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28th May 2023

Feature

The battle to fix the 'rigged' financial system needs a strong African voice

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"The financial system is, to put it bluntly, rigged against the Global South," the president of Kenya William Ruto said at the Mo Ibrahim Governance event hosted in Nairobi last week.

He was referring to the fact that poor countries pay much higher borrowing costs than wealthy countries—often between 10 and 20 percent, instead of just a little over zero—which is hampering their ability to deal with other crises such as climate change.

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"At 10, 12, 15 percent it becomes impossible. Impossible!, to meaningfully address our development needs using the financial resources from this architecture," he said.

Named after its eponymous founder, the Sudanese telecom billionaire Mo Ibrahim who was also the interviewer, the annual event has become an important forum for African leaders to speak candidly about the challenges facing African development and the failings of global finance.

"It is our responsibility to engineer the conversation, and put on the table a view of a financial system that works for everybody," Ruto said. To strengthen the African presence on the global stage African leaders have agreed that the African Union chair and a small team of AU commissioners should from now on represent Africa at meetings with foreign leaders. "It isn't intelligent" for all 54 African leaders to travel to the US or Japan to meet a "single foreign leader" to discuss bilateral relations. "Sometimes we are loaded into buses like school children. And it is not right."

Although admitting the reluctance among many African leaders to "relinquish" sovereignty to the AU — "we can't even support Somalia with $85m," he said — the push to unite at the global stage has been gaining momentum. African finance ministers recently demanded the African Union be confirmed as a full member of the G20 before the end of the year.

Coming out of the IMF and World Bank's Annual Spring meeting in Washington in April, they also laid out a five point plan for global financial reform, including a demand for more low-interest loans, to unlock the IMFs unused reserve assets for poor countries and a solution for the €3,9 trillion debt problem hanging over the developing world today.

The treatise is part of a global push to reform the financial system, a subject too complex to cover all at once, so here the focus is on two aspects: debt, and borrowing.

Worst debt crisis in a generation

One of the biggest problems facing poor countries today is the cost of borrowing and by extension the servicing cost of debt through interest payments. This is a problem that is not limited to the African continent.

According to World Bank figures 60 percent of the developing world — representing 40 percent of global GDP — is at risk of defaulting on loans, which in practice means bankruptcy. Marcello Estevao, global director of macroeconomics at the World Bank, recently described this as "the worst debt crisis in a generation."

The problems are such that the IMF, the World Bank, big private creditors such as Blackrock, bilateral lenders and debtor countries launched the Global Sovereign Debt Roundtable in February. The goal: to come up with a transparent, predictable way to deal with debt relief in countries that have defaulted on their loans.

The world currently has no standard approach of dealing with debt. Following the pandemic, the Group of 20 (G20) wealthy countries launched a "common framework" for debt resolutions, but this has failed to bring all creditors together.

Resolving debt problems quickly is crucial because countries facing default are unable to pay wages of civil servants, pay for health care services and generally perform state roles.

At least seven of a total of 21 troubled countries have been waiting more than a year for a debt deal since defaulting. The Annual Spring Meeting in Washington was a high water mark in these negotiations because for the first time, debtor countries — Ecuador, Ethiopia, Ghana, Sri Lanka, Suriname, and Zambia — had a prominent seat at the table.

But to try and look for progress in these negotiations turned out to be beside the point. Yes, the World Bank pledged to free up additional lending worth €5bn a year, and yes, disagreements between China and the West softened somewhat (more on that later). But poor countries have to raise €2.5 trillion over the next five years just to pay off creditors.

What the Roundtable has offered in solutions is a "drop in the ocean," said David McNair, executive director of the ONE campaign, a global campaign to end poverty.

To put some concrete figures to that statement: according to the World Bank, Nigeria — Africa's biggest economy — spent 96 percent of all the revenues on foreign investors. Pakistan, which recently suffered the worst flood in recorded history with cost for rebuilding estimated at €30bn — exceeding its total annual budget — spends 50 percent of its budget on debt. As does Egypt.

"Whatever we do, when we look ahead, debt is growing, and our economy is slowly shrinking. From my party's point of view, we've started thinking that we're stuck," former prime minister of Pakistan Imran Khan told the Financial Times.

Bickering at the table

The last time debt servicing costs were this high during the 'lost decade' of the 1990s, 60 to 80 percent of the debt had to be cancelled. Indeed many NGOs are advocating for just that. "Without debt cancellation, Southern debts will continue to rise," said Mae Buenaventura of Debt Justice, a UK based advocacy group.

