Issues and Options
- I. Patel
- Published Date:
- December 1992
The sluggish economic growth and declining per capita income in Africa during the last decade are the combined result of adverse institutional and natural circumstances, depressed commodity prices, and, in some cases, poor economic policies. This disappointing economic performance has been accompanied by rapid growth in Africa’s external debt. At the same time, stagnant export earnings have been stagnant and the balance of payments position of most African countries has deteriorated. External arrears have grown sharply, and large amounts of those arrears and scheduled debt-service payments have been restructured. Arrears on debt service have interrupted some aid flows and new loans from commercial sources have dried up. Against these trends, however, overseas development assistance (ODA) and grants to African countries have risen.
The above broad brush treatment of the aggregate economic situation of the region, and of sub-Saharan Africa in particular,1 masks the considerable diversity among the individual country situations. As the adjustment and financing experiences and the prospects of African countries are not the same, a case-by-case approach is essential in dealing with the debt situation.
Three themes relating to the debt situation in Africa are discussed in this paper. The first relates to the various country circumstances, and, for illustrative purposes, three broad country categories based on financing situations are distinguished: countries that have avoided rescheduling, countries with temporary debt-service difficulties, and countries with unsustainable debt situations. The second theme concerns the distinction between actual and scheduled debt service, and it is noted that actual debt-service payments (relative to exports) have been broadly unchanged since 1983. In view of the cash-flow relief obtained, the third theme relates to the impact of the outstanding stock of debt burden on the economic performance and prospects of African countries. Although an excessive stock of debt may harm growth prospects, there is little evidence that it is the immediate factor underlying the poor investment levels and economic performance in Africa.
Finally, some issues relating to the heavily indebted African countries are examined. For them, the debt situation appears to be unsustainable even with the adoption of policies to transform the economy and raise payments ability in the future; the poor prospects for honoring loan contracts and normalizing relations with creditors within a reasonable time frame suggest that fundamental debt relief may be required. A combination of appropriate debt relief, efforts to promote exports, and adequate flow of resources in support of growth-oriented reform programs would go a long way toward achieving a sustainable economic situation in such cases.
Several African countries have had repeated reschedulings with official and commercial creditors over the last decade; others have been able to service their debts in full through prudent economic and debt management policies and other forms of assistance. Some countries are indebted almost exclusively to official creditors, and their debt is mainly on concessional terms, whereas others have substantial debts to commercial creditors.
For illustrative purposes, three broad categories of countries in terms of financing situations may be distinguished. The first group has been able to maintain full debt-service payments and avoid rescheduling. It includes some countries that have heavy debt burdens in terms of conventional debt ratios. Confronted with external and domestic shocks, many of these countries have implemented significant policy adjustments to help retain access to capital markets and official credits. Preserving access to external financing is crucial, and the experience of the last decade has underlined that the costs of rescheduling and loss of access are high and often long lasting. For these countries, the level of debt may not be a problem, but debt management is. When they face temporary difficulties, prompt official assistance can help support sound economic policies that give confidence to domestic and foreign savers and investors. In the future, it would be hoped that they could rely to a greater extent on private flows, including in particular non-debt-creating equity flows.
The second group of countries has been temporarily unable to meet external obligations in full and may not yet have normalized relations with creditors. These countries have obtained support mainly in the form of the rescheduling of debt-service obligations—in some cases based on concessional options—and the provision of new credits. This support has been provided in conjunction with domestic policy efforts to adjust to external shocks and to reorient the growth strategy. With the sustained implementation of appropriate adjustment and reform policies, countries in this group could be expected to service their debts fully in the foreseeable future. Indeed, some have already graduated from debt rescheduling to normal debtor-creditor relations. For this intermediate group, when commercial bank debt stands at a significant discount, market-based debt buy-backs and exchanges would be beneficial for attaining a viable balance of payments position but are not essential. The opportunity cost of undertaking such operations would need to be carefully weighed.
The third group of countries has very high debt burdens, based on conventional indicators. Their debts are mainly to official creditors, but, in some cases, those to private creditors are not negligible. The rescheduling of debt on conventional terms with the capitalization of interest payments has resulted in an increase in the debt stock. This would be sustainable only if the debtor is undergoing a transformation that will raise its payments ability in the future.2 The experience, however, of many of these countries during the last decade suggests that this is not happening and that they may have passed the point where they are able to reduce consumption or increase production sufficiently to create the necessary surplus for full debt service. This group of countries, most of which are in sub-Saharan Africa, tends to get the most attention in the discussion of the debt problem in Africa, and is hence the focus of much of the remainder of this paper.
