Sub-Saharan Africa and the global financial crisis
The current millennium began with a new sense of optimism regarding prospects for sustained growth and poverty reduction in Sub-Saharan Africa (SSA). Better economic management, progress in governance, rising commodity prices, reduction in armed-conflicts, and increasing international support for SSA created hopes of a brighter future for the region. (2) There is no doubt that the recent economic performance of SSA has justified this new optimism. Evidence indicates that remarkable progress has been made since 2000: the average annual growth rate in SSA increased from 3.7% in 1996-2000 to 6.3% in 2003-2007, while inflation declined from 18.8 % to 8.2 % over the same period.
Impact of financial crisis on Sub-Saharan Africa
Despite this increase in optimism and the economy, there is concern that the recent global financial crisis may erode these gains. (3) While it is too early to know the exact magnitude of the potential impact on SSA, it is important to consider the following. First, the crisis will have short as well as medium-term effects on SSA, which may differ in magnitude depending on how long the crisis lasts. Second, the impact will vary across countries depending on their production and export structure, exposure to the international financial system, as well as capacity to cushion the potential negative effects of the crisis. For example, countries with very strong fiscal positions or with high international reserves are less likely to be severely affected. Furthermore, African countries with low inflation will also have a better ability to use monetary policy to dampen the impact of the crisis on real variables since in this case monetary policy is not constrained by the need to fight inflation.
In general, the short-run effects on SSA will be relatively small as most countries in the region are de-linked from the international financial system. Furthermore, the existence of varieties of exchange controls and the lack of exposure to the sub-prime market in developed countries means that banks in the region will not face any systemic risk and so the disruption to domestic credit markets should be minimal. (4) Of course, in larger economies where stock markets have some degree of exposure to the international financial system, the impact will be more pronounced. There is already increasing evidence that stock markets in South Africa and Nigeria, for example, are feeling the impact of the crisis.
The medium-term effects on SSA will depend on four key factors. The first is the degree to which the crisis leads to a severe and protracted recession in the US and Europe, which will certainly have a negative effect on other industrial countries given the interdependence of these economies through trade and foreign investment. This will in turn have a contagious effect on African countries through the following channels:
• International trade is a key source of growth in most modern economies. A slow down in economic activity in industrial countries will have a negative effect on exports of African countries and will lead to a reduction in trade credit. Since trade is an important source of foreign exchange, there will be a reduction in the ability of countries to import the capital and intermediate inputs needed by domestic industries.
• Foreign direct investment is likely to fall as a result of a global melt-down. Such reduction in capital flows will put pressure on the exchange rate and also reduce investment in infrastructure and the production sectors, leading to factory closures and increased unemployment.
• Remittances tend to be more stable than other private capital flows. However, a deep recession in industrial countries is likely to result in lay-offs and to the extent that migrants are affected, there will be a reduction in their ability to transfer money to their home countries. A reduction in remittances would mean more hardship for recipients since they have no alternative safety nets.
Although there is growing consensus that the crisis will lead to a significant slow down of the US economy in the short-run, it is not clear whether this will lead to a protracted recession. That said, recent actions and statements by the Bush administration in the US, as well as by leaders of other G8 countries, suggests that they stand ready to take any measures necessary. To the extent that they follow through on this promise and, assuming their actions have the desired result, it is unlikely that there will be a protracted recession in the major industrial countries. Consequently, the impact of the crisis on Africa emanating from this channel may not be as severe as one would expect.
The second factor that will determine the degree of the medium-term effects on SSA is inflation-expectations in Organisation for Economic Co-operation and Development (OECD) countries. If the recent easing of monetary policy (5) as well as implementation of proposed fiscal stimulus leads to an increase in inflation expectations, there is the possibility that monetary authorities in these countries will raise interest rates to ward-off inflation and preserve their currencies value. Such tightening will increase the cost of credit, making it even more difficult for African countries to access. Countries with high dollar denominated debt will also face an increase in the cost of servicing their debt. Furthermore, an increase in interest rates may slow down the economies of the industrial countries and reduce demand for African exports with negative consequences for growth and prospects for meeting the Millennium Development Goals (MDGs).
