Addis Ababa: Africa has experienced positive growth momentum in recent decades, registering previously unseen levels of economic performance, and weathering the negative effects of the ongoing global financial and economic crisis better than many other regions. Consequently, many analysts and policymakers project that the continent will become one of the fastest-growing regions in the world over the next decade.
However, the ongoing sovereign debt crisis in some countries of the euro area poses a serious risk for Africa’s economic prospects. While only a few countries are affected, there is now an increased risk that the crisis could spread rapidly to other countries in Europe and have spillover effects in other parts of the world. The escalation of the euro area crisis has sharply depressed business confidence in developed economies, while the negative shock is straining emerging markets and developing economies. The global economy is therefore expected to slow in 2012 and in the medium term, with an increased risk of another recession, if the euro zone crisis is not resolved urgently.
Since these developments will inevitably have an impact on Africa on several fronts, an assessment of their likely impacts is warranted. The main potential transmission channels include trade exposure through falling demand for Africa’s exports to Europe, sovereign risks (including reductions in official development assistance (ODA)), and liquidity risks that could affect other financial inflows such as foreign direct investment (FDI) and remittances.
Moreover, it has been suggested that the structure and governance system of the European Economic and Monetary Union is itself a root cause of the current crisis. The euro is viewed as an incomplete currency, because the 1992 Maastricht Treaty established a monetary union without a political union, as a result of which the common European Central Bank lacks a common treasury. Furthermore, while members share a common currency, they issue and manage sovereign debt individually. It is precisely the missing elements in this structure that financial markets are now questioning, and that is arguably the reason why the euro is the focal point of the current crisis. This can offer important lessons for Africa on how to manage its own agenda for achieving monetary union, as is envisaged in the 1991 Abuja Treaty. This is an important policy issue that requires consideration.
This background paper reviews the potential impact of the European debt crisis on Africa and offers policy advice on the actions that African leaders need to take to mitigate those negative effects. To that end, it overviews the characteristics of the euro area debt crisis, before discussing the risks it poses to Africa and the possible channels through which its effects may be transmitted. It concludes by drawing lessons from the experience of the European debt crisis for African leaders to consider in taking forward Africa’s own monetary union agenda.
IV. LESSONS LEARNED AND POLICY IMPLICATIONS
(a) Lessons learned
- Country-level lessons
There are several lessons to learn from the occurrence of recent financial crises, particularly the sovereign debt crisis in Europe. One critical lesson is that the current international financial architecture cannot be left unchanged. However, there is a need to adopt prudent macroeconomic policies at the national level, as well as a conducive political environment to support the new financial architecture. Central bankers, financial regulators and credit agencies should play a key role in establishing the new architecture, supported by governments passing the relevant legislation. African countries should continue implementing the macroeconomic and fiscal reforms that saw the continent achieving high growth rates prior to the financial and economic crisis. That sustained growth is part of the reason for the resilience shown by most African countries in the face of the crisis.
Country risk monitoring and analysis should be strengthened in an effort to identify problems earlier and to adjust exposure in a prompter and more systematic way. Specifically, financial sector supervision/regulation should now focus more strongly on macroprudential supervision, including the need to systematically link overall financial sector balance sheets to fiscal and external sector accounts. This type of monitoring should also be done regionally to complement what is being done on an individual country basis.
African central banks’ supervisory and regulatory functions should be strengthened and there should be minimal government intervention in the decisions taken by the regulatory agencies. This will assist in the enforcement of the rules and regulations of prudent financial management among financial institutions and will also ensure consistency of monetary aggregates with a sustainable balance of payments. It should be accompanied by the strengthening of financial institutions and enforcement of strict transparency standards in financial transactions.
Another lesson to be drawn from the crisis relates to the need for monitoring of countries with a high proportion of short-term debt as well as private capital flows in their external liabilities, since that might pose problems even if their overall indebtedness is modest. Countries should be required to provide data on their economy’s overall level of external indebtedness, with an emphasis on the private component of debt, and give a breakdown of the debt by maturity, debtor and creditor. If short-term debt is owed by banks, then the banking system’s soundness and the quality and liquidity of its external assets must be taken into account in assessing the country’s external creditworthiness. The current second wave of the global financial and economic crisis in the form of the sovereign debt default looming in Greece makes this lesson all the more important.