Scheduled and Actual Debt Service and Net Resource Flows
At the end of 1989, the estimated debt of all African countries was about $210 billion, or some $80 billion higher than at the end of 1983. Total debt was equivalent to over half of their gross domestic product (GDP) and nearly two and a half times their exports.3 For sub-Saharan African countries, these ratios are higher still and are considerably above those of developing countries in other regions of the world—total debt is equivalent to about three fourths of their GDP and nearly three and a half times their exports.
Much of the outstanding debt of sub-Saharan African countries is owed to official creditors, often on concessional terms. As a result, although debt has increased sharply (in both absolute and relative terms), scheduled debt service as a percentage of exports has increased less dramatically, by only 12 percentage points since 1983 to around 44 percent in 1989 (Table 1). The ratio of actual debt-service payments to exports, however, has remained roughly constant at around 21 percent of exports, because of reschedulings and the accumulation of arrears (which were often subsequently rescheduled).4 In 1983, sub-Saharan African countries had paid two thirds of scheduled debt-service payments; by 1989, this ratio of actual to scheduled debt service had declined to less than half.5 The actual debt-service payments, measured against exports, have thus remained broadly unchanged as countries have obtained cash-flow relief from their creditors. By postponing governments’ external debt-service payments, reschedulings have permitted higher public sector savings and freeing of resources for domestic expenditures. Of course, as the debt reschedulings have usually involved the capitalization of interest, the stock of debt has increased thus increasing future scheduled payments.
|(In billions of U.S. dollars: unless otherwise noted)|
|Stock of external debt||56.2||58.4||69.1||80.8||95.8||100.1||105.5|
|Medium- and long-term||49.6||52.3||61.6||72.3||84.8||88.1||92.4|
|Scheduled debt service||7.9||9.3||9.7||10.2||11.3||13.1||13.6|
|Payments not made2||2.7||3.1||3.9||4.3||5.6||6.6||7.1|
|Actual and scheduled payments||66.0||66.8||59.9||57.8||50.3||49.7||47.9|
|(In percent of exports of goods and services)|
|Stock of external debt||226.6||221.2||271.0||303.8||331.5||338.2||341.4|
|Medium- and long-term||200.0||198.1||241.6||271.8||293.4||297.6||299.0|
|Scheduled debt service||32.0||35.3||38.1||38.3||39.0||44.3||44.1|
|Payments not made||10.9||11.7||15.3||16.2||19.4||22.3||23.0|
|Export of goods and services||24.8||26.4||25.5||26.6||28.9||29.6||30.9|
There is, however, marked dispersion around these aggregate figures. For example, in 1989 the scheduled debt-service ratio in Mozambique was 178 percent, but actual payments amounted to 32 percent of exports. Scheduled debt-service payments in Madagascar also exceeded annual exports in 1989, but after debt relief actual payments amounted to 59 percent, around half the scheduled amount—though still high by any standard. In Tanzania, actual debt-service payments in fiscal year 1988/89 amounted to less than 5 percent of exports, while scheduled debt-service payments were some 56 percent of exports. Similarly, in Zambia scheduled debt service amounted to 57 percent of exports in 1989, but only the equivalent of 15 percent was actually paid.
For sub-Saharan Africa, the aggregate current account deficit excluding official grants was $13.4 billion in 1989, nearly double the nominal amount in 1984 (Table 2). About one third of this increase was accounted for by the rise in scheduled interest payments; the remaining two thirds was essentially the result of increasing trade deficits as imports increased faster than exports. New financing was provided through two main channels: grants from official sources and external borrowing (net of scheduled amortization payments), also mainly from official sources. In addition, countries have obtained exceptional financing in the form of debt reschedulings, which provided cash-flow relief on interest and amortization payments, and have accumulated arrears on debt-service payments.
