The World Turns Brighter
by Tony Addison
This year is set to see a new chapter open in Africa’s debt story and, for once, it looks like a positive story—as the region begins to access the international capital market in ways that could fund development and poverty reduction. Today 20 African countries have a sovereign credit rating (compared to only one in 1997) and many can now borrow commercially at interest rates less than half of those of the past. And they have access to the international capital market on a scale unimaginable just a few years ago.
In March Nigeria redeemed most of the debt owed to its commercial creditors (the London Club) in a deal that Nenadi Usman, the Finance Minister, said would ‘free Nigeria from its historic debt overhang’ (which in the late 1990s amounted to US$35 billion; equivalent to 60 per cent of GDP). The last US$500 million has been bought back, and there are high hopes that Nigeria’s sovereign bonds can now achieve an investment grade rating. Although a politically unpopular decision at home (much of the debt was incurred by Nigeria’s feckless military rulers with little thought to the future), the debt buy-backs over the last two years will lower the country’s risk premium and make it easier to finance the budget—including much needed spending on basic health services, primary education, and pro-poor infrastructure (all of which are needed to haul Nigeria out of deep poverty).
Likewise, Ghana is expected to raise up to US$750 million this year from the international capital market, and overall the prospects for the region’s poorer borrowers have improved significantly after completion of relief under the Enhanced Heavily Indebted Poor Countries (HIPC) Initiative and the Multilateral Debt Relief Initiative (MDRI)—the latter being announced at the 2005 Gleneagles summit of the G8. While eight African countries continue to languish at pre-decision point status under the HIPC Initiative (Central African Republic and Sudan, for example) debt relief is unlikely to do much to resolve their urgent political problems (the genocide in Sudan’s Darfur region, especially).
A new rush to borrow
Having just eliminated their HIPC debt (largely the legacy of past concessional aid loans to fund structural adjustment), why are countries in a hurry to borrow commercially? One reason is that aid is still an uncertain way to fund the public budget, and many of the donors have not lived up to the promises made at Gleneagles; far from rising to meet the Millennium Declaration’s target, total aid to sub-Saharan Africa from OECDDAC donors was constant in 2006, once debt relief to Nigeria is taken out. Aid from Italy, Japan, and the United States is actually down (Germany, Sweden, and the UK have substantially increased their aid in the last few years).
New donors, in particular China— which has returned to Africa with a vigour not seen since the 1970s—but also Brazil and India have entered the arena. China could use its enormous reserves to contribute to the next replenishment of the International Development Association (it gave nothing to the last IDA replenishment in 2005) thereby dispelling some of the accusations that it is following the well-trodden path of western donors in using its aid largely for commercial and diplomatic gain.
In summary, aid is proving to be a fickle friend (yet again). And so Africa countries are turning to commercial borrowing, taking advantage of a world that is, at least for the moment, abundant in capital looking for a return. The yield on emerging market debt is at historical lows (despite a wobble in early 2007) and the compression in spreads over US treasuries looks set to continue into 2008. This provides an excellent opportunity to finance Africa’s enormous investment backlog not only in ‘hard’ infrastructure but also in human capital. With the mid-point of the Millennium Development Goals (MDGs) fast approaching (June 2007) borrowing to improve education and health is all too necessary given the broken promises of the aid ‘community’.
The worlds of finance and environmental change also increasingly intersect; this year saw the first debt-for-carbon swap when the United States agreed to exchange US$12.6 million of Costa Rica’s US$93 million debt for carbon certificates (covering some 10 per cent of the country’s debt to the US). This looks promising for a future in which more capital flows to poor countries as rich countries seek to offset their carbon footprints by investing in sustainable forestry and alternative energy. Africa could benefit from this given its great tropical forests with their rich biodiversity—a global public good to be preserved for all of humanity’s benefit.
‘That ‘70s show’ again
But before we get too carried away with optimism, we must note some dark clouds that linger. There are dangers ahead which require careful navigation, not least rerunning ‘that ‘70s show’ in which countries borrowed recklessly on the 1970s commodity boom—only to see themselves saddled with enormous foreign debts. These had to be serviced on the back of meagre export earnings when commodity prices collapsed back again in the recession of the 1980s.
So it is imperative that this time round the borrowed funds be used to fund infrastructure to diversify economies away from their traditional dependence on commodity-exports. Getting the right infrastructure in place is no easy task, and one priority must be transport and communications infrastructure that facilitates more intra-Africa trade; the transport costs that countries face in trading with each other remain absurdly high, a problem that has been repeatedly emphasized for decades but one for which there has been too little finance available.
At least today’s financial markets offer more tools for hedging commodity-price and exchange rate risks, and governments would be well-advised to use these because the bonanza of cheap world capital cannot last forever. At some point in the next five years global inflation will rise (perhaps as a result of China’s seemingly insatiable demand for steel, copper, and oil), requiring the major central banks to tighten interest rates: easy credit will then come to an end, risk premiums will jump (including those on emerging market debt), and countries that have not used their borrowing productively will be exposed to the chill winds of expensive credit again.
It is therefore worrying that despite all the chatter about a ‘new international financial architecture’ over the last few years, we are no closer to its realization. There is still no institutional mechanism to manage private debt default since the IMF’s proposal for a sovereign debt restructuring mechanism fell by the wayside in 2003. And there are some very good ideas—such as GDP-indexed bonds and linking debt-service to commodity prices— that remain on the drawing board. It is in good times like now, when credit is easy and commodity prices are high, that we should be building a financial architecture that is robust for the bad times that inevitably come around.
After years of a dismal debt story, the future looks somewhat brighter— but to stay this way, Africa and the rest of the poor world needs to use its borrowing power wisely and the rich world’s donors need to live up to their pledges. Only then will the billions of people who live in chronic poverty start to see a better future for themselves and their children.
Debt Relief for Poor Countries Edited by Tony Addison, Henrik Hansen and Finn Tarp (hardback) 9781403934826 (paperback) 9781403934956 2004, Studies in Development Economics and Policy Palgrave Macmillan
Tony Addison is Executive Director of the Brooks World Poverty Institute (www.bwpi.manchester. ac.uk) Associate Director of the Chronic Poverty Research Centre (www. chronicpoverty.org), and Professor of Development Studies, University of Manchester. He was previously Deputy Director of WIDER.