growth in less attractive economies.
The bank’s policies often overlook the unique challenges of developing countries.
After the financial crisis of 2008/2009, the bank introduced a new, stricter set of regulations. Their complexity and stringent requirements have been inadvertently accelerated the withdrawal of international banks from Africa.
They have also made it increasingly difficult for global banks to operate profitably in African markets. As a result, many chose to curtail their activities or leave. The withdrawals have reduced competition in the banking sector, limited access to credit for businesses and individuals, and hampered efforts to promote economic growth and development.
The limitations of the new regulations underscore the need for a more nuanced approach to banking regulation. The adverse effects could be mitigated by simplifying the regulations. For example, the requirements could be tailored to the specific needs of African economies and to support local banks.
Focus on poverty alleviation
Multilateral financial institutions such as the IMF and the World Bank play a critical role in providing financial assistance to many countries on the continent. But their emphasis on poverty alleviation and, more recently, climate finance often overlooks urgent spending needs.
In addition, the liquidity squeeze Countries facing it further limit their ability to prioritize essential spending.
Wealthy nations enjoy the luxury of lenient regulatory frameworks and ample fiscal space. For their part, African countries are left to fend for themselves in an environment filled with predatory lending practices and exploitative economic policies.
Among them are sweet tax deals that often include tax exemptions. In addition, illegal economic practices by multinational corporations are draining countries of their limited resources.
Research by The ONE Campaign were found that financial transfers to developing countries fell from a peak of US$225 billion in 2014 to just US$51 billion in 2022, the latest year for which data is available. These flows are expected to decrease further.
Worryingly, the ONE Campaign report said that more than one in five emerging market and developing countries allocated more resources to debt service in 2022 than they received from external financing. Aid donors tout world aid records. However, nearly one in five aid dollars went to domestic spending on hosting migrants or supporting Ukraine. Aid to Africa has stagnated.
This leaves African countries looking for opportunities to access liquidity, which makes them prey to debt sweepers. As famous by Columbia University professor José Antonio Ocampo, the Paris Club, the oldest debt restructuring mechanism still in operation, deals exclusively with sovereign debt owed by its 22 members, mostly OECD countries.
With these limited efforts to address a significant structural problem of pervasive debt, it is unfair to stigmatize Africa as having incurred debt because of its performance or mismanagement.
Rating agencies
Rating agencies exert a significant influence on the global financial landscape. They shape investor sentiment and determine countries’ borrowing costs.
However, their estimates are often characterized by bias. This is particularly evident in dealing with African countries.
African nations argue that without bias, they should receive higher ratings and lower borrowing costs. This in turn would mean a better economic outlook as there is a positive correlation between financial growth and creditworthiness.
However, the subjective nature of the rating system inflates the perception of investment risk in Africa beyond the actual risk of default. This increases the cost of credit.
Some countries have disputed the assessments. For example, Zambia turned down Moody’s downgrade in 2015, Namibia appealed downgrade to junk status in 2017 and Tanzania appealed against inaccurate assessments in 2018. Ghana is disputed ratings by Fitch and Moody’s in 2022, arguing that they do not reflect the country’s risk factors.
Nigeria and Kenya rejected Moody’s downgrade. Both cited rating agencies’ lack of understanding of the domestic environment. They argued that their financial situation and their debt were less risky than Moody’s estimated.
Recently arguments by the Economic Commission for Africa and the African Peer Review Mechanism highlight the deterioration of sovereign creditworthiness in Africa, despite some recording growth patterns of more than 5% for consistent periods. Their joint report identifies challenges in ratings by rating agencies. This includes errors in the publication of ratings and reviews and the location of analysts outside of Africa to circumvent regulatory compliance, fees and tax obligations.
A recent UNDP report illuminates a shocking reality: African nations would gain a significant boost in sovereign debt financing if credit ratings were based more on economic fundamentals and less on subjective judgments.
According to the report foundingsAfrican countries could access US$31 billion in new financing while saving almost US$14.2 billion in total interest costs.
These figures may seem modest in the eyes of the big investment firms. But they are of enormous importance to African economies. If credit ratings accurately reflected economic reality, the 13 countries studied could unlock an additional $45 billion in capital. This is equivalent to the entire net official development assistance received by sub-Saharan Africa in 2021.
These figures highlight the urgent need to address the systemic biases that plague credit ratings in Africa.
Next steps
Discussions of Africa’s debt crisis often lean towards compensation-focused solutions. These advocate increased official development assistance, more generous climate finance measures, or lower borrowing costs through hybrid arrangements supported by international financial systems.
These measures may provide temporary relief. But they must be more genuine solutions in light of the three structural challenges facing African countries.