Why haven't markets disciplined public finance management practices in African states?
On the political of economy of debt and public finance
According to the IMF, as of May 2022 “16 African countries were at high risk of debt distress, and 7 were already in debt distress.” The regional debt-to-GDP ratio is well above 66%, meaning that ever more scarce resources will be channeled to servicing debt rather than funding schools and hospitals, building infrastructure, or subsidizing much-needed improvements in agricultural productivity.
The rise in unsustainable indebtedness comes barely two decades since the Heavily Indebted Poor Countries (HIPC) and multilateral debt relief initiative (MDRI) of the 2000s — and evokes memories of the pain and suffering that characterized Africa’s lost long decade (circa 1980-1995).
One interesting feature of the current public debt crises in several African states is that contrary to (at least my) expectations, the confluence of competitive electoral politics and borrowing from private lenders does not appear to have disciplined fiscal policy. Nominally democratic Ghana and Zambia have found themselves in the same boat as countries with reasonably secure hegemonic parties like Angola and Mozambique.
While commercial loans and eurobonds comprise relatively small shares of African countries’ sovereign debts, for-profit private lenders may still influence Public Finance Management (PFM) practices by discriminating across borrowers.
This post answers three questions: 1) how did we get here given the horrendous history of the last major debt crisis in the 1980s? 2) is this time different from the 1980s? and 3) why haven’t markets disciplined public finance management (PFM) practices in African states?
I: How did we get here?
Briefly stated, African states got to this point because HIPC and MDRI created fiscal space for more borrowing (see figure below); economic growth (driven by sound macro reforms) enabled governments to get credit from private lenders, domestic and foreign; new bilateral lenders like China, India, Turkey, etc found opportunities to create markets for their firms; multilaterals re-discovered the virtues of big push infrastructure investments; and perhaps most importantly, increased political competition created incentives for incumbents to build all manner of visible and attributable stuff (and to overprice projects in order to pay for campaigns).
Much of the borrowing by African countries was sorely needed. Given their sectoral profiles, many African countries cannot simply save their way out of poverty (although more could be done to suppress consumption of imported luxury goods). The debt was needed to pay for roads, schools, hospitals, power generation and transmission, dams, pipelines, railways, etc.
Not all of the borrowed money was spent wisely. White elephants mushroomed. Projects were overpriced. Politicians acquired expensive real estate in foreign lands. Some ambitious policy bets did not pay off.
Overall, it would be erroneous to interpret the current debt crisis as evidence of unique levels of widespread corruption and misuse of borrowed funds in African states. In reality, African countries are witnessing the consequences of being poor with very small margins for error. For example, while all countries have stories of infrastructure boondoggles and failed bold policy bets, corruption or simple bad luck looks singularly reckless in low-income countries. With this in mind, the IMF’s Abebe Selassie is spot on when he notes that:
Government borrowing to finance public investments is an essential part of any country’s macroeconomic toolkit. Over the last two decades, countries in Sub-Saharan Africa have used this option often, greatly improving human development outcomes as a result. For example, between 1990 and 2015, average life expectancy increased, infant mortality rates were halved, secondary school enrollment soared, and infrastructure gaps narrowed. These and other gains would have been impossible without pragmatic spending of borrowed resources.
It is absolutely important that African policymakers and voters to learn the right lessons on how we got here. Just because mistakes were made (understatement, I know) and some bets did not pay off does not mean that everything about the development models of the last two decades should be cast aside. The region must not repeat the same policy mistakes of the 1980s.
II: Is this time is different?
How will the debt-distressed African countries weather the current crisis? Will we go back to the dreaded days of structural adjustment, painful cuts on social spending, and generalized economic collapse?
I don’t think so. Here are five reasons to believe that this time is different:
African states and policymaking processes are a lot more consolidated. Decades of accumulated policy expertise should ensure that the bottom doesn’t fall out like it did in the 1980s. Most people forget that the 1980s crisis could not have hit at a worse time. African countries were barely 20 years old, with many still in the process of figuring themselves out. Many also lacked policy expertise, instead being heavily reliant on foreign technical advisers. This created a conducive environment for major policy mistakes.