|Services and private transfers (net)||-7.6||-7.6||-7.9||-9.2||-9.4||-10.1||-9.5|
|Of which: scheduled interest payments||-3.2||-3.8||-4.1||-4.4||-5.1||-5.6||-5.8|
|Deficit on goods, services and private transfers||-9.1||-6.5||-7.1||-10.1||-11.1||-13.4||-13.4|
|Other non-debt-creating flows||0.4||0.6||0.7||0.8||0.5||0.6||0.8|
|Net external borrowing||2.9||0.4||-0.1||2.2||0.9||1.6||1.1|
|Other net flows and net errors and omissions||-1.5||-1.1||-0.6||-0.3||-0.1||-0.3||0.0|
|Net resource flow3||6.2||2.9||3.4||6.4||6.2||8.3||8.4|
|Actual debt service||-5.2||-6.2||-5.8||-5.9||-5.7||-6.5||-6.5|
|Other net outflows and net errors and omissions||-1.5||-1.1||-0.6||-0.5||-0.1||-0.3||—|
|Disbursement from loans||7.6||5.9||5.5||8.0||7.1||9.1||8.9|
The net resource flow to sub-Saharan African countries has increased sharply from an average of $4 billion in 1983–85 to over $8 billion in 1988–89.6 Data reported in the World Bank’ s debt tables lead to a similar conclusion: net transfers increased from an average of $4.8 billion in 1983–85 to $8.7 billion in 1988–89.7 These figures are in contrast to the assertions sometimes made that the international community has been withdrawing resources from Africa. Often, such assertions are based on the export of real resources from Africa by way of debt service; they do not take into account the import of resources through grants and soft loans.
In view of the cash-flow relief on interest and amortization payments obtained through debt reschedulings, it is worthwhile to examine how excessive external debt affects economic performance. This is taken up in the next two sections.
Debt and Economic Performance
The poor investment and growth performance of highly indebted developing countries in the past few years has often been attributed to the large stock of their foreign debt. It is argued that when a debtor country is not fully performing on its external obligations, an increase in production and exports may be used at least partly for payments to foreign creditors, which gives rise to a disincentive effect for foreign and domestic investors. This disincentive problem, which has been referred to as the “debt overhang,” arises mainly when the debtor is unable to meet its scheduled debt-service obligations and the amounts actually paid are subject to uncertainty. This uncertainty arises in part due to the need to renegotiate frequently the terms of the debt. In brief, the debt overhang hypothesis states that the accumulated debt acts as a tax on future income and discourages productive investment plans of the private sector. Based on this hypothesis, it has been argued that if the amount of debt burden is excessive, reschedulings that provide only cash-flow relief and do not reduce the outstanding debt will not be sufficient to restore investor confidence.
Although a substantial body of theoretical literature on the effects of excessive debt on investment exists, little empirical work is available on the subject, which itself is symptomatic of the difficulties implicit in attempting such an evaluation.8 In practice, an evaluation of the impact or either market-based debt reduction of outright debt forgiveness on countries’ investment and growth performance must be preliminary and extremely tentative, because they are recent events and experience is thus limited; also expectations are notoriously difficult to measure. Moreover, the scale and timing of the effects of debt reduction will depend importantly on the domestic policy environment and the other policy reforms taking place at the same time.
In the 1980s, investment rates in Africa were among the lowest in the developing world. While gross capital formation in Africa ranged between 19 percent and 21 percent of GDP during 1983–89, the corresponding figures for Asia were 27 percent and 29 percent. The difference is further magnified by the low returns to investment (measured simply as the ratio of the growth of output to the rate of investment in a given year) in many African countries. Comparative figures cited in the World Bank’ s long-term perspective study on sub-Saharan Africa indicate that the average annual return on investment in sub-Saharan Africa declined from 13 percent in 1973–80 to 2.5 percent in 1980–87, while in South Asia it averaged around 22 percent throughout the two periods. The study concludes that neither drought nor falling world demand is the reason for the low and declining returns to investment in sub-Saharan Africa, nor the debt burden. Instead, in explaining the low productivity, it notes that “Africa’s crop yields are smaller, its cropping cycles on irrigated land are fewer, its transport costs are higher, and its utilization rates for factory capacity are lower.”9
Indeed, for many African countries, the external debt has become a heavy burden because past borrowing—undertaken mainly by the public sector, including public enterprises—has generally not resulted in a commensurate increase in the productive capacity to service the debt. Much of the borrowing, often on inappropriate terms, was incurred to finance investments that yielded little or no return; in such circumstances, even debt on concessional terms can impose a heavy burden. In many cases, external borrowing financed unrealistically high exchange rates and flight capital and was used to maintain domestic consumption—particularly government expenditures, including on the military—at levels which proved to be unsustainable.
