Looming debt trap: East African economies bogged down by low export base

Wednesday July 11 2018

Workers at a textile factory in Addis Ababa, Ethiopia.

Ethiopian workers at an apparel factory. The manufacturing sector in the region is growing but not yet large enough to support an export economy. PHOTO FILE | AFP 

By IEA KENYA
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Uganda, Burundi, Rwanda, Tanzania and Kenya all harbour the desires for economic and political federation of a kind.

The synchronisation of public budget readings is just the latest in a line of substantive if hesitant steps towards its realisation.

With shared history, culture and languages, these countries can add skyrocketing debt to their common characteristics.

The question of debt is not a moral one. A prudent nation borrows what it can reasonably repay given the strength of its economy.

Much has been said about the virtue of excessive borrowing for nation states. To wit, Japan’s debt-to-GDP of 200 per cent suggests that East Africa’s percentage debt-to-GDP ratio is in fact deficient.

In truth, Japanese lenders expect to be fully repaid over many decades to come. East African nations cannot count on the same as much of their debt is due well within the next 30 years.

Let’s take the analogy of the seven friends who decided to eat out for lunch. Everyone ate beyond their means so that everyone was back to by peel potatoes.

How much did each eat? How far beyond their means have they been living? How much harder will they need to work to reduce their debt? And what are the real market implications of holding so much debt?

With external debt totalling $75.23 billion, each citizen of East Africa and Ethiopia owes $1,435 to foreign lenders.

With a GDP of $246.095 billion, the region’s aggregate economic activity is surpassed only by Nigeria and South Africa.

The region’s foreign debt to GDP ratio is 30 per cent to South Africa’s 42 per cent.

When the debt figure is disaggregated, Kenya and Ethiopia together account for 56 per cent of the population and 61 per cent of its debt. In essence, the largest economies have accrued the largest debts.

Nigeria, the continent’s largest economy, has a percentage debt to GDP of eight per cent. Its bountiful oil revenues allow it the foreign reserves to pay for foreign debt.

South Africa’s indebtedness can be explained by its advanced capital markets. South Africa has many more years in exposure and experience in borrowing than Ethiopia.

Though every nation ate at the proverbial table, their portions were not equal in size.

Burundi’s debt was the lowest at $633 million whereas Ethiopia’s at $23 billion was 36 times Burundi’s and the highest in the region. A major infrastructure push has seen Ethiopia accrue its current large stock of debts.

Burundi and Rwanda together account for five per cent of the EAC plus Ethiopia’s total debt. The former has been relatively inactive in the capital markets.

The relatively small size of Burundi’s foreign debt can also be attributed to its small economy and a tough international stance against President Pierre Nkurunziza’s insistence on remaining in power.

The international community abhors Burundi’s political instability and blames Nkurunziza for it, and is loath to be seen to give his government material endorsement in the form of loans of any kind.

Poor performance

A nation will pay its way out of debt through the strength of its economic activity. The region’s external debt is just over two times the size of its exports.

It is a poorer performer than both Nigeria and South Africa.

As the numbers show, when the burden of foreign debt is compared with the value of exports, Burundi and Ethiopia stand out as the poorest performers in East Africa.

These two nations’ debts are outsized in comparison with the regional average.

For instance, if Ethiopia and Burundi sought to reduce their debt to export burden to the regional average in 2017, they would need to expand their exports by 66 per cent and 40 per cent respectively.

Another opportunity is reserves in foreign exchange — a saving that could be employed in repaying foreign-debt obligations.

These reserves are an important recourse for a nation. The size of the EAC reserves plus those of Ethiopia is 15.7 per cent of its foreign debt obligations, yet another indicator of the strain the region feels in making its payments.

Kenya’s $7.59 billion reserves accounted for 64 per cent of the region’s monetary reserves in 2017. When compared with its foreign debt obligations, Kenya’s reserves were 34 per cent of its total foreign debts. This figure is a rough indicator of the country’s ability to meet its obligations.

On this scale, Rwanda’s reserves accounted for 39.7 per cent of its debt, giving it the highest rating in the region.

Nigeria’s oil wealth may be to thank for its relatively healthy 93.9 per cent reserves to debt ratio.

South Africa does only a little better than the region, with its own reserves to debt ratio being 29.1 per cent.

Export giant China’s reserves to debt ratio of 212 per cent is a reminder that in the management of foreign debt, the region has a long way to go.

East Asia and the Pacific’s aggregated reserves to total-debt ratio, at 153, per cent suggests that not only is East Africa’s rating appalling, it is also not impossible for it to be better. In other words, it is not a given that East Africa’s foreign debt must exceed its reserves.

Since the World Bank international debt statistics (2018) were released, Ethiopia’s foreign exchange reserves have been so depleted that it could not afford more than two months in imports.

Foreign-exchange controls did not help. The United Arab Emirates has come to Ethiopia’s aid, offering an initial $1 billion with a promise of an additional $2 billion to alleviate Ethiopia’s foreign exchange crisis.

Economic strain

Kenya’s and Tanzania’s short- term bills are the largest at $2 billion each. On the face of it, both governments have exhibited signs of strain as they seek to match their respective ambitions with the reality of limited funds.