- Regional lessons
The global financial crisis had a major impact on many African countries as a result, inter alia, of reduced commodity exports, the shrinking of domestic tax bases owing to a contraction of domestic output, and reduced remittances, leading to a deterioration of balance of payments positions. Greater intra-African trade and regional integration are therefore required.
This builds a strong case for the establishment of an African Monetary Fund (AMF) to play an oversight role and to curb financial instability where it is detected. Some would argue that IMF exists to perform such a role. However, AMF would have the mandate to penalize defaulting members subject to the rules governing the African Union, whereas IMF would be inhibited in its response. In addition to AMF, the African Investment Bank (AIB) would play a critical role in mobilizing savings for investment within the continent at times of global crisis such as the present.
Africa is underrepresented in the G-20, which has been identified as the “premier forum” for international economic and financial cooperation. There is an urgent need for the continent to be better represented in the expanded G-20 given the extent of the impact of the recent crisis on African economies, which had nothing to do with its origins. This will ensure that Africa has a say in how the international financial system is crafted to maximize benefits. Ultimately, Africa is responsible for development across the continent, and the current global and European debt crises highlight the importance of turning development financing into a process driven at the regional and national levels within the continent. Africa should therefore strengthen its efforts to enhance domestic resource mobilization to finance its development agenda, which will facilitate greater ownership and accountability in the development process.
The current European economic crisis can also be seen as an opportunity for the African Union to learn from the structural weaknesses of the European Economic and Monetary Union. The African Union has a vision of establishing its own monetary union and creating its own currency. The European Union is a pioneer in this respect as a continent that has managed to achieve monetary integration. Yet, despite those accomplishments, the European Union member States are suffering from a debt crisis that was brought about by various discrepancies in the structure of the monetary union established. One of them is the lack of a fiscal policy framework consistent with a monetary union. The current European crisis has proved that it is necessary to establish a single fiscal policy in order to use government spending and taxation to regulate the region’s economy. In the absence of such a measure, governments have been able to run deficits that debilitate their own economies as well as that of the European Union as a whole. African countries will therefore need to establish a single fiscal policy as well as a single monetary policy in order to avoid such consequences. As a continent that encompasses countries with diverse political, economic and social backgrounds, establishing such a policy requires greater political will and policy coordination among individual countries. Just like most European member States, the leaders of African countries will want to maintain their sovereignty.
- (b) Policy implications
Given the immediate impact and ensuing consequences of the European debt crisis for Africa, it is vital that countries adopt a set of strong policy responses.
Fiscal and monetary policy – African countries that have fiscal space may choose to embark on discretionary fiscal easing to sustain aggregate demand, depending on the availability of domestic and external financing. However, such policies should be embarked on carefully so as not to crowd out the private sector and to avoid a negative impact on Africa’s progress towards debt sustainability. Monetary authorities should continue to foster a climate of high growth, whilst intervening when inflationary pressures prove excessive.
Financial resource mobilization – Given the potential fall in financial flows to Africa, measures must be taken to broaden the tax base as well as increase the efficiency of tax collection. Mechanisms must be found to ensure that the private and informal sectors are taxed appropriately. Issuing bonds should also be part of the fiscal framework. Africa can, for instance, mobilize financial resources by targeting its diaspora with tailored financial instruments.
Transfers to mitigate social impact – It is people in poverty who are most likely to suffer from the consequences of decreased economic activity and the reduction in the financial resources available to the African private and public sectors. Governments must therefore use whatever fiscal tools are available to facilitate transfers to those most affected, for example, by increasing support to the unemployed and temporarily providing subsidies to bring down the cost of food. Revenues from the extractive sectors can be utilized in this regard.
- Introduction and concluding section to: The impact of the European debt crisis on Africa’s economy - a background paper prepared for the 5th Joint Annual Meetings of the AU Conference of Ministers of Economy and Finance and ECA Conference of African Ministers of Finance, Planning and Economic Development. The 22 page document can be accessed here.