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Why Africa should default sovereign debt amid the COVID 19 pandemic

Why Africa should default sovereign debt amid the COVID 19 pandemic

 

Minga Negash[1]

05-07-20

At the time of writing this commentary (May 6, 2020) the John Hopkins University's Coronavirus Resource Center puts global infection and death respectively at 3.7 million and 258K, of which about a third are in the United States. No one is spared from the calamity, but the demographic breakdown of the victims reveals that race, gender, and wealth remain important variables. The low infection rates reported in many Sub Sahara African countries (SSA) are difficult to discern. Analysts agree that the storm has not passed and the reported figures in both developed and developing countries underestimate the true picture of the damage inflicted by the virus. Health and allied scientists as well as governments are busy searching for preventive/therapeutic/ interventions. Corporate greed and public interest are competing for the control of the soul of the drug/vaccine market. 

The economic, political, and social damages of the virus are yet to be accounted for. As regards the economic impact Paul Krugman, the 2008 Nobel Laureate in economics, described the current free-fall as "a medically induced coma" and a recent NBER study shows that the stock market crash is nothing like the ones observed in recent memories. Esther Duflo, another Noble Laureate, says "there is no trade-off in poor countries between helping people sustain themselves financially and getting the health conditions to improve; the two have to go hand in hand". Millions of people in SSA are already trapped in poverty, and authors have been calling for "alleviation". Covid 19 has frozen SSA's commodity exports and killed the tourism market. Landlocked countries are in distress. For the average SSA citizen who is facing the lockdown the tradeoff is between catching the virus and death from hunger. Some African leaders such as Abiy Ahmed and Cyril Ramaphosa have been pleading for debt service relief and cancellation and, warned that unless the virus is beaten, it will haunt the lenders.

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In accounting/finance bankruptcy/insolvency arises when debt becomes greater than assets (solvency) and/or when the company fails to pay its currently maturing liabilities (liquidity). Insolvency/bankruptcy protection laws are meant to recognize this temporary phenomenon and provide a chance for the entity to go back to its pre-crisis position. This may involve firing the existing management, major restructuring, and putting the company under new (judicial) management. There are several failure prediction models and, yet few escape the scrutiny of the financial market, triggering chain bankruptcies, and bank failures especially when there are collisions. The essence is the same for governments. Governments in both rich and poor nations have been borrowing to their limits. Rich nations' debts are often denominated in their currencies. Lending nations see sovereign debt cancellation owed by poor countries as aid. Credit rating agencies in turn downgrade sovereign debt, creating further economic misery and a sharp drop in the values of SSA's currencies which are critically dependent on exports of resources and commodities.

Added to this is the fact that SSA's debt has always been connected with sugar-coated "structural adjustment programs" that advance liberalization, deregulation, macroeconomic stability, underinvestment in the public sector (mainly health and higher education), and property right rearrangements, including the privatization of State-Owned Enterprises (SOEs).  Sovereign debt has been incurred following credit rating, often to finance mega turnkey projects whose actual rates of returns did not equate the cost of borrowed capital. As concessionary debts dried up, SSA countries were encouraged to go to the commercial debt market. Export promotion banks of lender countries were the windows. Some of the debts, including those from China, were obtained by using public assets such as airports/seaports and railway lines as collateral. Although sovereign debt default is considered a rare phenomenon, the conditions SSA countries find themselves make it unavoidable.

What is not addressed in sovereign debt discourse is the link between political connection and allocative distortion observed in many developing economies and, analysis of how connections (ethnic, clan, faith, networks) led to "state capture", the worst form of corruption.  Also, SOEs and political party owned endowment companies have been the main actors in the economies where  "stellar" GDP growth rates were reported. These entities served as conduits for channeling the proceeds from sovereign debt to favored groups, regions, and projects. In this respect, using 15 years of corporate debt data from 10 African countries Tesfaye Lemma (2015) provided "evidence that perceived corruption is important in shaping debt financing and ownership structure decisions of firms in Africa". This is observed in the corporate sector and despite making accountability the "top agenda" for global development. In other words, the market doxa did not raise serious concerns about accountability. In an unrelated study Mechkova, Lührmann& Lindberg 2019 indicate that government accountability can be divided into de jure and de facto and, has a sequence. They are vertical (elections and political parties), horizontal (legislature, judiciary, and other oversight bodies) and diagonal (civil society and media) and, provide evidence that "de-facto vertical accountability precedes other forms of accountability." Interestingly Covid 19 has been a factor for the postponement of several elections, some of which were supposed to be post-conflict and transformational.    