Tanzania has obtained a sovereign credit rating that will allow it to borrow from international markets. It plans to borrow $2 billion in the next two years.

Kenya has itself borrowed $2 billion in a 2018 Eurobond issue. Both nations’ recent budgets have introduced a slew of new taxes intended to raise more revenues.

On the whole, East Africa’s long term foreign debt obligations far exceed its foreign debts in the short term. This implies that a greater portion of their debt is not due soon, easing the immediate burden of debt repayment. In the interim period, economic growth can create more opportunities to service the debts.

Kenya and Ethiopia, the region’s biggest economies, are also its most indebted. East Africa’s debt to GDP ratio is 30 per cent.

The region owes foreign lenders $75.226 billion, a figure that relative to the rest of the sub-Saharan continent is extremely low nor too high.

Accounting for 14.94 per cent of the continent’s GDP, East Africa’s 16.57 per cent share of debt is a little larger than its share of production. The $2 billion that Kenya raised in its recent Eurobond issue would tip its share of debt past 17 per cent.

Driven by political tension, Ethiopia’s economic stagnation will itself require an injection of foreign loans in the billions of dollars if the nation is to remain on an upward trajectory. Should Abu Dhabi demand an immediate repayment, the $3 billion aid lifeline granted to Addis Ababa will raise the region’s indebtedness.

Infrastructure push

Kenya has initiated a number of public works projects that have pushed the economy to its current level of indebtedness.

Funded by Chinese loans, the standard gauge railway project is the most notable of its public debt-driven “grand” enterprises. Kenya’s total external debt stood at $22 billion in 2017. The ratio of foreign debt to the economy was 30 per cent.

Ethiopia is itself faced with twin headwinds of political and economic problems. The country has been engaged in a debt-driven infrastructure push.

With external debt totalling $23 billion, the nation edged out Kenya to be the most indebted in the region.

In relative terms, Uganda is the most indebted East African country with a debt-to-GDP ratio of 38 per cent. Uganda’s debt is remarkable as it has had its debt written off thrice in the past 30 years.

Along with Tanzania, Ethiopia, Rwanda and Burundi, Uganda was considered a highly indebted poor country by the World Bank and the IMF.

That the same institutions did not raise the alarm bells as far back as 2013 when it was evident that sub-Saharan Africa was showing signs of excessive borrowing remains a mystery. By 2016, sub-Saharan Africa’s debt-to-GDP ratio had doubled in less than a decade.

Growth is the engine that helps drive repayment of loans. As exports and foreign debt represent inflows and outflows of financial resources, their relationship is a good indicator of the strain an economy is experiencing from the debt it has taken on.

At two and a half times the size of its exports, the relative weight of East Africa’s foreign debt to exports is far greater than that of the greater sub-Saharan region and the East Asia and Pacific.

The unremarkable size of the East African GDP suggests economic weakness.

A disaggregation of East Africa’s $36.78 billion in exports reveals that with $10.52 billion and $9.38 billion’s worth of exports respectively, Kenya and Tanzania edge out runner up Ethiopia as the region’s top exporters. Ethiopia exported $5.92 billion in goods and services in that year.

The sustainability of debt is itself ascertained by comparing debt. At almost four times the size of its exports, Ethiopia’s foreign debt is the most crippling in relative terms.

Burundi’s foreign debt-to-exports ratio stood at 327.4 per cent, meaning that the country’s capacity to repay its $633 million loan as measured by exports generated by its economy is quite weak.

Debt obligations

Considering that external debt obligations will require repayment in foreign currency, the East African countries will need to expand their export capability at a rate higher than the growth of external debt to maintain macro-economic balance.

Their exposures individually to foreign exchange risks are considerable and especially for the four largest economies generally and for Ethiopia and Kenya specifically.

A currency crisis affecting the whole region is most likely to start in one of these larger economies and spread towards the rest as the regional economies become more open and connected.

An indispensable part of External debt-management policy should be the building of formidable export platforms to provide growth of reserves and ensure a steady supply of foreign currency for Uganda, Kenya, Tanzania and Ethiopia.

For instance, the largest exporter in the region is Kenya, whose exports in 2017 were less than $240 per person with Ethiopia’s at less than half that amount.

This low export base reveals the real risk that these countries face from a currency crisis sparked a strengthening of international currencies. That risk is not a remote one.

A helpful fact is that most of the external debt is due for repayment in the medium to long term. This is an advantage because it will mean that the external debt obligation will diminish as growth occurs.

Assuming a steady growth rate and reduced rate of external debt accumulation, the burden of repayment will fall and the external risk exposure will be brought under control.

This growth is also essential because it allows for building up of reserves, which are important for maintaining a currency’s value through central bank intervention.

With the exception of Ethiopia, which is not a member of the EAC, the high appetite for external debt shown by most countries here suggests that a co-ordinated monetary policy would be a monumental challenge.

Debt sustainability is an issue that these countries should look at critically before the discussion of a monetary union makes sense. Based on this short survey, to talk of introducing a common currency covering all the EAC countries appears to be premature.

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The next instalment in this series will review the internal debt position of each of the countries in this survey.

The Institute of Economic Affairs is a Nairobi-based think tank.