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Growing with Debt in African Economies: Options, Challenges and Pitfalls

Growing with Debt in African Economies: Options, Challenges and Pitfalls Downloaded from https://academic.oup.com/jae/article/30/Supplement_1/i3/6395209 by DeepDyve user on 19 July 2022 JournalofAfricanEconomies, 2021, Vol. 30, AERC Supplement 1, i3–i13 doi: 10.1093/jae/ejab019 Article Growing with Debt in African Economies: Options, Challenges and Pitfalls Njuguna Ndung’u, Abebe Shimeles and Damiano K. Manda African Economic Research Consortium (AERC), Kilimani Jakaya Kikwete Road, East Bank Tower Building, Nairobi, Kenya Corresponding author: Abebe Shimeles. E-mail: abebe.shimeles@aercafrica.org 1. Introduction The public debt in Africa started to increase sharply again after 2013 in the wake of the commodity price boom, reversing the gains from the heavily indebted poor countries (HIPCs) initiative. Almost all African countries experienced both an increase and change in the composition of public debt. The shift away from concessionary to market-based loans from private institutions further aggravated the debt burden due to high interest rate and short maturity period. In the aftermath of significant debt cancellation provided to 30 Sub-Saharan African (SSA) countries in the context of the HIPCs and the Multilateral Debt Relief Initiative (MDRI) in the early- to mid-2000s, the median public debt-to-GDP ratio fell from 85.3% in 2001 to 34.3% in 2011. These initiatives, together with resilient growth and improved solvency, provided an additional space for new borrowing. Despite these developments, recent trends show that countries have taken up more debt, driving the median public debt-to-GDP ratio to about 58% by 2019. The advent of the Covid-19 pandemic further accelerated the debt burden across Africa where the median debt-to-GDP ratio is expected to reach close to 70% (African Development Bank, 2021). By contrast with the debt crisis of the 1980s and 1990s, sustain- ability concerns are not region-wide (IMF, 2018; African Development Bank, 2020). Fiscal policies are, however, under pressure as many countries across the region contend with ele- vated interest burdens and continued weakness in commodity export markets. The Covid-19 pandemic further caused significant recession with estimated real GDP growth of −2% in 2020 for Africa with a resultant deterioration of the primary budget deficit from about 1.5% in 2019 to 3.5%, which is significant (African Development Bank, 2021). While external debt burden indicators are still below levels that triggered debt distress in most countries in the earlier periods, risks of a renewed cycle of debt crises and economic © The Author(s) 2021. Published by Oxford University Press on behalf of the Centre for the Study of African Economies. This is an Open Access article distributed under the terms of the Creative Commons Attribution License (http:// creativecommons.org/licenses/by/4.0/), which permits unrestricted reuse, distribution, and reproduction in any medium, provided the original work is properly cited. Downloaded from https://academic.oup.com/jae/article/30/Supplement_1/i3/6395209 by DeepDyve user on 19 July 2022 i4 Njuguna Ndung’u et al. Table 1: Selected Covariates of External Debt (% of GDP) in Africa (5-year average for 1990–2018) Low-income countries Africa Real per capita GDP growth −2.115∗∗∗ −9.850∗∗∗ (0.001) (0.000) Terms of trade (index) −0.0217 −0.255∗ (0.795) (0.042) Tax revenue (% of GDP) −0.275∗−1.184∗∗∗ (0.036) (0.000) Current account balance (% of GDP) −2.471∗∗∗ −2.374∗∗∗ (0.000) (0.000) Gross savings (% of GDP) −0.482∗−0.0179 (0.012) (0.959) Constant 63.61∗∗∗ 89.99∗∗∗ (0.000) (0.000) Number of observations 1928 667 Adj. R-sq 0.175 0.257 Note: Table 1 reports pooled regression of external debt as % of GDP for the period 1960–2018 on selected covariates, which were averaged over five period intervals with robust statistics. Source: authors’ computations based on data from World Economic Outlook (various issues), IMF. p < 0.05. ∗∗ p < 0.01. ∗∗∗ p < 0.001. disruption are growing, with several countries’ risk of external debt distress deteriorating, particularly in the wake of the COVID-19 pandemic. For instance, out of the 36 Poverty Reduction and Growth Trust (PRGT)-eligible SSA countries for which debt sustainability analyses (DSAs) were conducted between 2008 and 2018, 44% (or 16) were classified as either ‘in debt distress’ or facing ‘high risk’ of debt distress in 2018, from 31% (or 11) in such categories at the end of 2011 to 56% (or 20), which was conducted in 2020, partly driven by the COVID-19 pandemic. The main drivers of debt build-up, however, vary across countries and include exogenous shocks, weak fiscal management and macro- economic policy frameworks to support growth; changing composition of debt towards more expensive sources of financing; and high levels of public spending among other factors (World Bank 2018; African Development Bank, 2021). Table 1 presents the magnitude of the long-term association between external debt (% of GDP) and its close correlates for African and low-income countries for the period 1990–2018. Results suggest trade shocks (captured through terms of trade shocks), growth in real per capita GDP, current account deficits and tax mobilisation efforts play a significant role in the variation of external debt situation in Africa. Economic fundamentals, such as real per capita GDP growth, external balance and government capacity to mobilise revenue, explain over 80% of the variation in external debt due to observed factors reported in Table 1. 1 A country is in debt distress when it is struggling to service its debt, as demonstrated by accumulation of arrears or the restructuring of its debt. https://www.imf.org/external/Pubs/ft/dsa/DSAlist.pdf Downloaded from https://academic.oup.com/jae/article/30/Supplement_1/i3/6395209 by DeepDyve user on 19 July 2022 Growing with Debt in African Economies i5 Against this background, this special issue combines four papers presented during the June 2019 Plenary Session of the African Economic Research Consortium (AERC) biannual research workshop held in Cape Town, South Africa, on the theme ‘Growing with Debt in African Economies: Options, Challenges and Pitfalls’ and a fifth paper featured in the December 2017 Biannual under the theme ‘Governance for Development in Africa’. The first paper by Vera Songwe and Christine Awiti on ‘African Countries’ Debt: A Tale of Acceleration at Multiple Speeds and Shades’ propose a novel approach to monitor debt burden and argues that, instead of the levels, what matters is the speed of debt accumulation that could determine the path of debt to more sustainable debt levels. They also find that there is heterogeneity in country debt accumulation and that policies to ensure sustainable debt will need to be country specific. The second paper by Benno J. Ndulu and Stephen A. O’Connell on ‘Africa’s Development Debts’ notes that the debt management challenges that are now emerging for borrowers and lenders differ in important ways from those of the past. They argue in the paper that development assets are at risk—including advances in human capital and infrastructure and an improved investment environment—if these challenges are not managed well. They further note that preserving and enhancing these assets should be a central objective of domestic policy actions, inhibitory debt restructurings and institutional approaches to debt distress. The third paper on ‘Debt, Growth and Stability in Africa: Speculative Calculations and Policy Responses’ by Shantayanan Devarajan, Indermit Gill and Kenan Karakülah attempts to answer three questions that are being asked with increasing urgency to avoid another debt crisis. The first question: has the quality of institutions and policies of African countries, critical to sustaining higher levels of debt, improved since the debt relief of the early 2000s? Second, will debt markets get to know emerging Africa well enough before the next crisis? Third, have the resolutions of recent defaults in Africa been orderly so that debtor governments are not herded into traps set by foreign creditors? Their analysis suggest that the answer to all three questions is a ‘no’. The paper recommends preventive measures that involve full transparency in debt accounting, greater realism in growth forecasts and diligence in matching the region’s seemingly limitless public investment needs with weak public sector capacity to manage infrastructure investments to avoid another debt crisis. The fourth paper by Michael Atingi-Ego, Sayed Timuno and Tiviniton Makuve on ‘Public Debt Accumulation in SSA: A Looming Debt Crisis’ discusses recent debt trends and evaluates performance of DSA conducted in a sample of SSA countries over the period 2008–2016 to provide insights on risk of debt distress in SSA. The paper