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Debt and Development: Perspectives from the IMF in Africa

March 27, 2018

 

The growth rate of African economies over the last two decades has been impressive and driven by sensible macroeconomic policy, as well as strengthened institutions. The growth rate of the region has been further supported by a favorable economic climate across the world. However, the impressive growth slowed down in 2016 forcing African states to re-think how to balance their substantial investment needs while maintaining reasonable levels of debt. It is hard to imagine a better interlocutor to discuss this challenge than Abebe Selassie, Director of the African Department at the International Monetary Fund (IMF). The expert shared his insights in the lecture titled: “Growth in Sub-Saharan Africa: Drawing on the past, looking to the future” organized by the International Growth Center in the late last year in London.

 

The event was moderated by Jonathan Leape, Managing Director of the International Growth Centre, which is a joint initiative between the University of Oxford and the London School of Economics. This mission of the International Growth Center is well aligned with that of the Center for Industrial Development: “to promote sustainable development in the emerging economies.” It is crucial to note here that Sir Paul Collier – one of the greatest authorities on developing economies – is the Co-Founder of the IGC.

 

Adebe Selassie

Abebe Selassie’s career is a truly impressive one and has revolved around the IMF for the last 22 years. He started in his role as the Director of the African Department at the IMF on September 19th, 2016. Before that he represented the Fund in Poland and Turkey, as well as in Portugal during the last financial meltdown of 2008. Understandably, Abebe has spent significant time working on the African continent. Most recently he coordinated the IMF’s financial support to the three countries, Guinea, Sierra Leone and Liberia, all of which were affected by the Ebola crisis in West Africa.

 

In his presentation, the representative of the IMF noticed that in the last 25 years, Africa’s development was truly stunning and no one can argue against this fact. However, Abebe proposed that he will not spend too much time on praising Africa and instead focus on the challenges the continent has to tackle if it wants to for the next 25 years and beyond.

 

Therefore, while the impressive economic growth of the last 25 years is a fact, so is the slowdown in growth that started in 2016. It is further expected that the income per capita will decrease in the 20 African states within the near future. This group represents as much as 40% of Africa’s population. If one connects this piece of information with the insight that recently the average level of debt of African states has increased from 28% to 48% of their GDP, things start to look challenging. The situation is particularly dire in the oil exporting countries, as there the level of debt is increasing even faster. Abebe stressed that an increase in debt itself is not a reason for worry. What is concerning, however, is the rapid increase in debt levels and the subsequent management.

 

Managing Debt 

As each entrepreneur knows, the greatest worry of any business is not its profitably, but management of the cash flow. Exactly the same formula applies to management of a country’s finances. Therefore, it is hugely concerning to realize that the cost of debt management of African economies increased from 5% of the GDP in 2013 to 10% in 2015. Abebe underlined that situation is much more serious in oil exporting countries, as their ratio stands at 25% of GDP. The example of Zambia was used to illustrate the point, where the cost of debt service is larger than the financial resources available for medical care and education combined!

 

Before jumping into criticizing the way that African leadership manages their debt levels, we have to understand the bigger picture of incentives. In short, borrowing money does make sense in the short-run, and the argument flows like this: “I am a leader of this African state and I do not have enough money to develop my economy through investments for my citizens to live better lives than their parents. Therefore, I am going to borrow money, develop my economy, and in turn my citizens will start paying taxes, so that we can pay the loan off. If things do not go according to this plan, I am still not losing out, as it is extremely unlikely that my government is the one which will be ultimately responsible for the paying off the debt.” In conclusion, from the perspective of the African government, borrowing money is a no brainer.

 

Abebe commented that the current situation in the global capital markets is further supporting borrowing by the African states, as the cost of borrowing money is extremely low. Some governments are issuing securities which are guaranteed to make investors lose money, yet those securities are oversubscribed. This leads some investors to look for better rates of return in the developing world, which includes most of Africa. An increase in the money supply in developing markets means that the cost of borrowing there is also decreasing, which only fuels the desire of African governments to borrow more. This leads to a situation which does not support the much-needed structural reforms in African economies, as governments essentially operate on a line of credit rather than on a sustainable budget built on tax revenues.

 

Striking the Balance 

From the perspective of the representative of the IMF, African governments have only one task: to maintain the right balance between investment levels and sustainable increases in debt levels. Abebe showcased Ghana as a good example of a country trying to strike this balance. The Ghanaian government is working hard on increasing domestic revenue as well as decreasing expenditures. Achieving the former is possible by increasing the pool of taxpayers through designing programs that encourage people to exit the informal sector. Achieving the latter requires a much simpler solution, but one which is contentious within the population: cutting unnecessary subsidies like fuel subsidies.