In the absence of empirical studies on Africa, it is difficult to arrive at a firm judgment of the impact of debt on investor confidence. For many African countries, it would seem reasonable to postulate that debt is not the immediate factor underlying poor investment levels and the low yield of investment. Misaligned relative prices (exchange rates, interest rates, producer prices, wages), distortionary trade policies, an inadequate financial intermediation system, poor infrastructure, lack of human capital, an unsuitable climate for entrepreneurship, and low levels of domestic and foreign savings are perhaps more important in the African context.
If low investment has primarily been the result of structural impediments and distortions rather than a debt problem, reducing debt without removing other distortions would not be expected to increase investment significantly. That is, policies that discourage domestic investment and inhibit the private sector must be remedied. But, this is not to say that some countries do not have excessive debt. Rather, due to the low productive levels and narrow tax base in some of these economies, there may simply be little that the authorities could hope to further “tax away” to pay its creditors. On this hypothesis, once structural impediments and distortions are removed, the relative importance of the amount of outstanding debt when making investment decisions may increase.
Issues Concerning Countries with Unsustainable Balance of Payments Prospects
The section on country circumstances referred to a group of countries whose debt situation is such that rescheduling debt on conventional terms would unlikely bring about a viable balance of payments position within an acceptable time frame or at a reasonable level of economic growth. For these countries, the future normalization of relations with creditors will remain difficult if debt service falling due is in practice simply capitalized and postponed.
Even if the debt situation is not the immediate factor underlying the poor economic performance of these countries and a variety of structural impediments must also be addressed, the reform efforts of governments may themselves be affected by the existence of a debt problem. For example, frequent reschedulings create an uncertain economic climate and use up the scarce management resources of these countries. In addition, having arrears can dry up new loan commitments and disbursements of existing loans. As a result, the formulation of adjustment programs becomes difficult. Furthermore, the emergence of arrears often leads to substantial increases in effective import prices, as foreign suppliers—unsure of being paid on time or at all—charge premium prices for their goods and services.
The possibility of rescheduling debt may also introduce an element of moral hazard in the relationship between debtors and creditors. If a country adjusts successfully, the resources provided through future reschedulings falls, which may be viewed as a tax on reform efforts. Although creditors attempt to prevent this by requiring debtor countries to adhere to an adjustment program before agreeing to a rescheduling, the incentives to relax the adjustment effort once the debt relief is obtained may still exist. Moreover, the lack of adjustment itself could act as a disincentive to private investment. Under these circumstances, far-reaching debt relief may be required when long-run prospects are particularly bleak.
Conventional rescheduling practices assumed that loan contracts could be rewritten maintaining the contractual value of the debt, but with some “breathing room” before payments needed to be made. It is now increasingly recognized that the payments difficulties of some countries are deep-rooted and their indebtedness is clearly out of line with their export potential. It is unlikely, therefore, that these countries can normalize relations with creditors within an acceptable time frame unless the average terms of their debt are reduced significantly. That is, for some countries, contractual obligations need to be brought into line with what can reasonably be expected to be honored in the future; for these countries, there are strong arguments for fundamental debt relief. As commercial bank claims are only a small portion of these countries’ debts, debt relief initiatives by official bilateral creditors will be a key element. Private creditors, however, would clearly need to share the burden of debt relief measures.
The challenge of addressing Africa’s imbalances is enormous. Clearly, for some African countries a solution to the external debt problem needs to be found that, at the same time, meets the objectives of recovery and growth.
In this regard, African governments are recognizing that the key for improving the situation is domestic, and a number of countries have embarked on a process of structural and financial adjustment. Sustained economic growth requires greater and more efficient investment and higher domestic and foreign savings to support this investment. Higher foreign savings, in turn, requires confidence on the part of creditors, donors, and investors that the recipient country will pursue economic and financial policies conducive to restoring creditworthiness. Higher savings and investment will only bring about lasting economic growth if investments are productive; this requires structural reforms in a number of areas.