In a report published on Tuesday, researchers from a collaboration of institutes including the Boston University Global Development Policy Center found that for the 61 countries in debt distress to achieve debt sustainability, more than €740bn needs to be restructured — jargon for cancellation or delayed repayment—across all creditor classes.

But the financial system today is vastly more complex than during the 1990s, the politics have become more fraught, and debt restructuring talks have stalled for the countries that have defaulted.

What has changed, is that debt is no longer exclusively or largely owed to western countries and multilateral development banks, but increasingly to private creditors like Blackrock, and big new players like China, India and Saudi-Arabia.

Every debt restructuring therefore is also deeply geopolitical. China's insistence that the IMF and the World Bank should also take a haircut in case of a restructuring nearly derailed the roundtable discussions. In the end China relented, but the lack of great power cooperation is slowing down the process to the detriment of debtor countries.

Highest returns in the world

Adding to the challenge is the fact that private creditors now hold 60 percent of total African country debt, up from almost nothing in the 1990s. Negotiations with private debt holders are harder because they are less inclined to take a haircut and more complex because there are so many of them.

"Who do you speak with, you know? There are thousands of investors and you can't all bring them into a single room and have a discussion with them," Gyude Moore, former minister of work of Liberia and now a senior policy analyst at the Center for Global Development, a Washington based think-tank, told EUobserver.

And officials from debtor countries are reluctant to approach private creditors directly, out of fear of being seen as a bad investment. "Private capital has been an important part of building African infrastructure and holds 60 percent of our debt, so they don't want to burn private creditors," he said.

Investors are guided by the opinions on the creditworthiness of sovereign debt by rating agencies Fitch and Moody's, and the threat of being downgraded is always present in the minds of African policymakers—because higher perceived risk means even higher borrowing costs. Kenyan president Ruto has been fighting to change the system.

At the same time, Moore argues, African leaders should not be afraid to initiate debt restructuring talks with private investors as it also offers them transparency which could lead to a better deal for African countries in the end. "We have to bring in private investors much sooner. African countries have been content to let the Americans, the Germans and the World bank speak on their behalf. I think that is a mistake."

Similarly Moore says African countries should engage with China to solve its debt problems directly. "China has an excellent working relationship with almost every African country," he said.

In case you're wondering whether debt restructuring is a bad deal for investors: African countries pay what has been dubbed an "African premium" of €68bn a year in extra borrowing costs above what makes economic sense—more than twice the total amount of aid given to the continent, as the United Nations Economic and Social Council recently noted.

In a study covering sovereign bond prices in 91 countries since the battle of Waterloo in 1815, researchers Josefin Meyer, Carmen M Reinhart, Christoph Trebesch found that real returns on developing country bonds had been sufficiently high to compensate for the risk. Real returns average more than 6 percent annually across two centuries.

An investment made in Egyptian debt on average earned investors a 6.9 annual return rate over the entire period—between 3 to 4 percentage points above US or UK government bond returns, despite defaults, major wars, and global crises. Returns on Nigerian debt averaged 13,6 percent.

As Ruto said on Saturday: "We can authoritatively say, Africa has the highest return on investment in the world."

'I cry for Zambia'

It's easy to see why debtors need to have a determining voice in solving debt problems.

To quote Georgetown University professor of law Anna Gelpern: "drowning in debt" is not a "real problem" but a financial engineering challenge.

For example, Europe can simply create €1800bn and swap it for dollars, Africa can't. To change the plumbing of the financial system is no simple issue but would at the very least require a power shift in debates about financial reform.

But power dynamics at the Roundtable are still strongly tilted towards the creditors. "It was no match really. Debtors were at the table, but their impact on the negotiations was small," Aldo Caliari, senior director at Jubilee Network USA, a global NGO, who attended the proceedings in Washington told EUobserver.

And whatever little was achieved at the Roundtable was overshadowed by the IMFs turn to austerity. In a widely shared chapter of its World Economic Outlook report, the fund insisted indebted countries should cut public spending to beat back debt.

Although the fund admitted that austerity "on average" does not bring down debt, it encouraged countries to do so anyway because it helps restore financial stability (prices) in the global financial system. But this does not help countries in debt distress.

