The external debt crisis in Africa – Results and implications: Africa needs debt to finance its infrastructure and reduce the human development deficit. The rate and costs of this debt are weighing on the continent, especially in the wake of the Covid-19 crisis.

The external debt crisis in Africa – Results and implications

Africa needs debt to finance its infrastructure and reduce the human development deficit. The rate and costs of this debt are weighing on the continent, especially in the wake of the Covid-19 crisis.

African countries have incurred external debt at a rapid pace over the past decade, taking advantage of the abundance of low-cost international credit to support their budgets and balance of payments to help drive their development plans.

Total external debt held in Africa – debt owed by public and private sector entities and owed to foreign lenders – has surpassed US$1 trillion, with associated annual servicing costs crossing the US$100 billion threshold for the first time in 2021.

According to our data, external debt remains highly concentrated in Africa, with only nine countries holding two-thirds of the region’s total external debt in 2021: South Africa (holds 15% of Africa’s total external debt), Egypt (13%), Nigeria (7%), Angola (7%), Morocco (6%), Sudan (6%), Tunisia (4%), Kenya (4%), Zambia (4%).

The external debt crisis in Africa – Results and implications:

Countries weighing down the continent’s overall debt

Despite rapidly rising debt levels since 2011-2012, Africa’s average external debt-to-GDP ratio remains relatively low at 41% at the end of 2021 – about two-thirds of all African countries had a lower external debt-to-GDP ratio. This group includes regional powerhouses Angola, Egypt, Nigeria, Morocco, Kenya and South Africa.

However, 10 African countries have external debts that exceeded 75% of national GDP at the end of 2021: Angola, Djibouti, Mozambique, Rwanda, Sudan, Tunisia and Zambia, as well as island states; Cape Verde, Mauritius and Seychelles.

Most of these highly indebted countries have maintained high debt-to-GDP ratios for an extended period, while Mauritania, Namibia, and Senegal have been hovering around the 75 percent debt-to-GDP threshold for some time.

Uncomfortably high and rising debt service costs

The external debt crisis in Africa – Results and implications

External debt service has become a much bigger problem for Africa in recent years. On average, the region spent the equivalent of 15 percent of its foreign exchange earnings – measured as a mix of export earnings from goods and services, combined with primary income inflows and workers’ remittances – on external debt service in 2021.

This has kept the debt service ratio-a key measure of debt sustainability-on an upward trajectory since 2011, and the ratio for 2021 was the highest in over two decades.

Currently, about one-fifth of the continent spends 20 percent or more of its foreign exchange earnings on external debt service, and this burden is much higher for a few highly indebted countries, namely Mozambique, Namibia, and Sudan.

Strong pressure on public finances

African governments have accumulated huge stocks of debt that include a mix of domestic and external debt, while Africa has generated some of the highest interest bills in the world associated with external debt.

Approximately 15 to 20 African governments have set aside the equivalent of 20 percent or more of their annual revenues to service external debt to the public sector in 2021.

The pressure of external debt service on public finances is evident in the highly indebted states of Angola, Sudan, Tunisia, and Zambia, which rank uncomfortably high among a longer list of countries, including Cameroon, Chad, Djibouti, Ghana, Mauritania, Mozambique, and Senegal. The heavy debt burden on public finances will continue to undermine the ability to channel funds to economic and social development projects and the capacity to withstand external shocks.

More difficult financing conditions

High levels of external debt, heavy external debt service burdens, and strained public financing are likely to become a significant problem in the coming years in Africa and for selected African countries. This reflects a variety of factors, including weaker economic growth prospects and fiscal space, the prospect of higher borrowing costs and currency depreciation, the prospect of large debt repayments, less temporary G-20 debt relief, and even more restricted access to international capital.

Economic recovery is threatened by supply chain disruptions and inflationary pressures resulting from the lingering effects of the COVID-19 pandemic, the war in Ukraine, and successive spikes in food and energy prices. In addition, the region may see less elastic external demand and less financing from key markets and investment partners, notably Europe and China.

Most countries, including all major and most indebted countries, are expected to experience modest growth rates through 2026, meaning that increasing national income to relieve external debt pressures will not be a viable option for most countries.

The cycle of tightening monetary policy and increasing costs

Western central banks have embarked on a cycle of monetary tightening to combat the threat of inflation, which will increase the cost of borrowing and reduce the availability of financing for some African countries.