Taking a cue from the literature one can examine the link between de facto accountability and the sovereign debt level owed by SSA countries. The corollary for this proposition is the evident question as to whether the lender, perhaps inadvertently, invested in sovereign debt instruments issued by unaccountable governments. Holding aside the public asset collateral and neocolonial allegation against China, unconditional cancellation of sovereign debt lets the unaccountable borrower off the hook and, does not make the country investable at some future (post-pandemic) period. As noted above the intent of bankruptcy protection/insolvency laws is to protect the borrower from forced liquidation and fire sale. The argument in favor of sovereign debt cancellation is not different. However, one must ask why previous debt cancellations have not worked.    

Both the World Bank and the IMF raise their concerns about the debt absorption capacities of SSA countries and, yet they are the main actors in the lending and developing complex and often unachievable conditionalities. Intrigued by this, in 2014, when Ethiopia went into the private debt market for the first time, together with my co-authors (Seid Hassan, Tesfaye Lemma, and Abu Girma), documented the unsustainability of Ethiopia's sovereign debt, cautioned the use of commercial debt, questioned the debt measurement method itself and the sourcing of the greater percentage of the debt from China. Since then several commentators, including the World Bank, have raised similar concerns.

The dooms and glooms of the virus have created a new opportune moment for the further undermining of de facto accountability and the thriving of radicalism, sectarianism, bigotry, and pastoral politics in the region. Evangelicalism of all types is thriving, capturing the states. On April 13, 2020, the IMF statement came amid these. The Fund's debt service relief for 25 poor countries, the majority of which are in SSA, is a drop in the sea of poverty and unaccountability. Strangely, Ethiopia was not on the list of the 25 countries.  On April 30, 2020 the Fund announced U.S. $ 411 million and another 12 million to "help Ethiopia meet the urgent balance of payment needs stemming from the COVID-19 pandemic". The statement also stated "…in addition, Ethiopia will benefit from the IMF Executive Board decision of April 13, 2020, to provide debt service relief to the poorest and most vulnerable countries". The statements did not mention debt cancellation or government accountability in poor nations. Critics speculated that the generosity is likely to make governments more unaccountable while others appear to be concerned with the well-known phenomenon of the Dutch disease

Local economists, central bank governors and finance ministers in Ethiopia, South Africa, and Zimbabwe predict a GDP "decline of 10%", "deep recession" and "social downfall". Hence, SSA countries are facing the multiple edged sword of debt burden, credit rate downgrading, the collapse of the currency, postponement of elections, and the resilience to adequately respond to the pandemic. The debts that are maturing now were created in part because of the historically low-interest rates in capital source countries. Pressured for high returns, investment managers in capital source countries engaged in risky opportunistic investment (low-grade speculative junk debt) instruments issued by low-income countries who also happen to have unaccountable governments. Notwithstanding these, the Fund's economists continue to downplay the effect of the virus in SSA, a mere "1.6% contraction" in GDP.

China, the single most lender in SSA, has lots of friends in the region:- the groups that control political power, the guanxi type trust (often built through family, clan, ethnic, faith, and political networking), and supported by opportunistic scholarship. China's supporters argue against debt cancellation and favor "relief" but not "forgiveness". Similar, to the IMF and the World Bank, they favor rescheduling (deferment) and debt-equity swaps which allow the lenders to get back their money and easily convert speculative investments to real assets such as land, natural resources, and SOEs at bargain prices and fire-sale conditions. They do not raise the issues of governance and accountability. The sugar-coated structural adjustment programs (SAPs) that concomitantly push for privatization facilitate the debt-equity swap, eases cross border transfer of wealth, and enforces collateral agreements on public assets. This deal is not only unfair to SSA but also allows authoritarian regimes to continue without being required to facilitate the building of institutions of accountability.

Hence, default/cancellation of sovereign debt need be designed in such a way that (i) it alleviates the debt burden so that SSA countries can release funds for spending in the fight against the pandemic and, (ii) conditioned upon evidence that the countries will administer an unfettered free and fair election, the cornerstone of de facto government accountability, within a defined period. Failure to do so on the part of the governments must have consequences, such as the transfer the debt to the ruling regimes (the ruling parties) and their nomenklatura, the primary beneficiaries of the previous debts. Resuscitating some of the features of the African Peer Review Mechanism (APRM) may serve as one avenue. A collective default via the African Union, to minimize the wrath of the lenders,  is more than likely to spark the cancellation. For the African Union, it would be a better decision than calling member States to cancel membership at the International Criminal Court. For China, government accountability in SSA has never been an issue, and debt cancellation can be construed as reparation while for the lenders in the Paris club, it is a result of investment in option type (speculative) instruments.  In short, there is a business as well as a governance case for the cancellation of sovereign debt owned by SSA countries.  Taking a cue from Argentina, Africa needs to play its cards well and put a new "offer" to the creditors while also seeing itself in a new mirror. 

 

 



[1]The author is a Professor of Accounting at the Metropolitan State University of Denver and a Visiting Professor at the  University of the Witwatersrand, Johannesburg. The views expressed in this commentary do not represent the institutions he is affiliated to.

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