What Has Been Missing
In 2018, the IMF and World Bank finally acknowledged the weaknesses of their DSA framework, and introduced a new multi-pronged approach (MPA) that sought to strengthen debt transparency by working with borrowing countries and creditors to produce better public-sector-debt data and to mitigate debt vulnerabilities. The MPA also called for new tools to analyze debt developments and risks, and for reforms to the IMF and World Bank’s surveillance and lending policies to address debt risks and promote more efficient responses to debt crises.
The MPA represented a substantial improvement on the initial framework, but it still did not capture the specific economic identities of African countries. Since exports are these countries’ main engine of growth (owing to limited domestic demand), a realistic framework should account for the other macroeconomic and financial policies that are in place to boost external trade, promote economic and financial resilience, and reduce the volatility of export revenues.
Any DSA for Africa should place issues relating to external competitiveness and the appropriateness of exchange-rate policies at its core, to allow for a proper evaluation of national-currency overvaluation and devaluation in the medium term. Likewise, the analysis should consider a monetary policy’s capacity to provide a supply response in case of a currency devaluation.
DSA frameworks traditionally have not recognized the importance of the exchange-rate regime, even indirectly. While all countries should avoid excessive debt-service obligations, the risks and constraints are heightened for countries with a pegged exchange rate, especially when the anchor is a strong currency like the euro, which is the case for the 14 Sub-Saharan African countries in the CFA franc zone. For these countries, currency fluctuations have enormous implications for external debt, export revenue, employment creation, government revenue, and public debt.
Current analyses of debt sustainability do acknowledge the importance of reserves – which allow a country to absorb the shocks of curtailed or costly borrowing, boost confidence in its commitment to the timely discharge of external obligations, and support the value of its domestic currency. But even for countries with generally good macroeconomic management, a substantial volume of reserves is not a sufficient safety net in the case of sudden crises or financial contagion. Hence, a more effective DSA for African countries (and for developing countries more generally) would identify the critical element of their structural economic vulnerability – namely, their weak export structure (reliance on a few commodities and limited diversification of trade partners).
Finally, traditional DSA frameworks do not account well for security, even though this is a widespread issue on the continent, with significant macroeconomic implications. African countries at all levels of development are facing a myriad security risks that carry major economic costs. While security budgets are usually state secrets, it is safe to assume that a substantial portion of fiscal revenue in many countries is going to fight armed jihadist and rebel groups such as Boko Haram, Al-Shabab, and others.
These kinds of sustained security shocks incur heavy costs. Armed conflicts, civil wars, and terrorism destroy physical, human, and social capital, which in turn negatively affects production, trade, exports, consumption, and governments’ ability to collect adequate revenue to finance public expenditures. When military spending rises, social spending falls.
Armed conflicts are bad for business. They create unacceptably high levels of uncertainty (particularly for private-sector investment), fuel capital flight, and depress savings. Even after a conflict has ended, boosting investment remains difficult, because much of the necessary capital will have been damaged or destroyed. The harmful economic effects of conflict and war can last for years – or generations – undercutting growth and a country’s ability to service its debt. It’s therefore critical that development-finance institutions devise new, credible financing instruments to support African countries confronted with exogenous security shocks, without worsening their capacity to service their debt.
To be certain, concerns over Africa’s rising public-debt levels (both external and domestic) should not be downplayed or treated with complacency. Given the global rise of nominal interest rates and the heightened volatility and downward trends for commodity prices, African countries may find it difficult to service the debts they had accumulated during the last expansionary period. As such, they will struggle to maintain the elevated levels of government investment needed to sustain growth and structural transformations in the years ahead.
But this means that complementing the traditional, flawed DSA approach with alternative methods has become an urgent priority. We need a new process that accounts for additional information on a country’s debt trajectory, and that offers new policy levers to address debt concerns – such as through exchange-rate adjustments or a rebalancing of public investment.
Given African countries’ serious infrastructure gaps, limited public services, and persistent security issues, debt will remain an indispensable financing tool. To the extent that it’s used to fund productivity-enhancing public infrastructure, it can be justified. Under plausible assumptions, infrastructure improvements can increase growth sufficiently to decrease the higher debt-to-GDP ratio that results from the initial financing. The role that such investments play in boosting FDI – and the role that FDI then plays in boosting growth – should be considered fully in regards to any DSA.
Development institutions and rating agencies should focus more on the quality and proper uses of debt to finance inclusive growth and essential investments. Rather than setting arbitrary limits on a country’s debt-to-GDP ratio, the focus of monitoring institutions such as the IMF and World Bank should be on assessing whether increases in Africa’s public debt are getting used for the right purposes – namely, public infrastructure. This alone can go a long way toward reassuring investors and decreasing spreads.
Célestin Monga is a former managing director at the United Nations Industrial Development Organization and a former vice president and chief economist at the African Development Bank Group, is Adjunct Professor of Public Policy at Harvard Kennedy School. The article reflects the author’s opinions and not necessarily the views of The Southern African Times.