The Economic Information Unit of the British magazine “The Economist” expects the Federal Reserve (the U.S. central bank) to raise the main policy interest rate by a total of 250 basis points in 2022 and tighten further to push the main target to 3.1 percent by the end of 2023.

The Fed will also begin reducing its large balance sheet in mid-2022 and accelerate the process in 2023.

The European Central Bank will begin its own tightening cycle by stopping its asset purchases at the end of June and raising interest rates three times in the second half of 2022, followed by further interest rate hikes in 2023.

On the domestic front, many African countries will adjust their policy rates with extreme bias. For example, African monetary unions will follow suit and raise their own interest rates.

The GCA countries of South Africa, Namibia, Lesotho and Eswatini will raise their own domestic interest rates – led by the South African Reserve Bank seeking to prop up the rand and protect foreign portfolio investment from leaving. Meanwhile, the 14 member states of the two CFA franc zones that maintain their monetary peg to the euro – the West African Economic and Monetary Union and the Central African Economic and Monetary Union – will continue to follow the lead of the european Central Bank and increase their interest in policy rate hikes in late 2022 and 2023.

Reducing debt relief initiatives

Debt payments to official G20 creditors – the so-called Debt Service Suspension Initiative (DSSI) implemented in the aftermath of the pandemic and coordinated by the World Bank and the International Monetary Fund – were temporarily suspended for a total of $10.3 billion in debt service for eligible low-income countries.

However, the EITI expired at the end of 2021 and ended an important source of debt relief for African countries.

A joint framework has been launched by the Paris Club with G20 countries to consider debt restructuring requests, which are assessed on a case-by-case basis, for any of the 73 countries eligible for debt service suspension. However, only a few countries – Chad, Ethiopia and Zambia – have sought to restructure under the new framework for fear of a downgrade in their credit rating.

In addition, private creditors are reluctant to participate on an equal footing in the Common Framework-as was the case with the Debt Service Suspension Initiative-which would continue to deprive African countries of the opportunity to obtain forgiveness or restructuring of a significant portion of their loans.

SDRs in Africa

Principal and interest payments will remain steadily above $100 billion in 2022 and could rise to $110 billion in 2023 and remain at that level in 2024-26.

For its part, the International Monetary Fund disbursed $650 billion in special drawing rights (SDRs) – the largest in history – in August 2021 to provide liquidity to the global financial system, but only a small portion – about $34 billion – was allocated to Africa.

The majority of the SDRs have been earmarked for high-income countries elsewhere in the world – although it is acknowledged that some have reallocated a portion of their SDRs to Africa, led by China, which has pledged $10 billion of its $40 billion allocation. Significant withdrawals are expected and most, if not all, of the SDR allocation to Africa will likely be exhausted by the end of 2022.

China blows a little

China is a major source of bilateral development finance for Africa, but Chinese lending commitments have declined in recent years. This reflects some rebalancing and increased risk aversion in China as well as some tightening of the financial belt due to the negative effects of the epidemic.

Chinese loan commitments peaked at about $30 billion in 2016, but dropped to about $2 billion in 2020, according to the China-Africa Research Initiative at the Johns Hopkins School of Advanced International Studies.

The eighth ministerial conference of the Forum on China-Africa Cooperation held in November 2021 saw China’s investment pledges reduced for the first time, from the $60 billion pledged at the seventh meeting in 2018 to $40 billion in 2021.

Chinese financing will become more expensive as interest-free or concessional bilateral loans continue to give way to more commercial loans. In addition, there will be a greater emphasis on foreign direct investment as a tool for financing projects in Africa. China will reluctantly consider debt restructuring on a case-by-case basis, helping to protect its commercial and geostrategic interests.

High risk of debt distress

The near-term outlook for Africa presents a series of further increases in already high levels of external debt and higher debt service costs as global inflation, interest rates, and risk premiums rise, African currencies lose value against major trading currencies, and some credit lines become scarcer.

The region will continue to grow economically, albeit at a relatively slow pace-especially for the region’s major economies. International commodity markets will provide a much smaller financial lifeline for commodity traders as energy, industrial materials, and agricultural commodity prices retreat from their 2021-2022 highs.

For now, a full-blown debt crisis is not expected in Africa, thanks to modest positive economic growth and relatively healthy reserves. But the financial stresses caused by excessive debt and a heavy debt service burden will affect economic growth and stability in a group of countries, including those currently classified as high-risk or already over-indebted.