finds the existence of systematic optimism bias in past DSA vintages resulting from optimistic macro-economic projections that underpin the DSAs. As a result, the DSAs for the sample countries analysed projected higher debt-carrying capacities, which in most cases led to a faster pace of debt accumulation during this period. This was compounded by the fact that average interest rates on new debt commitments were rising faster relative to GDP growth rates while the necessary fiscal adjustment to counter this development remained insufficient. The fifth paper by Amdou Boly, Maty Konte and Abebe Shimeles on ‘Corruption Perception and Attitude Towards Taxation in Africa’ presented at the 47th Plenary Session complements the above papers by providing compelling evidence on the role of widespread perception of corruption among Africans in the mobilisation of taxes, which as shown in Table 1 plays a critical role in managing debt burden. Downloaded from https://academic.oup.com/jae/article/30/Supplement_1/i3/6395209 by DeepDyve user on 19 July 2022 i6 Njuguna Ndung’u et al. 2. African countries’ debt: a tale of acceleration at multiple speeds and shades The first paper by Songwe and Awiti focuses on debt sustainability for African countries. It begins with an analysis of the debt path for Africa in general and then for specific countries. Debt in African countries rose over the past few years, but the growth rate in the 5 years to 2018 was fast paced at an average of 9.3% in Africa. Songwe and Awiti argue that monitoring of debt through speed of debt, and thereafter adjusting structural indicators accordingly, can strengthen debt sustainability for African countries. They note that debt paths are not homogenous and that different countries follow different paths. Therefore, policies for debt sustainability should be applied on a country by country basis. The paper notes that other than the IMF/World Bank, and now the China Road and Belt Initiative Countries Debt Sustainability Frameworks, most debt monitoring is carried out through debt level thresholds. However, rather than monitor debt levels, focus should be on monitoring the speed of growth of debt, which can be instrumental in informing authorities how quickly they are approaching debt level thresholds and if borrowing is sustainable. While the speed of debt indicates whether borrowing is heading towards unsustainable levels, adjusting for structural indicators can steer debt back into a more sustainable path. Songwe and Awiti suggest a two-step approach that can be utilised by policy makers to monitor debt and then make adjustments, if need be, to ensure sustainability. First is keeping track of the speed of growth of debt and ensuring growth remains below 5% per annum. In countries where debt grew at less than 5% in 2018 such as in Guinea, Lesotho, Madagascar and Tanzania, debt levels remained below 40%. Second, where growth exceeds 5%, then adjustments to structural indicators can be adopted such as (a) a reduction in the flow of debt is desirable, that is, fiscal deficit can either be lower, or countries can adjust to have fiscal surpluses; (b) countries should negotiate for the most favourable borrowing conditions, that is, debt tenor should be long while interest rates should be as low as possible; and (c) promote policies that encourage exports to earn foreign currency, or alternatively, issue local currency bonds. The paper observes that such corrective measures are easier to put in place with an early warning system. Songwe and Awiti propose an early warning system for debt accumulation that should allow policy makers to put in place corrective measures before the situation becomes one of debt distress. Under the corrective framework, governments have more flexibility on the policy options to be adopted and can chose between a wider variety of fiscal policy options from working to increase tax revenues, adoption of counter cyclical measures to create buffers, implement and abide to strict fiscal rules to correct the acceleration of debt. Further, managing the cost of debt can strengthen debt sustainability for African countries. Songwe and Awiti give the following example to illustrate this: First they observe that Zambia issued a Eurobond in 2014 at a yield of 8.625%, 3 percentage points higher than its bond issuance in 2012, for an amount 30% higher (IMF, 2015). In the 3 years following the bond issue, Zambia’s interest rate payment grew by about 46%. Similarly, for Kenya and Ghana that issued about four Eurobonds between 2013 and 2018, interest payment made up almost half of the fiscal balance. Hence, lower cost of debt reduces fiscal pressures and strengthens debt sustainability. Downloaded from https://academic.oup.com/jae/article/30/Supplement_1/i3/6395209 by DeepDyve user on 19 July 2022 Growing with Debt in African Economies i7 According to the paper, the conditions of debt also matter. Cost and tenor of debt matter for economic growth. Government investment in public infrastructure ease supply side constraints and crowds in private sector investments. However, high cost of debt and short maturity periods lead to unsustainable debt where return on investments takes longer to be realised. For instance, Ethiopia borrowed externally to invest in export processing zones that were expected to increase the supply of foreign currency to repay debt. However, export growth has been slower than expected leading to exchange rate pressures, that could lead to more expensive debt in the future. Further, the paper notes that legislation that encourages greater transparency of contracts such as digitalisation and publication of procurement processes could increase the efficiency of use of public funds. This can lead to significant benefits derived from borrowing. Also, transparency in debt reporting, including timelines for debt issues, could ensure more efficiency in the use of debt as well as strengthen the development of local markets. Finally, the paper observes that for debt to remain sustainable, African countries must enhance revenue mobilisation. The Africa region has on average one of the lowest revenue to GDP ratios. There is scope for increase in revenue of up to 20% of GDP (Economic Report on Africa, 2019). Increase in revenue collection means lower fiscal deficit and leads to lower growth rates of debt. Thus, debt monitoring tools such as the speed of debt create an early warning system, with room to mitigate any challenges before debt becomes unsustainable. 3. Africa’s development debts The paper by Ndulu and O’Connell observes that the debt management challenges that are now emerging for borrowers and lenders differ in important ways from those of the past. They argue in the paper that development assets are at risk—including advances in human capital and infrastructure and an improved investment environment—if these challenges are not managed well. They further note that preserving and enhancing these assets should be a central objective of domestic policy actions, preventative debt restructurings and institutional approaches to debt distress. Ndulu and O’Connell note that in contrast with the debt crisis of the 1980s and 1990s, debt-sustainability concerns are not region wide in SSA and the policy environment for growth remains robust. They further observe that a long period of favourable borrowing conditions has nonetheless come to an end, with interest rates now exceeding underlying growth rates at the margin in most countries and commercial creditors increasingly sensitive to rollover risks on debts issued to date. The pace of new borrowing also appears to have declined very recently, reflecting unavoidable fiscal adjustments to a significantly more difficult borrowing environment. However, there are substantial risks associated with the stock of debt build-up over the past decade. The paper argues that Africa’s last debt crisis, finally resolved after two decades of bilateral and ultimately multilateral debt relief, is an imperfect model for resolving future debt crises. Recently accumulated debts are not only shorter term but also predominantly from commer- cial sources and new official donors and are subject to more volatile market interest rates and sentiments, as well as to new challenges of creditor coordination. Fundamentally, there are development assets at stake after two decades of investment and growth, including hard- fought improvements in policy environment and institutions, major public infrastructure Downloaded from https://academic.oup.com/jae/article/30/Supplement_1/i3/6395209 by DeepDyve user on 19 July 2022 i8 Njuguna Ndung’u et al. projects nearing fruition and cumulative increases in human capital formation that in most countries continue to await a transformative response of private investment. Ndulu and O’Connell observe that compositional changes in debt and significant shifts in the composition of creditors