The tide seems to have turned for emerging and African markets as slower growth rates cause investor money to seek better prospects elsewhere. The previous global investor favourites, African markets, are suffering severe market pressures.
In many ways, the current situation is a “perfect storm”, which has seen structural and cyclical issues combine to create twin deficits, rising inflation, rapidly depreciating currencies, multiyear low growth rates and a run on foreign exchange reserves.
Nowhere is this pinch felt more acutely than in Zambia and Ghana – both were touted as rising African stars, but now were cited by the International Monetary Fund (IMF) as the most vulnerable to debt distress.
The Zambian economy is under siege. The country is battling with a host of issues, both domestic and external. On the external front, the slowdown in the Chinese economy, emerging market risk aversion and a plunge in commodity prices have taken their toll, while internally the country is facing a power crisis, fiscal pressures and an election next year.
The combination of these issues has seen the Zambian kwacha become the worst performing currency over the past year, losing more than 80 percent of its value. Zambia’s situation bears similarities to those exhibited in Ghana around its 2012 election, which has raised alarm that it could be heading down the same path.
Ghana, formerly the darling of west Africa, and one of the fastest growing economies in the world, is in the middle of a major economic crunch. From a stellar 13.6 percent growth rate in 2011 driven by bumper cocoa, gold and oil revenues, the country’s economy deteriorated significantly to the point it was forced to seek external assistance to remedy its problems.
Like Ghana, Zambia’s economy is characterised by a lack of confidence arising from policy drift rather than decisive action at a time of economic trouble. But how exactly did these countries slip so badly? Zambia’s maiden eurobond issuance in 2012 was issued at a lower yield than Spain, while Ghana was the fastest growing economy in the world in 2011.
Strong growth in the last decade allowed both countries to achieve lower middle income status and tap international capital markets, while prudent macroeconomic management and the adoption of market liberalisation policies boosted their investment profiles.
Buoyed by a favourable commodity cycle, the countries displayed strong growth rates in the aftermath of debt relief, and were lauded as politically stable multiparty democracies with track records of peaceful transfers of power – a rarity on the African continent.
However, in many ways, these mature political systems are actually the reason for the turbulence. Many of these issues can largely be traced to the “political business cycle” around elections, and particularly excesses in relation to wage increases as incumbent parties are distracted by the prospect of re-election, and become lax. Indeed, this lack of fiscal discipline is at the heart of both countries’ problems.
Fiscal slippage
Ghana’s macroeconomic governance and structural reforms have been known to suffer from political budget cycles; the 1996, 2000, 2008 and 2012 elections were noted for high, unplanned expenditures by governing parties to renew their mandates.
Similarly, in Zambia, lifting of the public sector wage freeze has led to the expectation of fiscal slippage in the run-up to elections in November 2016, which would be disastrous in the current context.
In addition, both countries have used debt as a form of revenue. Capitalising on the positive sentiment towards emerging markets in the aftermath of the global financial crisis, African governments facing falling levels of foreign aid went on a borrowing spree to pay for new roads, power stations and other infrastructure, which ratcheted up debt levels.
With foreign aid declining and financing gaps remaining across the continent, both for capital expenditure on infrastructure and to plug short-term fiscal deficits, the countries are swopping concessional lending for capital markets. Yield-hungry investors have snapped up the bonds but many are concerned about the longer-term implications of rising government debt, slow structural reform and worsening macroeconomic indicators in some of the region’s most important economies.
Many are asking the question whether the trends are, in fact, sustainable in light of declining commodity prices and the prospect of monetary tightening in the US. Are short-sighted financial markets, together with short-sighted governments and investors, laying the groundwork for a debt crisis? The staggering 9.375 percent and 10.75 percent interest rates on Zambia and Ghana’s latest eurobonds reflected a marked change in investor sentiment.
Debt stock reaching levels closer to those before times of debt relief together with the strong US dollar has put pressure on currencies, causing debt servicing costs to spike significantly. If debt servicing costs continue on the current path, sovereigns will become heavily indebted to private financial institutions and not to the World Bank or IMF this time. This will make it more difficult to renegotiate or restructure sovereign debt.
With undiversified revenue streams, narrow tax bases and structurally constrained economies, the magnitude of the problem could be significant if not approached with prudence.
Boom bust
Domestic own goals have not helped matters either. In February 2014, Ghana’s central bank introduced a string of foreign exchange controls in a bid to halt the depreciation of their currency, the cedi, resulting from chronic trade and current account imbalances.
Similarly, in Zambia, the introduction of the SI 33 and later SI 32 exchange controls to limit transfer pricing by the mining sector left many businesses confused: many raised concerns that the regulation was rushed, clumsy and not thoroughly thought out by the authorities, due to numerous operational snags.
Zambia’s clashes with the mining sector around the implementation of the VAT Rule 18, the revision to the mining royalty tax regime, fuelled further uncertainty.
Ultimately, in Ghana, ballooning government debt and falling export revenue triggered a 31 percent plunge in the currency against the dollar in 2014, which left the cash-strapped government with no option but to turn to the IMF for financial and technical assistance.
A sense of a spiralling crisis has been growing in Zambia for several months, leading to speculation that the country will also turn to the IMF for financial support.
While an IMF programme could serve as a nominal policy anchor, which would provide investors with an additional level of confidence and open the doors for fiscal consolidation, it is likely to be met with political resistance due to the fact that such a programme would entail huge conditionality, which is less than ideal in the run-up to another tightly contested election in 2016.
As a result, authorities will attempt to “kick the can” and avoid this until after the 2016 elections, given that such a turn of events would be grasped by the opposition as evidence of economic mismanagement by the government.
Negative sentiment towards emerging markets is running high, with the steep plunge in commodity prices exposing the susceptibility to boom-bust scenarios of many African countries in particular.
Without the requisite political will to adopt the policy measures required to reform structurally, many sovereigns may again end up in the IMF casualty ward due to the combination of spiking debt serviceability costs, lower growth and revenues, poor tax collection and the absence of diversified economic bases.
* Ronak Gopaldas is the head of country risk at Rand Merchant Bank.
** The views expressed here do not necessarily reflect those of Independent Media.
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