Address the collection premium for sustainable development in Africa
The pandemic slowdown has exacerbated one of the most serious challenges Africa faces on its development path – the high costs of collection premiums – the overvalued risks eternally attributed to Africa, regardless of the improvement in its macroeconomic fundamentals, the global economic environment and the growth prospects of each country. . The global nature of the pandemic slowdown provides an opportunity to examine the extent to which collection premiums shape the allocation of sovereign risk among countries and regions; the disproportionately larger number of African countries affected by procyclical downgrades further strengthens the premium hypothesis.
More than 56% of African countries rated by at least one of the three major rating agencies (Standard & Poor’s, Fitch and Moody’s) were downgraded at the height of the pandemic in 2020, while only 9.2% in Europe and 28 % in Asia were — leading to a world average of 31.8 percent. The disproportionate degradation has occurred despite Africa showing greater resilience of growth in the face of the synchronized global slowdown triggered by the pandemic, contracting by less than 2%, from a global average of 3 , 3%.
Yet African countries continue to face higher premiums, with lasting consequences. In the short term, these premiums increase the risk of debt distress and limit fiscal space, compromising the ability of governments to respond effectively to recurring negative global shocks, as illustrated by the challenges associated with managing the COVID-19 crisis. . While significantly lower interest rates – negative in real terms – have allowed advanced economies to navigate the pandemic slowdown effectively by prolonging significant monetary and fiscal stimulus, with lending rates crushing growth and induced Defaults on African assets have paved the way for a divergence recovery and increase the risk of debt distress.
These bonuses also have broad implications for macroeconomic management and long-term sustainable development. By deterring investors and limiting access to long-term finance, they exacerbate liquidity constraints and undermine the process of economic transformation necessary for Africa’s effective integration into the global economy, trapping countries in a perpetual debt trap threatening global financial stability.
The calls by a growing number of leaders to tackle this problem are steps in the right direction. For example, at the World Bank-IMF Annual Meetings — held virtually in October 2020 — IMF Managing Director Kristalina Georgieva noted that “great attention needs to be focused on reducing perceived and actual risk. to invest in Africa, so that we can see this huge availability of funding for the rest of the world spilling over to Africa. Earlier this year, French President Emmanuel Macron, who called for “fairer financing rules for African economies,” hosted a summit on financing African economies. Indeed, a strong commitment and effective coordination between stakeholders will be essential for the emergence of an international financial architecture that promotes an inclusive global approach to affordable development finance.
What can and should be done?
For African countries, governments should step up on-going efforts to improve information architecture, deepen economic and institutional reforms, and accelerate the implementation of the African Continental Free Trade Agreement (AfCFTA) to boost diversification of sources of growth and exports and broadening the tax base. As the pandemic unfolded, Fitch, in a “move by several notches,” downgraded Gabon’s sovereign rating to CCC from B, largely on the grounds that falling oil prices would widen the double deficit. of the country and undermine the government’s ability to honor its commitments to foreign markets. creditors. Standard & Poor’s downgraded Botswana, one of the main diamond exporters and the only African country with an A- rating, for the same reason. Economic diversification will reduce the unhealthy correlation between growth and commodity price cycles and sustainably boost the growth of foreign exchange reserves and government revenues to put the region on the path to long-term fiscal and debt sustainability. , both of which are positive for the credit rating.
But to get Africa out of this vicious circle, in which the colonial development model of resource extraction is both a risk factor and an obstacle to long-term development finance, African sovereign risk models must integrate the diversity of African countries and their improving economic prospects. . Low levels of debt to GDP and robust economic growth should be positively correlated with sovereign credit ratings for greater consistency and incentives on the path to macroeconomic reforms. As strong economic reformers are rewarded with increased access to financing for sustainable development, incentives for more countries to adopt difficult reforms could follow, triggering a virtuous cycle of accelerating growth fueled by a globally competitive access to affordable development finance.
At the same time, rating agencies should refrain from procyclical downgrades, which often trigger sudden stops and reversals of capital flows in a ‘flight to quality’, and should instead grasp the long-term perspective. term of debtors. By increasing borrowing costs and accentuating liquidity constraints, procyclical downgrades can prolong and exacerbate economic crises. For example, by increasing pressure on the balance of payments and undermining the growth of investments, persistent liquidity crises can turn into lasting solvency crises and cascading defaults. Fostering transparency and strengthening coordination between the IMF and rating agencies will ensure greater coherence and gradually reduce the perception gaps at the root of Africa’s pro-cyclical downgrades and ruinous premiums.
While sovereign credit ratings have a direct impact on an affected country’s ability to raise long-term financing, the consequences of large-scale procyclical downgrades can be substantial, with potential risks to international financial stability. A globally coordinated approach that promotes accountability and transparency in producing consistent sovereign risk estimates will be more effective in regulating the business practices of rating agencies. Such a body could follow models established by the United States Securities and Exchange Commission and the European Securities and Markets Authority. With the exception of South Africa, which has tasked its Financial Services Board with administering the Credit Rating Services Act of 2012 and overseeing the operations of credit rating agencies, no other country in the region does not have a similar structure.
In the medium to long term, the development of deep, efficient and well-regulated domestic capital markets will be essential to diversify sources of funding and reduce liquidity and currency risks. These markets will reduce dependence on foreign currency debt and improve the ability of countries to withstand volatile capital outflows. They will provide a secure and stable source of finance, while helping countries establish appropriate yield curves to improve investment decisions and support them on a long-term trajectory of robust economic growth. At the same time, they will increase the effectiveness of monetary policy and ultimately put countries on the path to cyclical improvement in liquidity and borrowing costs.
That being said, progressing in the development of dynamic local currency government bond markets in the region will require transcending national constructs to integrate fragmented and highly illiquid financial markets to reflect the revolutionary reform of continental trade integration. supported by African continental free trade. Agreement. Subsequently, the emergence of a continental financial ecosystem that promotes the development of a money market to provide short-term liquidity to governments, commercial banks and other large institutions, as well as a repo market dynamic to provide secured, interest-bearing loans to meet short-term funding and liquidity — will be the next crucial piece of the puzzle of economic stability and financing for sustainable development in Africa.
In particular, while a vibrant money market is a necessary condition for the emergence of prosperous and liquid securities markets, the development of a local repo market is essential to strengthen the link between money and bond markets. Nonetheless, the successful development of local sovereign bond markets also depends on intensifying reforms aimed at improving Africa’s regulatory and policy environment and fostering policy coherence.
The perceived quality of the institutional framework, which has been identified as a key factor in market access, is positive for credit rating. Combined with the diversification of sources of growth and exports, which will reduce the correlation between growth and commodity price cycles and cultivate Africa’s reserve assets, this will act as a credit rating enhancer and multiplier. , putting the region on a long-term trajectory. fiscal and debt sustainability.
Over time, this combination of mutually reinforcing institutional reforms and diversification of sources of growth will stimulate global demand for African assets and gradually reduce the credit spreads of African sovereign and corporate bond issuers to equalize l ‘access to the global pool of financial resources and free up global capital for sustainable economic development.
For more on this issue, see my recent article, “The Ruinous Price to Africa of Pernicious ‘Perception Bonuses’. “