Why Athens' debt crisis is likely to become a tragedy for East African economies too

Saturday July 04 2015

If the crisis spreads to Europe, it would impact the trade, tourism and agricultural export earnings of this region’s economies. TEA GRAPHIC |

The economic tragedy playing out in far away Greece could mean massive losses for East Africa’s farmers, fishermen and hotel owners should the contagion from the debt default spread to the rest of Europe, the top market for fresh produce, tourists and capital.

Greece defaulted on its periodic debt payments to the International Monetary Fund valued at €1.6 billion ($1.8 billion) on Tuesday last week, becoming the first developed country to falter on its credit obligations in the IMF’s history.

This followed the collapse of bailout talks between Prime Minister Alexis Tsipras’s government, the European Central Bank and the Fund.

The country was set to hold a referendum on Sunday, July 5, to determine whether it should accept the austerity conditions proposed by the creditors and effectively remain a member of the EU.

A Yes vote is desired by the creditors while a No vote would embolden the anti-austerity movement in Athens and across the Eurozone, making it more difficult to stabilise the euro against other hard currencies.

A No vote may force European powers Germany and France to consider debt relief for Greece, a prospect they have rejected because their banks are the most exposed to Greece’s dud loans. Economists say a No vote would send European stockmarkets tumbling, with a spillover effect on the EAC economies.


“The immediate impact would be in terms of financial contagion. Should Greece vote No, we would see risk-aversion grip markets, with a flight to safe havens. Many emerging and frontier market currencies may come under short-term selling pressure. In East Africa, the Kenya shilling and the Uganda shilling would be the most impacted,” said Razia Khan, managing director and chief economist in charge of Africa global research at Standard Chartered Bank Plc.

Even before Greece makes a decision on the exit, there are signs that the contagion is hitting East Africa. The euro has depreciated over the past one year against currencies of East Africa Community member states and appeared to rapidly lose ground in the past two weeks. This would be ominous for exporters to the European Union, stifling demand for exports as well as travel from outside the EU.

There is contagion

“For the region, it could potentially affect exports to the Eurozone and generally undermine global economic performance. It would also impact capital markets, particularly if there is contagion. Italy’s banking system is particularly exposed to Greek debt,” said Andrew Mold, a senior economist with the United Nations Economic Commission for Africa at the sub-regional office in Kigali.

The Kenya Flower Council said the turn of events was likely to hit profitability.

“A weakened euro vis-a-vis a strong dollar means our returns will be affected,” said Jane Ngige, Kenya Flower Council chief executive.

Fresh produce farmers buy inputs like fertilisers and machinery in dollars but are paid in euros. They only use local currency for wages and operational costs. A strong dollar would therefore increase the cost of production.

Europeans staying at home would not be good for the tourism sector, which was hoping for a boost from the withdrawal of travel advisories by the United Kingdom and improving security in the face of terrorism threats.

The sector is also hoping to benefit from the high-profile visits of US President Barack Obama this month, World Trade Organisation ministerial delegates in October and Pope Francis in November.

“Although we do not get many tourists from Greece, we do get a good number from Italy and Spain, whose economies are also experiencing difficulty. A weak euro means a decline in the number of visitors to East Africa. The financial crisis in Greece is likely to have a serious impact on global trade and tourism,” said Mohamed Hersi, chairman of the Kenya Coast Tourism Association. The EU accounts for about 70 per cent of tourists to East Africa.

But George Mawadri, British Airways regional manager for East Africa, said the Greece debt crisis would only affect travel into East Africa in the short-term if there was a spillover into other European countries like France, Italy and the United Kingdom, from which the majority of air travel to the East African region originates. This, he said, could be aggravated if the Eurozone went into a recession, affecting the citizens’ spending power on goods and leisure.

“The way the crisis eventually plays out could impact on the euro-dollar exchange rate. And this could then spill over to East African currencies. But there is no consensus of the impact on the euro. Does the crisis undermine the Euro, or does resolving it make the euro stronger?” asked David Cowan, Citigroup’s chief economist in charge of the African region.

The euro’s decline and the dollar’s gain would make imported commodities, ranging from oil to machinery, more expensive, exposing the economies to bigger current account deficits, weaker currencies and high interest rates.

“A depreciation of the euro would affect our exports to the EU. But the dollar has strengthened further against other currencies following the Greek debt crisis and this may cause fresh external shocks against the Uganda shilling,” said a senior executive at Bank of Uganda.

Weakening currencies would carry with them higher debt service obligations for the EAC countries. First, more local currency would be required to meet existing obligations in dollar terms, making the loans more expensive. In this category would be commercial loans like the sovereign bonds issued by Kenya and Rwanda.

Second, any new borrowing would be priced at higher interest rates to accommodate the perceived higher risk of default. Tanzania, which is increasingly turning to the commercial market after falling out with donors over the Tegeta escrow scandal, falls in this category and would possibly be forced to postpone a $700 million sovereign bond that it had wanted to float.