Zambia has been waiting two and a half years to resolve the default on €17,3bn in debt after its public finances collapsed during the Covid-19 crisis. The IMF agreed on a €1.2bn bailout in November. But the conditions were harsh. The Zambian government had to agree to cut fuel subsidies and small-farmers subsidies which hundreds of thousands of people rely on. To increase revenue the IMF advises electricity tariffs and a higher VAT.

This would change a fiscal deficit which currently sits at 6 percent into a surplus of 3.2 percent by 2025, but the cost would have to be borne by the population. "I cry for my beloved Zambia," economist Grieve Chelwa, a director at the Institute of Race of the New School in New York, wrote in his blog 'Africa Watch' at the time. "This is the definition of austerity."

In chapter 3 of its World Economic Outlook, the IMF conceded that some countries facing acute debt distress would need "substantial or rapid debt reduction." But with debt resolution talks moving at a snail's pace there is no resolution in sight.

Meanwhile countries like Zambia, Chad, Ethiopia and many others will just have to wait. As of today, Zambia is still waiting for its bailout money because the process is blocked by creditors that can't agree on the details of the restructuring.

The system is rigged

To truly understand the debt dynamics in the Global South it's "essential" to look at monetary policy in the north, as former Argentine minister of economy Martin Guzman noted in a recent interview.

During the pandemic, government debt ballooned by almost €1.8 trillion in more than 100 developing countries (excluding China), as social spending went up while incomes froze due to lockdowns.

Central banks are focused on financial stability and they "don't consider the international spillovers of their actions," Guzman said. But the effects on developing countries are significant.

What pushed many over the edge in the last year was one of the steepest increases of interest rates perpetrated by the US Fed and the ECB in the history of central banking. High interest rates increase the dollar value of food on the global market, especially hurting sub-saharan countries where between 50 and 85 percent of the food is imported.

By the IMFs own estimates 340 million people will go hungry this year. The fund's commitments to countries affected by the global food crisis total $13.2bn since February 2022, of which $3.7bn has been disbursed as of March 2023.

Amplifying the problem is that 35 percent of poor country debt is taken out against variable rates (as opposed to debt in wealthy countries which are at a set rate of years or decades.) This means existing debt is subject to abrupt cost increases when the Fed and the ECB raise interest rates.

"What's good for the North, is good for the South, East and West," Mia Mottley, prime minister of Barbados, who has been a powerful voice for financial reform, said this week. "Cheap borrowing is the best development strategy for people in the developing world."

Yet at the annual meeting the IMF advocated for interest rates to be raised further. "Interest rates are bearing fruit," said chief economist Pierre-Olivier Gourinchas in a speech at the Annual meeting referring to lower inflation, adding that financial instability was "well contained."

But when 60 percent of the developing world—40 percent of the global economy—is facing bankruptcy, does it still make sense to conclude risks are contained?

A strong African voice

"There is an alarming tendency among the international community to regard debts in the developing world as sustainable because they can, after some sacrifice, be paid off," secretary-general Rebeca Grynspan of The United Nations Conference on Trade and Development wrote in February. "This is a full-blown development crisis with debt distress at its core [and it] threatens a new lost decade for much of the world economy."

"I think we need to humanise this conversation very, very urgently," Jason Braganza, executive director of Afrodad, said at one of the events hosted by the World Bank. "We need to move away from short-term crisis management that favours creditors."

The question is: how? To break through the impasse, "Africa has to unite behind a single agenda on debt resolution," Moore told Euobserver. "We know what China wants, we know what the US wants, we know what the World Bank wants, but we don't know what Africa wants."

Development Reimagined, a consultancy group that works on China-Africa issues, proposes a borrowers' group as the counterpart to creditor groups like the Paris Club—a proposal Moore supports. "Creditors represented by the Paris Club speak with a unified voice. It seems odd a similar thing doesn't exist on the borrowing side," said Moore.

A stronger and more focused African Union could move the needle in favour of debtor countries in debates now dominated by creditor countries and private investor interests. "If 54 African leaders keep coming to these meetings with 54 separate agendas, they won't go back with much. The power of your voice is determined by the size of your economy," he said. "African leaders will achieve much more if they act in concert."

"It makes sense for the AU to have some permanent voice on the G20 as well," added Moore. "Things don't always happen because they make sense in this world, but I am cautiously optimistic."

The next big finance meeting will be in Paris in June, where debt sustainability and cheap (climate) lending are again top of the agenda.

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