require countries to enhance their own debt-management capabilities, particularly as a number of them are set to graduate from IDA. This need to be more consciously embraced in multilateral country programs, with a view to incorporating capacity-building programs that pay attention to the expansion of external market-based financing and that are capable of operating in a multi-creditor environment. The IMF’s multi- pronged approach to debt management is key to this transition. The paper notes three main challenges that SSA countries have still to contend with in the context of elevated debt. The first concerns those countries already under stress from debt obligations that are maturing ahead of the revenue streams from the infrastructure investments (physical and social) they financed. The challenge here is to address maturity mismatches without recourse to destructive adjustment patterns that compromise ongoing projects by cutting capital budgets, starve infrastructure assets of recurrent expenditures for their maintenance and operation or simply monetize large primary deficits with the resultant macro-economic instability. A number of countries—including Kenya, Ethiopia, Nigeria and Ghana—have managed to roll over commercial debts through restructurings and lengthening maturities for modest increases in interest rates. Pressures for restructuring will be particularly high in 2020, when there is a concentration of maturing obligations across African countries (see Christensen and Schanz, 2018). On the other hand some countries are considering refinancing local currency debt with foreign currency debt to take advantage of lower interest rates for the latter. However, this opens up possibilities for reducing expected borrowing costs by swapping domestic-currency for foreign-currency claims, although this bargain can be treacherous in a situation of high exposure to distress. The second challenge relates to the plurality of creditors, which complicates coordination in the event of resolution and may make this process much more protracted. Issues of creditor coordination are arguably more daunting now than they were in the mid-1990s, reflecting the increasing importance of private creditors and the emergence of China—not a member of the Paris Club—as a major source of official finance. The third challenge relates to rollover risks in light of greater exposure to market-based external financing. Countries facing increased exposure to global market volatility require enhanced domestic capacity for real-time analysis of the drivers of exchange rates, global interest rates and risk premia. The context requires not only a capacity for active policy responses but more fundamentally an enhanced capacity to understand and interact with key market players including rating agencies. Ndulu and O’Connell end by suggesting a number of promising directions for AERC researchers. 4. Debt, growth and stability in Africa: speculative calculations and policy responses This paper attempts to answer three questions that are being asked with increasing urgency to avoid another debt crisis. The first is whether the increases in public debt-to-GDP ratios in Africa during the past decade are because of hard-won improvements in institutions and policies or because they were made temporarily creditworthy by HIPC programs and the MDRI. The second is whether African governments are prepared for the vagaries of private debt markets that tend to not discriminate—in good times and bad—between countries with Downloaded from https://academic.oup.com/jae/article/30/Supplement_1/i3/6395209 by DeepDyve user on 19 July 2022 Growing with Debt in African Economies i9 strong and weak economic fundamentals. The third question is whether the resolution of current crises on the subcontinent provides reassurance that a generalised crisis will not precipitate the sales of public assets and mortgaging of Africa’s natural resources. The authors find that the answer to all three questions is a ‘no’. Deverajan et al. then discuss what can be done given this outcome. They provide arguments in favour of three steps, ranging from the long term to immediate. The first is to treat commodity price increases as temporary shocks, not permanent changes—this rule applies to every country. The second is to address the cost of taxation in countries where the marginal cost of funds is high before applying a blanket policy of increasing domestic revenues to reduce the external debt burden. The third is to make sure that the maturity of loans matches the gestation periods of infrastructure investments; this is especially important for African countries that are becoming dependent on nontraditional lenders such as China and India. The paper concludes by raising a question and some speculations. First is that as African economies grow through to middle income, the contagion effect of debt distress or crisis could be severe compared to what has been experienced so far. If the larger economies in the subcontinent—Nigeria, South Africa, Angola, Sudan and Kenya—go into debt distress, the likelihood of a region-wide economic crisis will spike. The question is what SSA’s next debt crisis will look like. Will it look like Latin America’s fiscal crisis of the 1980s when indebted governments could not pay back their foreign creditors? Will it look like East Asia’s financial crisis in the 1990s when private borrowers could not pay back foreign lenders due to a sudden loss of confidence and precipitous devaluations? Will it look like Southern Europe in the 2000s when private borrowers and indebted governments brought down otherwise solvent lenders both at home and abroad? The paper speculate that Africa’s next crisis will be uniquely African. This is both because African economies are different in large measure because they depend more on natural resources than those in Asia and Europe and because the world today is not the same as it was even a decade ago. In the 2000s, Africa was a low-income region that depended on the largesses of high-income economies. Today, it is a middle-income region interdependent with the middle-income economies of East Asia, South Asia and Latin America. This will make both booms and busts different, in ways that have not been seen before. Finally, the dynamics of African debt will be a learning experience for policymakers and global market players. African policymakers can already witness the differences between how Chile managed its economy and what the Venezuelans have done to theirs. In the coming years, they—and investors around the world—will suddenly get to know a lot more about the differences between Africa’s 50 economies. Then it will no longer be necessary to remind foreigners that Africa is a continent, not a country. 5. Public debt accumulation in SSA: a looming debt crisis The paper notes that the pace of sovereign debt accumulation has increased substantially in SSA countries in recent years, raising concerns that it could bring back debt crises. It also notes that key drivers of debt build-up vary across countries and include exogenous shocks, weak fiscal management and macro-economic policy frameworks to support growth and changing composition of debt towards more expensive sources of financing and high levels of public Downloaded from https://academic.oup.com/jae/article/30/Supplement_1/i3/6395209 by DeepDyve user on 19 July 2022 i10 Njuguna Ndung’u et al. spending. The paper by Atingi-Ego et al. further discusses recent debt trends and evaluate performance of DSAs conducted in a sample of SSA countries over the period 2008–2016. Based on qualitative and quantitative analysis, the findings of the paper suggest existence of systematic optimism bias in past DSA vintages resulting from optimistic macro-economic projections that underpin DSAs. As a result, the DSAs for the sample countries analysed projected higher debt-carrying capacities, which in most cases lead to a faster pace of debt accumulation during this period. Moreover, he notes that this was not helped by the fact that average interest rates on new debt commitments were rising faster relative to GDP growth rates while the necessary fiscal adjustment to counter this development remained insufficient. Countercyclical policies supported by fiscal buffers that were used to address the impact of the 2008 global financial crisis have largely not been reversed despite the erosion of the buffers and a pick-up in growth in some countries. As a result, the overall risk of debt distress in the region has deteriorated in the last decade. Atingi-Ego et al. suggest the following key policy considerations drawn from study findings. First is that findings underscore the need for countries to adequately resource and strengthen capacity of key research departments and institutions for macro-economic modelling and forecasting. Countries should review capacity needs and secure appropriate technical assistance and training from a range of relevant technical assistance providers, including MEFMI, AERC, IMF and the World Bank. Second, countries need to continue reforming in terms of governance and the quality of institutions and policies as these are keys to strengthening debt-carrying capacity. Key considerations include putting measures such as fiscal responsibility rules and institutions that constrain policy discretion to promote sound fiscal policies. Third, recourse to market-based financing has increased countries’ exposure to market (fluctuations in exchange rate and interest rate risk) as well as refinancing risk and sudden shifts in market sentiment. Therefore, countries should consider use of active public debt management techniques such as liability management operations, including use of techniques such as buy backs from secondary market whenever opportunities arise, to manage these risks. Finally, countries should create an environment conducive to diversifying export growth. A diversified export base, with limited reliance on commodities that are subject to large price swings, is important in reducing the vulnerability of export receipts to commodity price shocks. 