Life after debt: AfDB Chief Economist reflects on governance and growth in Africa
Following the launch of the 2021 edition of the African Economic Outlook, Rabah Arezki, the African Development Bank’s Chief Economist and Vice President for Economic Governance and Knowledge Management, discusses strategies to rebuild stronger African economies.
In 2021, Africa is forecast to rebound from its worst economic recession in half a century. Which indicators underpin the likelihood of such a recovery?
After contracting by 2.1 % in 2020, Africa’s real GDP is expected to grow by 3.4 % in 2021. This anticipated recovery from the worst recession in more than half a century would be underpinned by COVID-19 vaccinations and helped by a resumption of tourism, a rebound in commodity prices, and the lifting of restrictions aimed at stemming the spread of the virus. However, the picture is clouded by unusually high uncertainties.
On the downside, the emergence of more contagious strains of COVID-19 could derail the recovery. If progress in deploying safe and effective treatment is slower than expected, governments would have to reinstate lockdown restrictions. A slow rebound in financial inflows, subdued commodity prices and tight financing conditions would suppress public finances and jeopardize the recovery. Social and geopolitical tensions in the region are also a major source of risk.
On the upside, the projected recovery could be better than anticipated if there is timely, fair and universal access to COVID-19 therapeutics and vaccines and if structural transformation efforts, including digitalization and work-from-home measures, are intensified by countries and employers. Continued fiscal and monetary stimulus measures would also strengthen the recovery.
Can you provide a clear picture of the debt situation in African countries? Why does debt relief matter now, more than ever before?
To cushion the economic and social impacts of the COVID-19 pandemic, many governments in the continent announced fiscal stimulus packages that averaged about 3% of GDP. This caused a surge in the gross financing needs of the continent, which has been financed partly by ramping up debt. The average debt-to-GDP ratio, which had somewhat stabilized at around 60% of GDP at the end of 2019, is expected to climb by 10 to 15 percentage points by 2021.
The composition of Africa’s debt continues to shift towards commercial and non-Paris Club creditors, and from external to domestic sources. The Paris Club, which used to account for more than half of Africa’s external debt, now accounts for only about 27%. Africa owes the rest of the world about $546 billion – equivalent to one-quarter of its GDP and nearly equal to the size of its annual revenues of $501 billion. The recent debt accumulation has been driven mainly by the depreciation in exchange rates, growing interest expenses, and high primary deficits.
Debt relief matters now because a large number of countries are in debt distress or at high risk of debt distress. Out of the 38 low-income countries with DSA ratings, six are currently in debt distress and 14 are at high risk of debt distress. Shorter maturity of debt and increasing interest expenses on the public debt (about 18% of revenue) have exposed countries to higher refinancing risks. Increased reliance on external commercial debt has exposed countries to higher exchange rates and market risks. Debt relief would help create the fiscal space required to cushion the pandemic’s impact and drive a fast and sustainable economic recovery.
What specific reforms does AEO 2021 propose for handling debt resolution, governance, and sustainable growth issues in Africa?
The 2021 African Economic Outlook (AEO) recommends three blocks of reforms to improve the process of debt resolutions and the nexus with governance and sustainable growth. Reforms to the international financial architecture of sovereign debt to promote orderly restructuring and resolution. The current global architecture requires better coordination among creditors, which can be achieved by establishing a wider forum that brings together official bilateral, multilateral, and private-sector creditors to agree on common terms for debt restructuring and resolution.
Because African economies are particularly exposed to exogenous shocks that amplify uncertainties associated with debt contracts and repayments, the use of value recovery instruments should be embraced. Governments should use state-contingent debt instruments and value recovery sweeteners to offer risk- and reward-sharing benefits to creditors to facilitate debt restructuring negotiations. These instruments would link debt-service obligations to predefined indicators or states of the world so that in times of crisis, such as the COVID-19 pandemic or a natural catastrophe, debt and financing pressures are automatically alleviated.
Innovations in contract design that incorporate collective action clauses and aggregation clauses in bond contracts can allow agreed debt restructuring proposals to be aggregated across creditors for different bond series. Using a standardized design would help limit legal vulnerabilities, enhance creditor coordination, and market acceptability.
To get to the root of Africa’s debt problem and avoid the need for future debt jubilees, the relationship between debt, governance, and growth must be strengthened. Governance reforms that block leakages in public finances, improve transparency in debt management, and promote the efficiency of public investments would have to be reinforced. Growth-friendly policies that focus on accelerating digitalization and promoting free and fair competition are required to grow Africa out of the COVID-19 crisis and avoid a looming debt crisis.
What should African countries do to mitigate the short, medium, and long-term economic consequences of the COVID-19 pandemic?
In the short term, African countries should continue to support the health sector to consolidate gains in the fight against the pandemic. Countries should also continue to sustain monetary and fiscal support to underpin economic recovery and address increasing poverty by expanding social safety nets and making growth more equitable.
In the short to medium term, countries should address increasing poverty by expanding social safety nets and making growth more equitable. The coverage and scope of social protection must be expanded to aid the newly impoverished through in-kind support such as free food banks, medical supplies and subsidized housing.
In the medium to long term, regional integration and multinational solidarity, especially through the African Continental Free Trade Area agreement, should be strengthened. Policymakers should accelerate structural transformation through digitalization, fair competition, industrialization, and diversification. Active labour market policies need to be scaled up to retool the labour force for the evolving needs of the workplace and to build a more resilient future.