“The Greek debt crisis has destroyed the perception that governments cannot default on loans and this may translate into higher interest rates for small African economies borrowing from international markets. Further appreciation of the dollar against other currencies during the debt crisis will certainly weigh against the Ugandan shilling in the next few days,” said Joseph Lutwama, a research economist with the Uganda Capital Markets Authority.

It is feared that limited access to international markets for project finance would see East African governments rely more on domestic borrowing, given the lead time required to arrange development finance from multilateral agencies like the African Development Bank and the World Bank. This would push interest rates up and possibly crowd out private investors from accessing affordable capital for new ventures, expansion and job creation.

“The effect on East African markets is indirect, as investors’ concerns about Greece affect their overall investment decisions. If investors react, they will move money out. The reality, though, is that they would only react if there was turmoil in European markets. At the moment, the European markets are calm,” said John Ngumi, head of investment banking for East Africa at CfC Stanbic Bank.

Capital flows to the region would also be impacted by risk mitigation measures being taken by other European countries — perspectives that may spill over to the East African region.

“The effects may see banks limiting the amount of money customers withdraw, leaving them with less disposable income to invest in the EAC capital markets or even purchase goods and services from the region, impacting trade, tourism and hotel occupancy,” said Einstein Kihanda, chief investment officer at ICEA Asset Management.

“Taking on even more external debt would be a risky proposition for East African countries with negligible export growth. The recent Kenyan shilling decline has highlighted the country’s vulnerability as a result of its now larger external debt commitments. A worsening Greece crisis would also affect the performance of the so-called risk assets, including East African asset markets,” said Ms Khan.

Outgoing African Development Bank president Donald Kaberuka said Africa leaders should draw lessons from the Greece debt crisis.

“The crisis in Greece is a reminder of the need to preserve the hard-won macroeconomic stability in Africa that was achieved after years of pain. Borrow carefully, spend wisely. It must be preserved,” Dr Kaberuka said on Twitter.

Dr Nzioki Kibua, an economist and former Central Bank of Kenya deputy governor, said the actual impact of the Greece crisis will depend on how the outcome of the referendum disrupts the power play in the euro-dollar parity.

The EAC Secretariat said Greece in itself would have a minimal impact on trade because its exports to EAC are largely finished goods, which can be sourced from other markets.

“With the crisis, imports of these goods are likely to drop or cease but they are finished products that can be sourced from other European countries,” said Peter Kiguta, EAC director general in charge of customs and trade.

He said EAC countries import pharmaceuticals, machinery, electrical and olive products from Greece. The country also has strong trade links with Egypt and Turkey.

Egypt is a partner with East African Countries under the Tripartite Free Trade Area while 390 Greek companies have invested more than $5 billion in Turkey since signs of the crisis emerged in 2008, making it the leading investor in Ankara, according to Turkey’s Foreign Ministry.

Turkey is known as a hub for the retail trade and is, together with Dubai and China, a preferred source of East Africa traders for clothing, carpets and upholstery. About 60 per cent of the cotton used in Turkey’s textile yarns comes from Greek firms, a line of production that could be hit by austerity measures.

Prof Haji Semboja of the University of Dar es Salaam said the Greece debt crisis would see European economies like UK, Germany and France reduce their commitments to African countries after seeing their credit ratings hit a record low in order to save Athens.

“Europe cannot afford a fallen Greece, which may spell doom for the European Union. This will make European countries abandon other priorities in Africa,” said Prof Semboja. He gave an example from 1999, when Tanzania, a highly indebted country, benefited from debt relief, which he said was intended to save Western interests in the country.

Mr Mold said markets seem to have already discounted what has been on the cards for some time now and are not fazed by the euro crisis.

“For the developing world, what is happening in the Chinese stockmarket is perhaps of more direct relevance, given the strong investment and trade links which have developed with Africa over the past 15 years,” he said.

The Chinese stockmarket has lost $2.3 trillion in the past three weeks.

Additional reporting by Scola Kamau, Dicta Asiimwe and Christabel Ligami

Will others follow?

It’s hard to imagine any other country choosing to follow Greece into the economic abyss, but some weaker Eurozone economies may pay the price in permanently higher borrowing costs if a ‘Grexit’ materialises, despite the ECB’s best efforts.

Greece has already suffered a huge amount of pain. The economy has shrunk by 25 per cent, unemployment has rocketed to record levels, and one in two young people are without work.

Wages and pensions have been cut. Shops are shuttered.

But it could get a whole lot worse before it gets better if Greece leaves the euro. A new drachma would be worth much less than a euro — some analysts expect a devaluation of 50 per cent — meaning the cost of imports would rocket, sending inflation soaring.

The social catastrophe could be much worse than that seen in the early years of Greece’s bailout programmes.