6. Improving tax compliance through good governance While debt expressed as a share of GDP is an indicator of solvency, it does not necessarily measure the ability of governments to service debt. An indicator that better reflects the capacity of governments to service public debt is the ratio of debt to revenue. For African countries, this indicator has been rising faster than the debt to GDP ratio as revenue collection has not been expanding proportionately with economic activities. Hence, for many African governments, fiscal sustainability critically depends among others on vigorous revenue collection, even more than expansion in GDP (see Figure 1). Attention often is focused on building state capacity to improve tax collection, which is important. The paper by Boly et al. analyses instead the perceptions of citizens regarding tax compliance, which ultimately determines the magnitude of revenue to be mobilised. Downloaded from https://academic.oup.com/jae/article/30/Supplement_1/i3/6395209 by DeepDyve user on 19 July 2022 Growing with Debt in African Economies i11 Figure 1: Trends in External Debt as a Share of Government Revenue The findings based on data obtained from Afrobarometer that covered about 36 countries in two rounds that surveyed over hundred thousand individuals indicated that 26% do not believe they should pay taxes to the government with significant variation across countries and 27% declined or refused to pay taxes in the fiscal year the survey was conducted. In some countries these figures were over 45%, while the highest compliance rate was recorded in countries such as Tunisia with comparable rate of 10% of the sample who failed to pay taxes. One of the reasons documented in the paper for low compliance was high perception of corruption within the government system that included the office of the head of the state, government officials in general and those of tax officials. It is possible that non-compliance is not entirely due to perception of bad governance. Self-interest veiled under the guise of corruption, and low level of enforcement by tax authorities, could also be an important factor for high incidence of noncompliance. To address this potential confounding factor that also includes reverse causality from low compliance to low capacity of tax authorities to control corruption, the paper used an Instrumental Variable (IV) strategy. The estimate based on an IV approach suggest that high perception of corruption of the tax authorities could reduce tax compliance by as much as 35%, which is very large and suggestive of significant structural problem in the relationship between tax authorities and tax payers. 7. Concluding remarks The four papers presented at the AERC June 2019 Plenary Session on ‘Growing with Debt in African Economies: Options, Challenges and Pitfalls’ have tackled several issues relating to the theme of the plenary. The studies show all African countries experienced an increase in public debt and change in its nature with a number of countries now classified by the World Bank and IMF as being at high risk of debt distress. In particular, the pace of sovereign Downloaded from https://academic.oup.com/jae/article/30/Supplement_1/i3/6395209 by DeepDyve user on 19 July 2022 i12 Njuguna Ndung’u et al. debt accumulation has increased substantially in SSA countries in recent years with the main drivers of debt build-up varying across countries. Some of the key findings from the studies are as follows: First, it is the existence of systematic optimism bias in past DSA vintages resulting from optimistic macro-economic projections led to projected higher debt-carrying capacities hence faster pace of debt accumu- lations. This is compounded by the fact that average interest rates on new debt commitments are rising faster relative to GDP growth rates while the necessary fiscal adjustment to counter this development remained insufficient. As a result, the overall risk of debt distress in the region has deteriorated in the past decade. Second, the speed of debt matters and that monitoring the speed of debt could alter the path of debt to more sustainable debt levels. Also, sustainability can be achieved when debt is used to fuel capital accumulation and income convergence, even in the absence of explicit government reaction functions to higher debt burdens. Third, there is heterogeneity in country debt acquisition and policies to ensure sustainable debt need to be country specific. Fourth, development assets are at risk—including advances in human capital and infras- tructure and an improved investment environment—if challenges associated debt are not well managed and that preserving and enhancing these assets should be a central objective of domestic policy actions, preventative debt restructurings and institutional approaches to debt distress. Fifth, preventive measures that involve full transparency in debt accounting, greater realism in growth forecasts and diligence in matching the region’s seemingly limitless public investment needs with weak public sector capacity to manage infrastructure investments should be encouraged so as to avoid another debt crisis. The studies recommend that strengthening of analytical/research work on country macro- economic projections underlying their DSAs, relationship between investment and growth, impact of natural disasters on DSA frameworks and quantifying and monitoring fiscal risks would be important pieces of work in leveraging DSA results for financing and policy decisions. They also recommend capacity building to enhance quality of policies, transparency and accountability at institutional level; managing roll over risk; and developing and implementing sound debt management strategies. The paper presented at the AERC December 2017 Plenary Session complemented the above papers by presenting evidence on governance systems that impede tax mobilisation efforts that are not only critical for maintaining liquidity position of governments to service public debt, but also help reduce reliance on borrowing to finance development. African governments can enhance tax mobilisation by building the trust of citizens on government institutions by taking credible measures to fight corruption and improve the quality and quantity of provision of public services equitably across all dimensions including security, justice, education, health and other public goods. Funding African Economic Research Consortium (AERC), Kilimani Jakaya Kikwete Road East Bank Tower Building, Nairobi, Kenya. Downloaded from https://academic.oup.com/jae/article/30/Supplement_1/i3/6395209 by DeepDyve user on 19 July 2022 Growing with Debt in African Economies i13 References African Development Bank (2020) ‘State and dynamics of debt in Africa’, memo. African Development Bank (2021) African Economic Outlook 2021: From Debt Resolution to Growth: The Road Ahead for Africa. Côte d’Ivoire: African Development Bank Group. Christensen B., Schanz J. (2018) ‘Central banks and debt: emerging risks to the effectiveness of monetary policy in Africa?’ BIS Papers No. 99, October. ECA (2019) Economic Report on Africa: Fiscal Policy for Financing Sustainable Development in Africa. Addis Ababa: ECA. International Monetary Fund (2015) Policy Papers. Washington DC: IMF. International Monetary Fund (2018) Sovereign Debt: A Guide for Economists and Practitioners. Washington D.C.: IMF. UNCTAD (2018) Debt Vulnerabilities in Developing Countries: A New Debt Trap. Geneva: UNCTAD. https://unctad.org/en/PublicationsLibrary/gdsmdp2017d4v1_en.pdf. World Bank (2018) Debt Vulnerabilities in IDA Countries. IDA, staff paper. http://www.deepdyve.com/assets/images/DeepDyve-Logo-lg.png Journal of African Economies Oxford University Press