At the same time, the international community has recognized that many African countries cannot turn the corner on their own, even with stronger domestic adjustment efforts. Creditors and donors have shown a willingness to support countries that are undertaking sound growth-oriented adjustment and reform programs. The debt strategy pursued in the last several years has been explicitly based on a cooperative approach between creditors and debtor countries. There has recently been considerable adaptation of the strategy with regard to the rescheduling terms for certain groups of countries. But it is clear that for some African countries more needs to be done on this front.
The IMF and the World Bank can play a role in this process by assisting countries in the design and the implementation of comprehensive macro-economic and structural reform programs and by supporting such programs with adequate resources. As of the end of August 1991, 23 African countries had IMF arrangements in place: 1 extended arrangement and 4 stand-by arrangements for middle-income countries, and 6 arrangements under the structural adjustment facility and 12 under the enhanced structural adjustment facility, for low-income countries.
The IMF also stands ready to assist member countries in arrears to the IMF to become current again. For the countries with protracted arrears to the IMF, the Executive Board of the IMF has endorsed the concept of a “rights” approach, under which a country could accumulate rights—conditioned on performance during the period of a program monitored by the IMF—toward a disbursement of IMF resources once its arrears have been cleared. In addition, external resources are required to meet the country’ s financing needs during the program period, such as its import and other direct financing requirements, including obligations falling due to the IMF and the World Bank. To complement the country’ s own efforts to meet these obligations, the assistance of support and consultative groups, often in the context of the World Bank’ s Special Program of Assistance for Africa, is envisaged. To enhance the effectiveness of this approach, the IMF has also decided to suspend the application of special charges, which fall mainly on overdue charges, for those members that are actively cooperating with the IMF.
In sum, the active and coordinated participation of creditors and donors is essential in supporting the efforts of the African countries. African countries, however, must themselves come forward with appropriately strong programs that the international community can support. The challenge of achieving economic recovery and a sustainable solution to the external debt problem can be met with strengthened and concerted efforts by all.
In this paper, sub-Saharan Africa comprises all African countries, except Algeria, Morocco, Nigeria, South Africa, and Tunisia. All data are taken from International Monetary Fund, World Economic Outlook: A Survey by the Staff of the International Monetary Fund, World Economic and Financial Surveys (Washington, October 1990), unless noted otherwise.
For sustainability, the stock of external debt (expressed, for example, in terms of U.S. dollars) must grow more slowly than nominal GDP (expressed in the same currency as the stock of debt). If the average nominal interest rate on the external debt is lower than the growth of nominal GOP, sustainability would allow for a deficit on the current account (excluding interest payments and including official transfers), but with a limit on its size.
In the context of debt ratios in this discussion paper, the term exports applies to exports of goods and services. When relevant, workers’ remittances are included as a part of service receipts.
Between 1980 and 1983—a period of declining exports, rising trade deficits, and, consequently, high external borrowing by sub-Saharan Africa—both scheduled and actual debt service as a percentage of exports rose by about 5 percentage points.
As a number of countries continued to service their debts as scheduled, the decline in payments actually made by countries that rescheduled is therefore substantially larger than the average.
’ The concept of net resource flows, as used in the IMF’ s World Economic Outlook, is the sum of the deficit on goods, services (excluding scheduled interest payments), private-transfers, and the net accumulation of reserves.
The World Bank, World Debt Tables, 1990–91, Vol. 1 (Washington, 1990), page 130. In this case, net transfers (excluding IMF transactions) are calculated as loan disbursements plus official grants and foreign direct investment, minus total debt-service payments (interest and amortization).
One contribution in this area is an econometric study on the Philippines, which discerns a debt effect as a factor depressing private investment after 1982 (sec Eduardo Borensztein, “Will Debt Reduction Increase Investment?” Finance and Development (Washington), Vol. 28 (March 1991), pages 25—27). Some evidence of a link between debt restructuring and economic performance is also provided by the case of Mexico, where domestic interest rates declined by over 20 percentage points to a 33 percent nominal annual rate following the announcement in July 1989 of the preliminary agreement with banks on a comprehensive debt- and debt-service reduction package. This was accompanied by large inflows of private capital contributing to a 5 percent real increase in domestic investment in 1989, and the acceleration of real output growth to 3 percent, twice its level in preceding years.
The World Bank, Sub-Saharan Africa: From Crisis to Sustainable Growth (Washington, 1989), pages 26–27.