When African finance ministers and central bankers gathered in April 2016 in Washington, US, for the International Monetary Fund and World Bank Spring Meetings they encountered some cold realities. The circumstances were far removed from the warm glow of economic success surrounding the “Africa Rising” conference in Maputo less than two years ago.
Now the macroeconomic climate is decidedly frosty. Growth forecasts continue to be pegged back. Even after accounting for consumers’ gains from lower oil prices, the end of the commodity price super-cycle has cut primary export earnings. It has also undermined planned investments in the oil and gas sectors in the region. Weak global growth has depressed demand for non-traditional African exports, such as manufactured goods.
With aid donors appearing less willing to provide support and private capital flows to Africa declining, balance of payments deficits have started to widen. These deficits have become more expensive to finance.
As growth weakens and the costs of borrowing increase, external debt ratios are rising, most sharply in resource-dependent economies that had previously borrowed heavily in global capital markets. Think Nigeria, Ghana and Zambia.
Two decades of rapid change and high growth
It seems the “Africa Rising” moment coincided with a pause in a period of unprecedented macroeconomic stability and growth dating back to the mid-1990s. Boosted by debt relief for heavily indebted poor countries in the early 2000s and strong global demand, African countries have enjoyed rapid growth and high consumption.
After 15 years of stagnation between 1980 and 1995, the subsequent two decades saw the overall sub-Saharan African economy more than double in size. Growth was broad based. There were high average growth rates from both smaller economies such as Ghana and Uganda, as well as larger economies like Nigeria and Ethiopia. Even fragile states like Angola and the Democratic Republic of Congo shared this growth.
Previously inaccessible sources of private capital were tapped to finance ambitious and much-needed public investment programmes. Capital inflows kept currencies strong and government budgets in relatively good shape. Despite ever-widening current account deficits, robust domestic growth and low interest rates kept external debt burdens relatively low.
The strength and breadth of this impressive growth performance owes much to the deep structural reforms that began back in the 1990s.
Many countries moved to liberalise their external markets by adopting floating exchange rates, reducing tariffs on trade and removing controls on cross-border capital flows. The hope was to deepen economic integration and attract foreign capital into the region.
On the domestic front, increasingly independent central banks shifted towards monetary policies more clearly focused on targeting stable inflation. Finance ministries drove through comprehensive structural and administrative tax reforms. These provided the foundations for an extended period of macroeconomic stability.
A stable macroeconomic environment is not a sufficient condition for growth. But, as we have learnt in sub-Saharan Africa over the past two decades, it does appear to be a necessary condition.
This means decisive action is needed to navigate the difficult economic waters that lie ahead without undoing the gains of the past two decades. Success will require difficult political choices, especially on taxation and government expenditure.
With the expected decline in aid and limits on prudent levels of new borrowing, policy needs to pursue conventional adjustment strategies. These must seek to establish macroeconomic balance. How? Through efforts to reduce current account deficits through real exchange-rate adjustment and measures to control domestic expenditure.
Countries must resist the temptation of imposing excessive tariffs and quantitative controls on imports or rationing foreign exchange. Here, the lessons of the late 1980s are clear: such measures led to “black markets” for foreign exchange. They also led to widespread shortages and only worsened rather than improved macroeconomic conditions.
The same applies today. Defending indefensible exchange rates is an invitation to rent-seeking and corruption. This is corrosive to the foundations of good economic policy.
The current travails of Nigeria point clearly to these dangers. The Nigerian economy has been hard hit by declining oil prices. But authorities’ attempts to restore balance by rationing imports and pegging the exchange rate have been counter-productive.
Increasing fuel and goods shortages have reduced investor confidence. Foreign exchange reserves have dwindled and inflationary pressures have increased. This has damaged exports and growth in non-oil sectors. It contributed to higher public debt and prospects for a rapid recovery in Nigeria are not good.
This does not mean monetary and exchange rate policy should be passive. In east Africa a number of central banks now have the capacity to use exchange rate and monetary policy purposely and should do so to smooth the adjustment path. This means conducting policy not to target a fixed exchange rate but to avoid excessive volatility in either interest rates and exchange rates.
But this capacity is constrained. Domestic asset markets remain relatively thin. Increasing integration of African capital markets into global markets makes it progressively harder to insulate domestic monetary conditions from global forces. While financial systems are still continuing to mature and markets still deepening, central banks should proceed cautiously to uncover and assess monetary policy limits.
Ultimately it is fiscal policy that will play the decisive role in ensuring that Africa’s macroeconomic adjustment is successful. It needs to be designed in a way that does not undercut the growth-promoting effects of recent infrastructure investments. It may then preserve the gains in poverty reduction and improved service delivery that materialised in health and education.
This means that critical infrastructure investments such as power generation are completed and maintained. It also means the false economy of the “quick fix” fiscal adjustment of cutting back on operations and maintenance expenditures is avoided. Expenditure adjustment must also fall on other areas, either by postponing or scaling back planned expenditures and exerting greater control over public sector wage bills.
Perhaps the most potent area for fiscal policy – at least in the medium term – remains tax reform. Domestic revenue mobilisation continues to be below international norms. Countries need to be more effective in capturing gains from growth, structural change and urbanisation.
Rather than hiking already high marginal tax rates this should be achieved by widening tax bases. In practise it means eliminating the vast array of exemptions and leakages that currently pepper tax systems.
None of these choices are straightforward. All fiscal policy changes entail winners and losers. The costs of tax increases and expenditure reductions fall harder on some groups than others and as such fiscal policy is intensely political.
Fiscal policy is always political. The delivery of a coherent and equitable fiscal adjustment still offers the best prospects for supporting a smooth macroeconomic adjustment to current circumstances. This allows for sustained growth when conditions improve. That will be the ultimate test of the economic transformation that was justly celebrated at the Africa Rising conference in Maputo in 2014.
This article was co authored by Tanzania’s Central Bank Governor, Benno Ndulu. A longer version of this article can be found here.