Growing with Debt in African Economies: Options, Challenges and Pitfalls

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Downloaded from https://academic.oup.com/jae/article/30/Supplement_1/i3/6395209 by DeepDyve user on 19 July 2022 JournalofAfricanEconomies, 2021, Vol. 30, AERC Supplement 1, i3–i13 doi: 10.1093/jae/ejab019 Article Growing with Debt in African Economies: Options, Challenges and Pitfalls Njuguna Ndung’u, Abebe Shimeles and Damiano K. Manda African Economic Research Consortium (AERC), Kilimani Jakaya Kikwete Road, East Bank Tower Building, Nairobi, Kenya Corresponding author: Abebe Shimeles. E-mail: abebe.shimeles@aercafrica.org 1. Introduction The public debt in Africa started to increase sharply again after 2013 in the wake of the commodity price boom, reversing the gains from the heavily indebted poor countries (HIPCs) initiative. Almost all African countries experienced both an increase and change in the composition of public debt. The shift away from concessionary to market-based loans from private institutions further aggravated the debt burden due to high interest rate and short maturity period. In the aftermath of significant debt cancellation provided to 30 Sub-Saharan African (SSA) countries in the context of the HIPCs and the Multilateral Debt Relief Initiative (MDRI) in the early- to mid-2000s, the median public debt-to-GDP ratio fell from 85.3% in 2001 to 34.3% in 2011. These initiatives, together with resilient growth and improved solvency, provided an additional space for new borrowing. Despite these developments, recent trends show that countries have taken up more debt, driving the median public debt-to-GDP ratio to about 58% by 2019. The advent of the Covid-19 pandemic further accelerated the debt burden across Africa where the median debt-to-GDP ratio is expected to reach close to 70% (African Development Bank, 2021). By contrast with the debt crisis of the 1980s and 1990s, sustain- ability concerns are not region-wide (IMF, 2018; African Development Bank, 2020). Fiscal policies are, however, under pressure as many countries across the region contend with ele- vated interest burdens and continued weakness in commodity export markets. The Covid-19 pandemic further caused significant recession with estimated real GDP growth of −2% in 2020 for Africa with a resultant deterioration of the primary budget deficit from about 1.5% in 2019 to 3.5%, which is significant (African Development Bank, 2021). While external debt burden indicators are still below levels that triggered debt distress in most countries in the earlier periods, risks of a renewed cycle of debt crises and economic © The Author(s) 2021. Published by Oxford University Press on behalf of the Centre for the Study of African Economies. This is an Open Access article distributed under the terms of the Creative Commons Attribution License (http:// creativecommons.org/licenses/by/4.0/), which permits unrestricted reuse, distribution, and reproduction in any medium, provided the original work is properly cited. Downloaded from https://academic.oup.com/jae/article/30/Supplement_1/i3/6395209 by DeepDyve user on 19 July 2022 i4 Njuguna Ndung’u et al. Table 1: Selected Covariates of External Debt (% of GDP) in Africa (5-year average for 1990–2018) Low-income countries Africa Real per capita GDP growth −2.115∗∗∗ −9.850∗∗∗ (0.001) (0.000) Terms of trade (index) −0.0217 −0.255∗ (0.795) (0.042) Tax revenue (% of GDP) −0.275∗−1.184∗∗∗ (0.036) (0.000) Current account balance (% of GDP) −2.471∗∗∗ −2.374∗∗∗ (0.000) (0.000) Gross savings (% of GDP) −0.482∗−0.0179 (0.012) (0.959) Constant 63.61∗∗∗ 89.99∗∗∗ (0.000) (0.000) Number of observations 1928 667 Adj. R-sq 0.175 0.257 Note: Table 1 reports pooled regression of external debt as % of GDP for the period 1960–2018 on selected covariates, which were averaged over five period intervals with robust statistics. Source: authors’ computations based on data from World Economic Outlook (various issues), IMF. p < 0.05. ∗∗ p < 0.01. ∗∗∗ p < 0.001. disruption are growing, with several countries’ risk of external debt distress deteriorating, particularly in the wake of the COVID-19 pandemic. For instance, out of the 36 Poverty Reduction and Growth Trust (PRGT)-eligible SSA countries for which debt sustainability analyses (DSAs) were conducted between 2008 and 2018, 44% (or 16) were classified as either ‘in debt distress’ or facing ‘high risk’ of debt distress in 2018, from 31% (or 11) in such categories at the end of 2011 to 56% (or 20), which was conducted in 2020, partly driven by the COVID-19 pandemic. The main drivers of debt build-up, however, vary across countries and include exogenous shocks, weak fiscal management and macro- economic policy frameworks to support growth; changing composition of debt towards more expensive sources of financing; and high levels of public spending among other factors (World Bank 2018; African Development Bank, 2021). Table 1 presents the magnitude of the long-term association between external debt (% of GDP) and its close correlates for African and low-income countries for the period 1990–2018. Results suggest trade shocks (captured through terms of trade shocks), growth in real per capita GDP, current account deficits and tax mobilisation efforts play a significant role in the variation of external debt situation in Africa. Economic fundamentals, such as real per capita GDP growth, external balance and government capacity to mobilise revenue, explain over 80% of the variation in external debt due to observed factors reported in Table 1. 1 A country is in debt distress when it is struggling to service its debt, as demonstrated by accumulation of arrears or the restructuring of its debt. https://www.imf.org/external/Pubs/ft/dsa/DSAlist.pdf Downloaded from https://academic.oup.com/jae/article/30/Supplement_1/i3/6395209 by DeepDyve user on 19 July 2022 Growing with Debt in African Economies i5 Against this background, this special issue combines four papers presented during the June 2019 Plenary Session of the African Economic Research Consortium (AERC) biannual research workshop held in Cape Town, South Africa, on the theme ‘Growing with Debt in African Economies: Options, Challenges and Pitfalls’ and a fifth paper featured in the December 2017 Biannual under the theme ‘Governance for Development in Africa’. The first paper by Vera Songwe and Christine Awiti on ‘African Countries’ Debt: A Tale of Acceleration at Multiple Speeds and Shades’ propose a novel approach to monitor debt burden and argues that, instead of the levels, what matters is the speed of debt accumulation that could determine the path of debt to more sustainable debt levels. They also find that there is heterogeneity in country debt accumulation and that policies to ensure sustainable debt will need to be country specific. The second paper by Benno J. Ndulu and Stephen A. O’Connell on ‘Africa’s Development Debts’ notes that the debt management challenges that are now emerging for borrowers and lenders differ in important ways from those of the past. They argue in the paper that development assets are at risk—including advances in human capital and infrastructure and an improved investment environment—if these challenges are not managed well. They further note that preserving and enhancing these assets should be a central objective of domestic policy actions, inhibitory debt restructurings and institutional approaches to debt distress. The third paper on ‘Debt, Growth and Stability in Africa: Speculative Calculations and Policy Responses’ by Shantayanan Devarajan, Indermit Gill and Kenan Karakülah attempts to answer three questions that are being asked with increasing urgency to avoid another debt crisis. The first question: has the quality of institutions and policies of African countries, critical to sustaining higher levels of debt, improved since the debt relief of the early 2000s? Second, will debt markets get to know emerging Africa well enough before the next crisis? Third, have the resolutions of recent defaults in Africa been orderly so that debtor governments are not herded into traps set by foreign creditors? Their analysis suggest that the answer to all three questions is a ‘no’. The paper recommends preventive measures that involve full transparency in debt accounting, greater realism in growth forecasts and diligence in matching the region’s seemingly limitless public investment needs with weak public sector capacity to manage infrastructure investments to avoid another debt crisis. The fourth paper by Michael Atingi-Ego, Sayed Timuno and Tiviniton Makuve on ‘Public Debt Accumulation in SSA: A Looming Debt Crisis’ discusses recent debt trends and evaluates performance of DSA conducted in a sample of SSA countries over the period 2008–2016 to provide insights on risk of debt distress in SSA. The paper finds the existence of systematic optimism bias in past DSA vintages