 

Economics allows us to predict, with high probability, which kinds of macroeconomic policies work, and which simply do not work. Therefore, Abebe was concerned to not hear any conversations on the African continent about adjusting debt. The argument, however, is that debt reduction policies would not affect development. This is an especially poignant observation when one considers demographic projections that predict massive increases in the work force: through 2030, half of all new workforce entrants in the global economy will be Africans. The representative of the IMF noticed that most of the past economic growth in Africa was rooted in reform that removed obstacles to growth. Therefore, the last thing Africa needs right now are policies that may erect new obstacles to growth.

 

Managing a family budget is not easy, so one can only imagine how overwhelming managing a country’s budget must be. Nevertheless, one has to face the challenge, and according to Abebe there are two things one has to get right. The first one is mobilization of internal revenues, which – if successful – will decrease the country’s need to borrow externally. The representative of the IMF notices that in the majority of African states, tax collection systems are not effective as the state lacks tolls necessary to make them effective. Therefore, Abebe suggests that temporal introduction of revenue tax instead of relying on the profit tax should be seriously considered. An equally critical part of the challenge is to move people from the informal sector to a formal sector, which in the long-run will also increase domestic revenue. The point of such a policy would not be to start taxing those people straight away, but rather to incorporate them into the economy and allow them to enjoy the benefits of being a legal business. Finally, while there is an enormous amount of work to be done in the field of taxation, Abebe notices that currently, tax collection systems developed for telecoms or mining companies offer plenty of examples of how to do tax collection right, which should serve as inspirations for new systems.

 

Past and Future Successes 

The presentation concluded with a lively Q&A session during, which the representative of the IMF stated that, looking back at his career within the IMF, he is the proudest of the Fund’s role in the fight against the Ebola crisis in 2014. This is when the IMF created a credit facility of $400 million USD available to the governments of the three countries affected by the crisis: Guinea, Sierra Leone and Liberia. When asked to comment on the political developments in Africa – which due to the nature of his function he cannot do – Abebe stated that he is full of hope when it comes to the development of democracy in Africa. He referred to the example of Kenya, which during the time of the event was undergoing political challenges caused by the presidential elections. Abebe noticed that that development proves profound change is happening in Africa, as he can remember times when there were no elections at all! Therefore, he thinks the trajectory of development is right. The question remains whether African states will be able to build institutions which will continue working smoothly even as the governments change. In other words, independent institutions which will guarantee the economic stability of the state.

 

Climate Change is Real 

It is obvious to state that it is better to conduct reforms during booms rather than recessions. Additionally, there are external factors that affect growth: Abebe mentioned that climate change must be considered in the policymaking process in Africa. We have talked about this issue extensively in our article from the Chatham House Climate Change Conference. He expressed disappointment over the fact that this consideration is not on the agenda of the African leaders who tend to think much more short-term. Furthermore, it is critical to note that the Sahel countries – Burkina Faso, Capo Verde, Chad, Gambia, Guinea-Bissau, Mali, Mauretania, Niger and Senegal – already require substantial capital investments for mitigating climate change. We would like to note here that the Center for Industrial Development works with representatives of CILSS to design financial mechanisms for attracting capital to the region, including for mitigating climate change.

 

Is Agriculture the Key?

In the final part of the Q&A, Abebe suggested that African governments should care much more about the development of the agricultural sector, which in turn supports development in other sectors of the economy. Infrastructure development is key for agricultural development. Uganda exemplifies this: Abebe remembers vividly each time he travelled outside of Kampala during the raining season, when he passed plenty of trucks loaded with corn flour that could not make it to the top of the hill. Therefore, a sizable group of people unloaded the truck and brought corn in bags to the top of the hill, where the truck was reloaded. Within the next 2,000 yards, the whole process was repeated. Abebe concluded: “If people are happy to do business with such high transaction costs how rich would Africans be if the infrastructure was there?”

 

 

The Center for Industrial Development is delighted to present in this article the latest’s thoughts of one of the most important people in the financial world of Africa: Abebe Selessaie, Director in the African Department of the IMF. We hope this article encourages our readers to look further into and benefit from enormous – but indeed hard to tap into – opportunities offered by Africa, particularly in agriculture. Our raison d'etre is to guide you in conducting business in Africa, which is both fascinating and complex. Contact us today to take advantage of these great opportunities!

 

 

 

 

 

 

Mateusz Ciasnocha is constantly on a mission to “unleash dormant potential.” He specializes in agriculture, energy, and Africa, and is also passionate about innovation and entrepreneurship. A Hult International Business School graduate, Mateusz currently studies at ESCP Europe Business School and the University of Oxford, where he is receiving a Masters in Energy Management and Philosophy Certificate, respectively. Mateusz is currently in India participating in the prestigious IDEX Fellowship, which enables him to work with Vrutti  to support 130,000 smallholder farmers.

 

 

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