Multilateral Fiscal Support for African Governments Addresses Liquidity More than Solvency Risk

Download Scope Ratings’ full report on Africa’s debt crisis and multilateral initiatives.

Fiscal vulnerabilities among African sovereigns were building in the years even before this year’s pandemic. This reflected challenging economic conditions, unfavourable exchange-rate and commodity-price changes, alongside significant new borrowing – including loans from Africa’s largest bilateral lender, China, and increased bond issuance.

Covid-19 has pushed most African economies into recession, driven, among other factors, by lost tourism revenues, falls in commodity prices and a decline in remittances. Real GDP in 2020 is set to contract by 2.3% on average across the continent, tax revenues will shrink and pressures to increase expenditure have risen.

An emphatic policy response needed in Africa, however fiscal constraints prevail

“This calls for an emphatic policy response,” says Dennis Shen, director at Scope. “Reinforcing public health systems, providing emergency food where necessary, offering income relief to vulnerable persons and supporting strategic economic sectors and small and medium-sized enterprises are short-term priorities alongside the long-term need to bolster economic development.”

However, in addition to overcoming weak governance structures and administrative capacities for the policies’ effective implementation, such measures also come with considerable price tags. Many African governments lack the fiscal space to implement such relief programmes without jeopardising the sustainability of their public debt.

African countries’ average public debt ratio increased from a 2011 low of 38.5% of GDP to 62.3% in 2019, while debt ratios more than doubled in that period in one third of the 53 economies on which there’s data. The burden of servicing debt has risen in parallel: regional average interest payments doubled from 5% to just under 10% of government revenues over the same period.

Multilateral institutions have increased emergency lending and debt service suspension

Multilateral organisations have ramped up emergency support in the form of loans and grants of around 0.6% of Africa’s 2019 GDP to-date, while the G20 has agreed on a Debt Service Suspension Initiative (DSSI) with average savings of 0.6% of 2019 GDP.

“International initiatives can support African sovereign creditworthiness, though, critically, DSSI debt relief has led to suspension rather than outright debt forgiveness,” according to Shen. “The international support programmes primarily address short-run liquidity rather than long-run solvency issues.”

“In addition, any private sector involvement in DSSI could be tied to a temporary (selective) default credit rating – potentially restricting market access near-term,” Shen says. “However, such a default credit rating in a scenario of private sector involvement would likely be transitory and, longer term, involvement of private sector creditors in debt relief could be viewed as positive for creditworthiness especially were underlying solvency issues addressed.”

DSSI elements such as enhanced debt transparency, multilateral monitoring and borrowing ceilings are considered by the rating agency as positive for the region’s sovereign ratings.

Governments will need to independently weigh the benefits vs costs of debt suspension participation

“Governments will need to judge the benefits of participation in DSSI – especially of any element of private debt bail-in – against the costs,” Shen says. “If a suspension of 2020 bond coupon and principal payments leads to a significant debt service hump in future years, this could be considered a significant risk even after a debt suspension – given potential for renewed debt distress over future years.”

“Conversely, if an economy’s debt sustainability is adequately enhanced by momentary suspension of debt payments to official and/or private sector lenders and repayment schedules are subsequently smoothened, this could support stronger market access and lower borrowing rates long term, and with this, bring a potentially stronger sovereign credit rating long term.”

The ongoing shift in African governments’ funding source in the direction of markets and China

Rising public debt burdens have coincided with a shift in African governments’ reliance on multilateral institutions and bilateral lenders towards capital markets. There has been a parallel longer-term shift to non-Paris Club bilateral creditors, predominantly China. The proportion of private funding has risen, up at almost 40% of public and publicly guaranteed debt in 2018.

Increased issuance of sovereign bonds can diversify a country’s investor base and subject a government to market discipline especially in crises, but it comes with higher borrowing costs than concessional multilateral and bilateral loans and increases exposure to volatility in investor sentiment.

Multilateral and bilateral financial support alongside debt relief initiatives, such as the DSSI, support African governments’ capacities to cope with the economic and public-health crises – they mitigate economic and financial damage, ease immediate liquidity risk, and can improve sovereign creditworthiness over time.

For a look at all of today’s economic events, check out our economic calendar.

Dennis Shen is a Director in Sovereign and Public Sector ratings at Scope Ratings GmbH. Thibault Vasse, Sovereign Ratings Analyst of Scope, co-authored this article.