resulting from optimistic macro-economic projections that underpin the DSAs. As a result, the DSAs for the sample countries analysed projected higher debt-carrying capacities, which in most cases led to a faster pace of debt accumulation during this period. This was compounded by the fact that average interest rates on new debt commitments were rising faster relative to GDP growth rates while the necessary fiscal adjustment to counter this development remained insufficient. The fifth paper by Amdou Boly, Maty Konte and Abebe Shimeles on ‘Corruption Perception and Attitude Towards Taxation in Africa’ presented at the 47th Plenary Session complements the above papers by providing compelling evidence on the role of widespread perception of corruption among Africans in the mobilisation of taxes, which as shown in Table 1 plays a critical role in managing debt burden. Downloaded from https://academic.oup.com/jae/article/30/Supplement_1/i3/6395209 by DeepDyve user on 19 July 2022 i6 Njuguna Ndung’u et al. 2. African countries’ debt: a tale of acceleration at multiple speeds and shades The first paper by Songwe and Awiti focuses on debt sustainability for African countries. It begins with an analysis of the debt path for Africa in general and then for specific countries. Debt in African countries rose over the past few years, but the growth rate in the 5 years to 2018 was fast paced at an average of 9.3% in Africa. Songwe and Awiti argue that monitoring of debt through speed of debt, and thereafter adjusting structural indicators accordingly, can strengthen debt sustainability for African countries. They note that debt paths are not homogenous and that different countries follow different paths. Therefore, policies for debt sustainability should be applied on a country by country basis. The paper notes that other than the IMF/World Bank, and now the China Road and Belt Initiative Countries Debt Sustainability Frameworks, most debt monitoring is carried out through debt level thresholds. However, rather than monitor debt levels, focus should be on monitoring the speed of growth of debt, which can be instrumental in informing authorities how quickly they are approaching debt level thresholds and if borrowing is sustainable. While the speed of debt indicates whether borrowing is heading towards unsustainable levels, adjusting for structural indicators can steer debt back into a more sustainable path. Songwe and Awiti suggest a two-step approach that can be utilised by policy makers to monitor debt and then make adjustments, if need be, to ensure sustainability. First is keeping track of the speed of growth of debt and ensuring growth remains below 5% per annum. In countries where debt grew at less than 5% in 2018 such as in Guinea, Lesotho, Madagascar and Tanzania, debt levels remained below 40%. Second, where growth exceeds 5%, then adjustments to structural indicators can be adopted such as (a) a reduction in the flow of debt is desirable, that is, fiscal deficit can either be lower, or countries can adjust to have fiscal surpluses; (b) countries should negotiate for the most favourable borrowing conditions, that is, debt tenor should be long while interest rates should be as low as possible; and (c) promote policies that encourage exports to earn foreign currency, or alternatively, issue local currency bonds. The paper observes that such corrective measures are easier to put in place with an early warning system. Songwe and Awiti propose an early warning system for debt accumulation that should allow policy makers to put in place corrective measures before the situation becomes one of debt distress. Under the corrective framework, governments have more flexibility on the policy options to be adopted and can chose between a wider variety of fiscal policy options from working to increase tax revenues, adoption of counter cyclical measures to create buffers, implement and abide to strict fiscal rules to correct the acceleration of debt. Further, managing the cost of debt can strengthen debt sustainability for African countries. Songwe and Awiti give the following example to illustrate this: First they observe that Zambia issued a Eurobond in 2014 at a yield of 8.625%, 3 percentage points higher than its bond issuance in 2012, for an amount 30% higher (IMF, 2015). In the 3 years following the bond issue, Zambia’s interest rate payment grew by about 46%. Similarly, for Kenya and Ghana that issued about four Eurobonds between 2013 and 2018, interest payment made up almost half of the fiscal balance. Hence, lower cost of debt reduces fiscal pressures and strengthens debt sustainability. Downloaded from https://academic.oup.com/jae/article/30/Supplement_1/i3/6395209 by DeepDyve user on 19 July 2022 Growing with Debt in African Economies i7 According to the paper, the conditions of debt also matter. Cost and tenor of debt matter for economic growth. Government investment in public infrastructure ease supply side constraints and crowds in private sector investments. However, high cost of debt and short maturity periods lead to unsustainable debt where return on investments takes longer to be realised. For instance, Ethiopia borrowed externally to invest in export processing zones that were expected to increase the supply of foreign currency to repay debt. However, export growth has been slower than expected leading to exchange rate pressures, that could lead to more expensive debt in the future. Further, the paper notes that legislation that encourages greater transparency of contracts such as digitalisation and publication of procurement processes could increase the efficiency of use of public funds. This can lead to significant benefits derived from borrowing. Also, transparency in debt reporting, including timelines for debt issues, could ensure more efficiency in the use of debt as well as strengthen the development of local markets. Finally, the paper observes that for debt to remain sustainable, African countries must enhance revenue mobilisation. The Africa region has on average one of the lowest revenue to GDP ratios. There is scope for increase in revenue of up to 20% of GDP (Economic Report on Africa, 2019). Increase in revenue collection means lower fiscal deficit and leads to lower growth rates of debt. Thus, debt monitoring tools such as the speed of debt create an early warning system, with room to mitigate any challenges before debt becomes unsustainable. 3. Africa’s development debts The paper by Ndulu and O’Connell observes that the debt management challenges that are now emerging for borrowers and lenders differ in important ways from those of the past. They argue in the paper that development assets are at risk—including advances in human capital and infrastructure and an improved investment environment—if these challenges are not managed well. They further note that preserving and enhancing these assets should be a central objective of domestic policy actions, preventative debt restructurings and institutional approaches to debt distress. Ndulu and O’Connell note that in contrast with the debt crisis of the 1980s and 1990s, debt-sustainability concerns are not region wide in SSA and the policy environment for growth remains robust. They further observe that a long period of favourable borrowing conditions has nonetheless come to an end, with interest rates now exceeding underlying growth rates at the margin in most countries and commercial creditors increasingly sensitive to rollover risks on debts issued to date. The pace of new borrowing also appears to have declined very recently, reflecting unavoidable fiscal adjustments to a significantly more difficult borrowing environment. However, there are substantial risks associated with the stock of debt build-up over the past decade. The paper argues that Africa’s last debt crisis, finally resolved after two decades of bilateral and ultimately multilateral debt relief, is an imperfect model for resolving future debt crises. Recently accumulated debts are not only shorter term but also predominantly from commer- cial sources and new official donors and are subject to more volatile market interest rates and sentiments, as well as to new challenges of creditor coordination. Fundamentally, there are development assets at stake after two decades of investment and growth, including hard- fought improvements in policy environment and institutions, major public infrastructure Downloaded from https://academic.oup.com/jae/article/30/Supplement_1/i3/6395209 by DeepDyve user on 19 July 2022 i8 Njuguna Ndung’u et al. projects nearing fruition and cumulative increases in human capital formation that in most countries continue to await a transformative response of private investment. Ndulu and O’Connell observe that compositional changes in debt and significant shifts in the composition of creditors require countries to enhance their own debt-management capabilities, particularly