The domestic politics of adjustment have changed. As they address the current debt crisis, African policymakers will have to contend with the demands of democratic/electoral politics. As such, we are less likely to see the irresponsible choices that characterized the 1980s. While it’s true that some African policymakers pushed back against politically unpalatable structural adjustment programs, for the most part the Bretton Woods institutions and their Western backers essentially dictated policy to African policymakers who were in turn insulated from public opinion by autocracy (and structural departicipation).
African economies have changed. Before the COVID shock, African countries had clocked 25 years of positive growth. The growth was not merely driven by commodity exports (although the China-fueled 2000-09 supercycle helped). The service and (to a lesser extent) manufacturing sectors in African countries have emerged as important engines of growth and sources of resilience.
Furthermore, back in the 1980s the non-agricultural “informal” sector in most countries was relatively small (see the example of Kenya above). Its current large size in most countries is an under-appreciated source of resilience during periods of downturn (for the record, I despise the formal/informal distinction, especially because in most African countries the “informal” sector is the real economy on account of labor absorption).
The geo-politics of sovereign debt and defaults have changed. China and other non Paris Club lenders are now major sources of financing for African countries (see below). And as the example of Ghana (see below) shows, commercial lenders and eurobonds are also non-trivial sources of credit. This means that Paris Club members and the Western-dominated multilaterals have to contend with competition from China and other non Paris Club lenders. While negotiations in Ghana and Zambia are yet to conclude, I believe that this reality will likely reduce the ease of coordination on fiscal consolidation policies (i.e. austerity). The fact that these shifts are global (see also below) further reinforces the idea that the handling of the current debt crisis will be different.
The intellectual zeitgeist is also different. Industrial policy is back in vogue, big time; performative infliction of pain on workers and the poor in the name of fiscal discipline is now frowned upon; concern over inequality is more salient (including among economists); and even the IMF now questions the virtues of neoliberalism (by which I mean market fundamentalism). All this to say that the ideational posture in the current environment reduces the likelihood of all African countries being forced to accept wrong procrustean policy prescriptions like happened in the 1980s. Restructuring processes will continue to be sympathetic to public spending.
III: On markets and public debt
Back to the original question in the title of this post: why haven’t markets disciplined public finance management in African states? By discipline here I simply mean the process through which debt markets create incentives for prudent spending and debt management. The assumption here is that better run countries get loans at lower rates.
Three main factors may explain why markets (esp. commercial lenders & eurobonds) haven’t helped the affected African countries avoid debt crises.
Two-way moral hazard involving foreign creditors
Under normal conditions, markets are supposed to hold the line when it comes to debtors’ reputations. In reality, however, most market lending operations typically come with presumed sovereign guarantees — which expose creditors to sovereign-to-sovereign compromises. For example, when a firm like Glencore lends money to Chad, it is very likely that the transaction doesn’t solely rely on Chad’s concerns about its reputation on debt markets (executives at Glencore may be unimaginably corrupt, but presumably they aren’t stupid).
To ensure repayment, Glencore executives may lean on a European sovereign to influence Chadian officials directly or through multilaterals in which the sovereign has influence. Chad, too, may (perhaps for geopolitical reasons) lean on the European sovereign and associated multilaterals to assure Glencore that it can deliver on its commitments. The net result is that the market reputations of countries like Chad lose their bite, and risk-loving firms like Glencore keep lending them money in the hopes of blockbuster returns. Importantly, under these conditions countries like Chad are likely to ignore prudential public finance management as a means of strengthening their reputations in credit markets. Sovereign debts are almost always negotiable.
The circularity is such that rating agencies rely on multilaterals in their opinions about country outlooks, while multilaterals often aren’t typically motivated by market reputation concerns. So in the end you get what Grieve Chelwa describes in the case of Zambia:
After having much of its external debt written off in the mid 2000s as part of the Heavily Indebted Poor Country initiative, Zambia began to unsustainably accumulate new debt in 2012. The new debt cycle was facilitated by the country getting a sovereign debt rating in 2011. The rating was bestowed by the international ratings agency Fitch, which, at the time, considered the country to have a “stable” outlook in so far as the risk of default was concerned.
