By Elijah Kimani
After the First World War (WW1), government-to-government debt contracted for the reconstruction and stabilization of desolate Europe skyrocketed. The largest creditors were the United States and the United Kingdom, funding Germany, France, Italy and the like to the tune of 18% of the US GDP and 29% of the UK’s GDP in 1934. By current standards, that would amount to $4.2 trillion, close to twice the current nominal GDP of the entire African continent.
By 1934 all of these countries, bar Finland, had caucused to default on this debt obligation. After the 1931 Hoover Moratorium in which European countries were given temporary relief and allowed to halt payments for a year to catch their breath, many of these countries did not resume repayments. In hindsight, Finland must have lamented its hurried repayment just to watch the rest of Europe abscond on their debt obligations without ramification.
At a time when Europe was on its economic and political deathbed occasioned by colossal losses from the war, going against the US, the de facto global superpower at that moment, was risky. But Europe did, and that allowed it to free up resources that were critical in its subsequent growth spurt. Some economic historians argue that these debt obligations and reparations may have driven Germany into wanton destruction. In fact, John Maynard Keynes, arguably the most influential post-WW1 economist, wrote his seminal book The Economic Consequences of the Peace after attending the signing of the Treaty of Versailles. He walked out in protest predicting a disaster if Germany was forced to pay up. In periphery Europe today, much of the debt is back in the hands of sovereign creditors and as the gods of irony would have it, this time Germany holds the till.
While there’s a case for not allowing Greece and its PIIGS peers (Portugal, Italy, Ireland and Spain) to default on loans, there’s consensus even from the martinet IMF that that may be the best course of action for the good of Europe and the survival of the Eurozone. The solution, while bitter to swallow for Germany, may be the panacea to the ailing euro body. Greece is unlikely to unilaterally default on its loans given its questionable sovereignty on the matter, but for countries that enjoy monetary policy independence, that card is still on the table. It’s akin to filing for bankruptcy and getting a fresh start, albeit on a dirtied slate.
The China conundrum
In the past 15 years, China’s annual loans to Africa have grown from a fraction at the turn of the millennium to $30 billion in 2016. This adds up to $143 billion – about 3% of Africa’s GDP. In an unexpected departure from this trend, China has recently cancelled some and adjusted the debt owed by both Ethiopia and Cameroon, a pointer to a looming problem that China has to contend with. As more African countries borrow amidst worsening balance of payments and falling total factor productivity, more countries will inevitably go into debt distress. The construction of wider highways and bigger airports fuelled by a credit boom in China will continue to bloat the primary deficits across the continent. The money is too accessible and our politics too accepting of it.
However, between Malaysia’s cancellation of $22 billion worth of Belt and Road Initiative (BRI) projects, the Maldivian government’s unwinding of BRI projects and the fallout over Sri Lanka’s long lease of a major port to China as part of debt concessions, China should be worried about the future of its credit dish-outs. Sierra Leone went as far as cancelling a $300 million airport project that was already underway. Jeopardizing the bigger geopolitical picture would be a massive financial and political loss. China is bound to benefit more politically from engaging with Africa than it will financially from debt repayments and, as such, allowing for restructuring, and in rare cases defaults won’t hurt. The US needed to be in Europe’s good graces back in 1934 to cement its place in global geopolitics just as much as China needs it from Africa today.
While China wields outsized political and economic might bilaterally and through international political and financial institutions such as the UN and the IMF, its options for recourse are limited in the case of a default. Worse if the default is en masse. More debt will push more countries towards default and attempting to take over physical assets like ports and railway lines is a fool’s errand, even for assets domiciled abroad. Halting further advancement of debt would certainly impact African economies, but at 3% of GDP in Chinese debt stock, the net impact would be negligible especially considering the current wastage, corruption and misappropriation of these funds.
On the flip side, China still needs to push out its excess savings to the developing world due to low appetite for credit in the local Chinese economy. Failure to do this will push down interest rates and choke out any room for monetary policy adjustments, potentially a bigger concern for China than Africa’s caprice. If money will have to be lent out, then it might as well be lent where it buys political influence.
While this is not a call for Africa to borrow more or default at will, overemphasis on Chinese debt and its implications can be hysterical at times and as such destabilising. In fact, while Chinese debt has grown several fold, government debt across Africa has declined from a high of 100% of GDP in 2000 to about 50% in 2018. Africa’s receipts as a percentage of China’s planned BRI budget are still in single digits, and at par with Pakistan’s allocation. Sub-Saharan Africa’s public debt to GDP ratio is relatively low by global standards and China only holds about 14% of this pie. Of note is that 30% of China’s loans to Africa have been to Angola alone, its second largest trading partner in Africa and a critical source of petroleum and minerals.
We could certainly manage our debt better as a continent, but it is not as bad as it looks. We should instead worry and focus more on how proceeds of such loans are utilised. Debt by itself is not evil but our style of leadership and politics turns innocuous fiscal practices into nuclear ticking time bombs.
Worst case, default. But do it early!
Defaulting on sovereign debt, while highly discouraged, when inevitable harbours a silver lining. In any case, investors price in any prospects of default way before default happens. It could not possibly get much worse. As an example, Argentina’s 2001 default on $132 billion of debt resulted in a significant devaluation of its currency, boosting exports. In effect, the impact of the default on the economy was short lived. Borensztein and Panizza point out that such effect disappears within 5 years. While Argentina’s economy is a going concern, it still successfully floats bonds in international markets, some of which are better priced than those floated by safer African countries. Of course, Argentina is not a fair comparison but maybe the fear of inability to raise or service future debt after a default is overstated, especially in an era of excessive credit and negligible market returns. Ghana and Kenya’s Eurobonds were highly oversubscribed earlier this year, an overwhelming endorsement in total disregard of distress warnings by the IMF.
At the end of the day, African economies should pursue responsible public finance practices that would allow them to run reasonable primary balances and pursue sustainable economic growth. Debt default would be a temporary fix and the wound would fester again in due course as exemplified by Argentina, which just received the largest credit line ever extended by the IMF amidst fear of economic collapse.
In a world of sensible economic policies, default should not be an option and African governments should work on taming their appetite for easy money as it can quickly destabilize fledgling economies. Nevertheless, when push comes to shove, and African economies can no longer service Chinese debt, maybe defaulting would not be the worst option; others have already set the precedent.
Elijah Kimani is a Graduate Student of Economics & Policy, at the Princeton University and a Summer Research Analyst at ACET.