as a number of them are set to graduate from IDA. This need to be more consciously embraced in multilateral country programs, with a view to incorporating capacity-building programs that pay attention to the expansion of external market-based financing and that are capable of operating in a multi-creditor environment. The IMF’s multi- pronged approach to debt management is key to this transition. The paper notes three main challenges that SSA countries have still to contend with in the context of elevated debt. The first concerns those countries already under stress from debt obligations that are maturing ahead of the revenue streams from the infrastructure investments (physical and social) they financed. The challenge here is to address maturity mismatches without recourse to destructive adjustment patterns that compromise ongoing projects by cutting capital budgets, starve infrastructure assets of recurrent expenditures for their maintenance and operation or simply monetize large primary deficits with the resultant macro-economic instability. A number of countries—including Kenya, Ethiopia, Nigeria and Ghana—have managed to roll over commercial debts through restructurings and lengthening maturities for modest increases in interest rates. Pressures for restructuring will be particularly high in 2020, when there is a concentration of maturing obligations across African countries (see Christensen and Schanz, 2018). On the other hand some countries are considering refinancing local currency debt with foreign currency debt to take advantage of lower interest rates for the latter. However, this opens up possibilities for reducing expected borrowing costs by swapping domestic-currency for foreign-currency claims, although this bargain can be treacherous in a situation of high exposure to distress. The second challenge relates to the plurality of creditors, which complicates coordination in the event of resolution and may make this process much more protracted. Issues of creditor coordination are arguably more daunting now than they were in the mid-1990s, reflecting the increasing importance of private creditors and the emergence of China—not a member of the Paris Club—as a major source of official finance. The third challenge relates to rollover risks in light of greater exposure to market-based external financing. Countries facing increased exposure to global market volatility require enhanced domestic capacity for real-time analysis of the drivers of exchange rates, global interest rates and risk premia. The context requires not only a capacity for active policy responses but more fundamentally an enhanced capacity to understand and interact with key market players including rating agencies. Ndulu and O’Connell end by suggesting a number of promising directions for AERC researchers. 4. Debt, growth and stability in Africa: speculative calculations and policy responses This paper attempts to answer three questions that are being asked with increasing urgency to avoid another debt crisis. The first is whether the increases in public debt-to-GDP ratios in Africa during the past decade are because of hard-won improvements in institutions and policies or because they were made temporarily creditworthy by HIPC programs and the MDRI. The second is whether African governments are prepared for the vagaries of private debt markets that tend to not discriminate—in good times and bad—between countries with Downloaded from https://academic.oup.com/jae/article/30/Supplement_1/i3/6395209 by DeepDyve user on 19 July 2022 Growing with Debt in African Economies i9 strong and weak economic fundamentals. The third question is whether the resolution of current crises on the subcontinent provides reassurance that a generalised crisis will not precipitate the sales of public assets and mortgaging of Africa’s natural resources. The authors find that the answer to all three questions is a ‘no’. Deverajan et al. then discuss what can be done given this outcome. They provide arguments in favour of three steps, ranging from the long term to immediate. The first is to treat commodity price increases as temporary shocks, not permanent changes—this rule applies to every country. The second is to address the cost of taxation in countries where the marginal cost of funds is high before applying a blanket policy of increasing domestic revenues to reduce the external debt burden. The third is to make sure that the maturity of loans matches the gestation periods of infrastructure investments; this is especially important for African countries that are becoming dependent on nontraditional lenders such as China and India. The paper concludes by raising a question and some speculations. First is that as African economies grow through to middle income, the contagion effect of debt distress or crisis could be severe compared to what has been experienced so far. If the larger economies in the subcontinent—Nigeria, South Africa, Angola, Sudan and Kenya—go into debt distress, the likelihood of a region-wide economic crisis will spike. The question is what SSA’s next debt crisis will look like. Will it look like Latin America’s fiscal crisis of the 1980s when indebted governments could not pay back their foreign creditors? Will it look like East Asia’s financial crisis in the 1990s when private borrowers could not pay back foreign lenders due to a sudden loss of confidence and precipitous devaluations? Will it look like Southern Europe in the 2000s when private borrowers and indebted governments brought down otherwise solvent lenders both at home and abroad? The paper speculate that Africa’s next crisis will be uniquely African. This is both because African economies are different in large measure because they depend more on natural resources than those in Asia and Europe and because the world today is not the same as it was even a decade ago. In the 2000s, Africa was a low-income region that depended on the largesses of high-income economies. Today, it is a middle-income region interdependent with the middle-income economies of East Asia, South Asia and Latin America. This will make both booms and busts different, in ways that have not been seen before. Finally, the dynamics of African debt will be a learning experience for policymakers and global market players. African policymakers can already witness the differences between how Chile managed its economy and what the Venezuelans have done to theirs. In the coming years, they—and investors around the world—will suddenly get to know a lot more about the differences between Africa’s 50 economies. Then it will no longer be necessary to remind foreigners that Africa is a continent, not a country. 5. Public debt accumulation in SSA: a looming debt crisis The paper notes that the pace of sovereign debt accumulation has increased substantially in SSA countries in recent years, raising concerns that it could bring back debt crises. It also notes that key drivers of debt build-up vary across countries and include exogenous shocks, weak fiscal management and macro-economic policy frameworks to support growth and changing composition of debt towards more expensive sources of financing and high levels of public Downloaded from https://academic.oup.com/jae/article/30/Supplement_1/i3/6395209 by DeepDyve user on 19 July 2022 i10 Njuguna Ndung’u et al. spending. The paper by Atingi-Ego et al. further discusses recent debt trends and evaluate performance of DSAs conducted in a sample of SSA countries over the period 2008–2016. Based on qualitative and quantitative analysis, the findings of the paper suggest existence of systematic optimism bias in past DSA vintages resulting from optimistic macro-economic projections that underpin DSAs. As a result, the DSAs for the sample countries analysed projected higher debt-carrying capacities, which in most cases lead to a faster pace of debt accumulation during this period. Moreover, he notes that this was not helped by the fact that average interest rates on new debt commitments were rising faster relative to GDP growth rates while the necessary fiscal adjustment to counter this development remained insufficient. Countercyclical policies supported by fiscal buffers that were used to address the impact of the 2008 global financial crisis have largely not been reversed despite the erosion of the buffers and a pick-up in growth in some countries. As a result, the overall risk of debt distress in the region has deteriorated in the last decade. Atingi-Ego et al. suggest the following key policy considerations drawn from study findings. First is that findings underscore the need for countries to adequately resource and strengthen capacity of key research departments and institutions for macro-economic modelling and forecasting. Countries should review capacity needs and secure appropriate technical assistance and training from a range of relevant technical assistance providers, including MEFMI, AERC, IMF and the World Bank. Second, countries need to continue reforming in terms of governance and the quality of institutions and policies as these are keys to strengthening debt-carrying capacity. Key considerations include putting measures such as fiscal responsibility rules and institutions that constrain policy discretion to promote sound fiscal policies. Third, recourse to market-based financing has increased countries’ exposure to market (fluctuations in exchange rate and interest rate risk) as well as refinancing risk and sudden shifts in market sentiment. Therefore, countries should consider use of active public debt management techniques such as liability management operations, including use of techniques such as buy backs from secondary market whenever opportunities arise, to manage these risks. Finally, countries should create an environment conducive to diversifying export growth. A diversified export base, with limited reliance on commodities that are subject to large price swings, is important in reducing the vulnerability of export receipts to commodity price shocks. 