A template for understanding the African debt crisis

The American financial crisis of 2008 has been revisited on the 10th anniversary of the collapse of Lehman Brothers and the release of Ray Dalio’s new book, A Template For Understanding Big Debt Crises.

History is embroidered with distinct debt crises from different regions of the world. However, very little attention has been drawn to the African debt crisis, which stems from the mismanagement of foreign (external) loans which burden the African economy, which is further strained by unsatisfactory rates of continental economic growth.

The nature of the African debt crisis is comparable to what is categorised as an inflationary form of a debt crisis.

For the purpose of this article the term Africa is being used to collectively describe the economics of a majority of African states that behave in a similar manner or display similar economic traits, such as high inflation, low employment rates, poor or inconsistent economic growth which operates against the backdrop of high borrowing from foreign states.

The term Africa in this article is not being used to imply that Africa is one homogenous continent comparable to the homogenous nature of a state. That said, we can consider Africa as a collective to be approaching a catastrophic debt crisis of its own.

An oversimplified overview of the the typical nature of a debt crisis is as follows. Its starts off with the banks being supported by the government through (low) interest rates or monetary policies to issue more credit into the economy. The purpose of this increase in credit is to stimulate the economy.

However, greed takes over and to the fault of both the creditors and the debtors several debtors become over-indebted. Once the debtor is over-indebted they begin to default on their loan repayments, and this results in losses for the bank.

These losses continue to accumulate, sometimes to the extent that the bank can no longer function and operate as a bank. Depending on the parties involved, in order to prevent the bank from declaring bankruptcy, the government will have to step in and give the bank a bailout. This bailout is usually done at the expense of the taxpayers. When the parties involved are states, the consequences can be more detrimental and have a larger effect.

In the context where states are the parties involved, the matter is more complex as there are several factors that influence the outcome. For example, when the loan is issued it either has to be paid back in American dollars (the reserve currency of the world) or in the local currency of the debtor state.

As Dalio points out, when the country has to repay the loan in another currency rather than in their own local currency, it makes it harder for the debtor state to control the crisis. It is also for this reason that America is able to recover from financial crises much better than most states, because it prints the reserve currency of the world and is paying back loans in its own local currency.

Africa, in spite of its inherited wealth captured in its abundant pool of natural resources, it is the biggest recipient of foreign aid. This can be provided in the form of either a grant or a loan. In Africa most foreign aid is provided in the form of a loan which is usually requested to be paid back in American dollars, known as dollar-denominated debt.

The present context is that most African currencies are much weaker than the dollar and depreciate at much faster rates in comparison to the currencies of stronger economies, because of high inflation. This pairing makes repaying the loans very expensive, and places great financial burdens on the continent.

The only way in which this can be mitigated is if the creditor restructures the agreement and resets the interest rates to offset the inflation and depreciation in the respective currency. This is the first problem that we are eclipsed with.

The role of debt in Africa is that of a mechanism that has created an enslaving relationship between Africa and its creditors. The economies that have dollar-denominated debt are the most vulnerable to the volatility of the financial markets. As the dollar strengthens the cost of repaying the debt rises and usually results in the rapid depreciation of the debtors’ currency. Here in South Africa we have seen these dynamics play out with our own currency.

The role of debt in the global economy is a double-edged sword. Debt can play a positive role in fostering economic growth and aiding economic development. However when debt is issued recklessly or mismanaged it can lead to an economic crisis.

Several interesting papers have been written to study the correlation between foreign aid (loans) and economic growth within the African context, but no definite conclusion has been made. However, several papers collaboratively agree that the amount of foreign aid received in the African context has negative social effects that have subsequent negative economic consequences.

Lending and borrowing is not the crux of the problem in the African debt crisis. The problem in Africa is that loans are being mismanaged in the framework of contracting economies. This is our second critical problem.

When we speak about mismanaging money we are concerned with two main categories of mismanagement. First is the reality that a lot of money pumped into the African economy is not necessarily absorbed into the African economy. It is not uncommon for foreign loans to underfund infrastructure development in Africa, but fatten the wallets of prominent politicians.

The second form of money mismanagement contrasts with the first in that foreign loans can also create the false impression of fast economic growth.

False impressions of economic growth can have detrimental consequences. This was well showcased in Turkey’s recent economic crisis. There are several components that contribute to the collapse of Turkey, but indisputably the unsustainable economic growth that was critically dependent on foreign loans was a large contributor to the crisis.

The third problem we face is that African leaders seem very removed and passive in the face of our pending debt crisis. This is reflected by the absence of strong monetary policies that guide the continent’s relationship with external loans.

To mitigate the risks and ensure that foreign loans are implemented in an effective manner that drives continental development and growth economically and socially, we need to have strong regulation of foreign aid that enforces accountability and prioritises economic growth and development throughout the continent. DM