With Fitch’s blessing secured, dollars began to flow into Zambia, heralding the era of the international financialisation of the country. In September 2012, Zambia issued its first Eurobond worth $750-million to much fanfare on Wall Street. This bond issuance was so oversubscribed that two additional bonds totalling $2.25-billion were issued in 2014 and 2015, bringing the total bond outstanding to $3-billion.
Poor linkages to political institutions of enforcement
As an interest group, creditors stand to benefit from serving in important institutions through which they can directly compel sovereigns to prudently manage public finances and pay their debts — often in legislatures or as shareholders of central banks. All else equal, the payoffs associated with this tactic would be negatively correlated with quality of governance. That is, creditors ought to invest in means of direct enforcement of repayment in contexts with a history questionable PFM practices.
Yet I cannot think of a single African country where creditors (domestic or foreign) have ever had, as corporate entities, direct representation in legislatures or on the boards of central banks. The lack of capacity for direct enforcement leaves creditors reliant on multilateral processes of debt restructuring as a remedy to default instead of market reputation backed by credible threats of proactive direct interventions to influence PFM practices.
Bankers don’t always care about sovereign reputation risk
One of the more bizarre episodes of commercial lending gone bad is Mozambique’s “tuna bond” scandal. The banks involved were Credit Suisse (Switzerland), BNP Paribas (France) and VTB (Russia). According to the guardian:
The tuna bonds scandal arose from $1.3bn (£940m) worth of loans that Credit Suisse arranged for the Republic of Mozambique between 2012 and 2016. The loans were said to be aimed at government-sponsored investment schemes including maritime security projects and a state tuna fishery, located in the capital Maputo. However, a portion of the funds were unaccounted for, with one of Mozambique’s contractors later found to have secretly arranged “significant kickbacks” worth at least $137m, including $50m for bankers at Credit Suisse meant to secure more favourable deals on the loans, according to regulators.
Such schemes were not limited to Mozambique. In fact, many African governments that could get access preferred commercial loans and eurobonds because, unlike official (bilateral or multilateral) loans, they came with little scrutiny and were seldom tied to specific projects.
It goes without saying that the mechanism for market discipline collapses when bankers knowingly lend money to money laundering officials.
IV: Concluding thoughts
First, it is important to understand how African countries found themselves highly indebted, barely two decades after HIPC and MDRI; and why the advent of commercial loans and eurobonds did not discipline PFM practices.
Since African countries cannot simply save their way to prosperity, debt should not be uncritically vilified. These countries will continue to borrow and make (smart) risky bets. Some of those bets will fail, resulting in losses.
One cannot rely on markets to discipline PFM practices. Moral hazard, lack of institutional mechanisms of enforcement, and corruption limit the influence of commercial borrowing on PFM practices.
Second, policymakers and voters should internalize the right lessons from the last 20 years. Those lessons ought to include:
The need to democratize public finance management, in part by increasing public participation and the role of legislatures (recall that Mozambique hid its tuna bond loans from parliament). This will increase the odds of borrowed money being spent well, and that the right kinds of bets are made. It will also safeguard government legitimacy (and integrity of sovereign debts) when some bets fail.
The fact that societies and political systems learn best by doing. As long as governments are run by fallible men and women, mistakes will be made. And when that happens, we should heed Mkandawire’s caution against unnecessarily pathologizing policymaking in African states. Instead, we should endeavor to learn from the mistakes and move on to a higher plane of operation. This means always having the right perspective even when it seems like the sky is falling (think Ghana and Zambia today) on account of the fact that low-income countries often have very little margin for error.
To reiterate, this time will be different.
Nice piece. All I'd add is a paragraph or two about why SSA govts can't save themselves to prosperity, when so many in Asia can, and some in Africa can (thinking Morocco / Mauritius as examples in the last 20 and 40 years respectively). The why appears to be related to fertility and the ability of families to save money (pretty well impossible for many families with 4+ kids, but possible and normal when the average drops to 2-3 kids). The Time Travelling Economist published last year flagged this link. To avoid another default/borrowing/default scenario in 20 years, some countries need to consider this link - and the attention of widespread female education as a support for this change