6. Improving tax compliance through good governance While debt expressed as a share of GDP is an indicator of solvency, it does not necessarily measure the ability of governments to service debt. An indicator that better reflects the capacity of governments to service public debt is the ratio of debt to revenue. For African countries, this indicator has been rising faster than the debt to GDP ratio as revenue collection has not been expanding proportionately with economic activities. Hence, for many African governments, fiscal sustainability critically depends among others on vigorous revenue collection, even more than expansion in GDP (see Figure 1). Attention often is focused on building state capacity to improve tax collection, which is important. The paper by Boly et al. analyses instead the perceptions of citizens regarding tax compliance, which ultimately determines the magnitude of revenue to be mobilised. Downloaded from https://academic.oup.com/jae/article/30/Supplement_1/i3/6395209 by DeepDyve user on 19 July 2022 Growing with Debt in African Economies i11 Figure 1: Trends in External Debt as a Share of Government Revenue The findings based on data obtained from Afrobarometer that covered about 36 countries in two rounds that surveyed over hundred thousand individuals indicated that 26% do not believe they should pay taxes to the government with significant variation across countries and 27% declined or refused to pay taxes in the fiscal year the survey was conducted. In some countries these figures were over 45%, while the highest compliance rate was recorded in countries such as Tunisia with comparable rate of 10% of the sample who failed to pay taxes. One of the reasons documented in the paper for low compliance was high perception of corruption within the government system that included the office of the head of the state, government officials in general and those of tax officials. It is possible that non-compliance is not entirely due to perception of bad governance. Self-interest veiled under the guise of corruption, and low level of enforcement by tax authorities, could also be an important factor for high incidence of noncompliance. To address this potential confounding factor that also includes reverse causality from low compliance to low capacity of tax authorities to control corruption, the paper used an Instrumental Variable (IV) strategy. The estimate based on an IV approach suggest that high perception of corruption of the tax authorities could reduce tax compliance by as much as 35%, which is very large and suggestive of significant structural problem in the relationship between tax authorities and tax payers. 7. Concluding remarks The four papers presented at the AERC June 2019 Plenary Session on ‘Growing with Debt in African Economies: Options, Challenges and Pitfalls’ have tackled several issues relating to the theme of the plenary. The studies show all African countries experienced an increase in public debt and change in its nature with a number of countries now classified by the World Bank and IMF as being at high risk of debt distress. In particular, the pace of sovereign Downloaded from https://academic.oup.com/jae/article/30/Supplement_1/i3/6395209 by DeepDyve user on 19 July 2022 i12 Njuguna Ndung’u et al. debt accumulation has increased substantially in SSA countries in recent years with the main drivers of debt build-up varying across countries. Some of the key findings from the studies are as follows: First, it is the existence of systematic optimism bias in past DSA vintages resulting from optimistic macro-economic projections led to projected higher debt-carrying capacities hence faster pace of debt accumu- lations. This is compounded by the fact that average interest rates on new debt commitments are rising faster relative to GDP growth rates while the necessary fiscal adjustment to counter this development remained insufficient. As a result, the overall risk of debt distress in the region has deteriorated in the past decade. Second, the speed of debt matters and that monitoring the speed of debt could alter the path of debt to more sustainable debt levels. Also, sustainability can be achieved when debt is used to fuel capital accumulation and income convergence, even in the absence of explicit government reaction functions to higher debt burdens. Third, there is heterogeneity in country debt acquisition and policies to ensure sustainable debt need to be country specific. Fourth, development assets are at risk—including advances in human capital and infras- tructure and an improved investment environment—if challenges associated debt are not well managed and that preserving and enhancing these assets should be a central objective of domestic policy actions, preventative debt restructurings and institutional approaches to debt distress. Fifth, preventive measures that involve full transparency in debt accounting, greater realism in growth forecasts and diligence in matching the region’s seemingly limitless public investment needs with weak public sector capacity to manage infrastructure investments should be encouraged so as to avoid another debt crisis. The studies recommend that strengthening of analytical/research work on country macro- economic projections underlying their DSAs, relationship between investment and growth, impact of natural disasters on DSA frameworks and quantifying and monitoring fiscal risks would be important pieces of work in leveraging DSA results for financing and policy decisions. They also recommend capacity building to enhance quality of policies, transparency and accountability at institutional level; managing roll over risk; and developing and implementing sound debt management strategies. The paper presented at the AERC December 2017 Plenary Session complemented the above papers by presenting evidence on governance systems that impede tax mobilisation efforts that are not only critical for maintaining liquidity position of governments to service public debt, but also help reduce reliance on borrowing to finance development. African governments can enhance tax mobilisation by building the trust of citizens on government institutions by taking credible measures to fight corruption and improve the quality and quantity of provision of public services equitably across all dimensions including security, justice, education, health and other public goods. Funding African Economic Research Consortium (AERC), Kilimani Jakaya Kikwete Road East Bank Tower Building, Nairobi, Kenya. Downloaded from https://academic.oup.com/jae/article/30/Supplement_1/i3/6395209 by DeepDyve user on 19 July 2022 Growing with Debt in African Economies i13 References African Development Bank (2020) ‘State and dynamics of debt in Africa’, memo. African Development Bank (2021) African Economic Outlook 2021: From Debt Resolution to Growth: The Road Ahead for Africa. Côte d’Ivoire: African Development Bank Group. Christensen B., Schanz J. (2018) ‘Central banks and debt: emerging risks to the effectiveness of monetary policy in Africa?’ BIS Papers No. 99, October. ECA (2019) Economic Report on Africa: Fiscal Policy for Financing Sustainable Development in Africa. Addis Ababa: ECA. International Monetary Fund (2015) Policy Papers. Washington DC: IMF. International Monetary Fund (2018) Sovereign Debt: A Guide for Economists and Practitioners. Washington D.C.: IMF. UNCTAD (2018) Debt Vulnerabilities in Developing Countries: A New Debt Trap. Geneva: UNCTAD. https://unctad.org/en/PublicationsLibrary/gdsmdp2017d4v1_en.pdf. World Bank (2018) Debt Vulnerabilities in IDA Countries. IDA, staff paper.

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Journal of African Economies – Oxford University Press

Published: Nov 8, 2021

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