The third factor that will determine the medium-term effects on SSA is commodity prices. The recent boom in commodity prices played a key role in boosting growth in the region. If the current slow-down results in a decrease in the demand for primary commodities, it will have a devastating effect in the region. What happens to China and India—key players in the market for commodities—are critical in terms of the impact of the crisis on commodity prices. At the moment, there are indications that the Chinese economy is slowing down due to the crisis: forecasts for the first three quarters of 2008 suggest that the economy grew by 9%, which is below the double-digit figures observed in recent years.
The final factor that will determine the medium-term effect is what happens to official development assistance (ODA) flows to SSA. If OECD countries respond to the economic slow down by reducing ODA flows, this will deepen the potential impact of the crisis on African economies: a large number of countries in the region rely on ODA to finance their budgets. Such action will further reduce the fiscal space available to African countries to cushion the impact of the crisis. In the past, ODA flows have been pro-cyclical rather than counter-cyclical giving African policymakers good reason to worry.
The current financial crisis calls for actions by Sub-Saharan African countries and the international community in order to limit the impact on the region. It underscores the need for better regulation and supervision of domestic financial systems in SSA. Since banks in SSA account for over 80% of the assets of the financial system, the cost of a banking crisis is high as is the need for strong oversight of the system to reduce vulnerability. Also, most countries in the region do not have the ability to bail out institutions that fail. Governments may thus want to recapitalize domestic banks to ensure a strong capital base.
In some countries, there is scope to use foreign exchange reserves to cushion the effects of the shock and to finance any possible decline in capital flows. In countries with no reserves, international assistance may be needed.
Another domestic policy response is the adoption of more flexible exchange rate regimes. This will allow the nominal exchange rate to absorb some of the impact of the external shock and reduce the real effects in the domestic economy. (6) It will also reduce the possibility of an exchange rate crisis. (7)
Developed countries have a role to play in helping African countries respond to the crisis as well. They must resist the temptation to reduce ODA and instead meet their promise to double aid to Africa by 2010. More assistance will enable African countries to offset the impact of any reversal in private capital flows and reduce the likelihood of a sharp decline in spending on social sectors that would have dire consequences for poverty reduction.
At the international level, there is also the need for more involvement of African countries in discussions on how to improve the management of the international financial system. In particular, they should have representation in any new governance architecture that may be designed to avoid the occurrence of global financial crises. This is particularly important given that the consequences of recent financial crises go beyond national borders and most African countries have no safety nets to cushion the potential impact of such crises.
1. Patrick N. Osakwe is Chief, Financing Development, UN Economic Commission for Africa, Addis Ababa, Ethiopia
2. Recent efforts by G8 leaders have been critical in focusing attention on Africa’s development needs. For example, the G8 Africa Action Plan adopted in 2002 in Kananaskis, Canada, and the Gleneagles Summit declaration of 2005 were important steps in galvanizing international support for development in Africa.
3. The recent global financial crisis began in the US and was triggered by the collapse of the sub-prime market in August 2007.
4. Foreign ownership of banks is increasing in Africa and to the extent that multinational banks respond to the current crisis by withdrawing funds from their subsidiaries in Africa, this could represent a big source of vulnerability.
5. In October the USA Federal Reserve, in coordinated rate cutting moves with European and Asian central banks, reduced short-term interest rates.
6. Osakwe, P. N. and Schembri, L. L. (1998). Currency crises and fixed exchange rates in the 1990s: a review. Bank of Canada Review Autumn, 23-38. See also: Agbeyegbe, T. D. and Osakwe, P. N. (2005). Real exchange rate volatility and the choice of regimes in emerging markets. Journal of Asian Economics 15, 1005-1022.
7. Osakwe and Schembri, 1998.