By BERNA NAMATA

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The director of the African Department at the IMF, Abebe Aemro Selassie, talks to Berna Namata about his optimism for East Africa’s economic growth and the challenges for countries.

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To what extent is the current global economic environment undermining growth across the East African region?

It’s not so much what is happening right now, but almost everything that’s been happening since the Covid-19 pandemic.

The pandemic had huge effects on people’s lives and livelihoods, then Russia’s invasion of Ukraine. Also, the commodity price increases on food and fuel were quite negative. And then, subsequently, the tightening of monetary policy in advanced countries also has had an adverse effect, pulling capital out of countries.

Cumulatively, all of these things are impacting the region and we now have some financial market uncertainty.

In terms of growth, East Africa is probably doing a bit better than the regional average, but it is the quality of growth that we are worried about. I mean, food prices, higher fuel prices are hitting people’s pockets directly, hence the cost-of-living crisis. 

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At the government level, we are seeing a big funding squeeze. This is also going to have an impact on governments’ ability to invest in health and education.

For a given amount of financing, countries are having to pay much higher.

And then of course, there is pressure on exchange rates. The dollar has strengthened across most currencies.

We have seen a wave of protests, most recently in Kenya, due to the high cost of living. How can this issue be addressed? What are the options for policymakers?

This is an imported problem. Food price shocks came after Russia’s invasion of Ukraine. The fuel price hikes, similarly from the disruption. Imported inflation is compounding some localised challenges such as the drought in the Horn of Africa.

Policy must tackle it because if it persists, it will continue to undermine standards of living.

Policy rates have to go up and will vary from country to country. Getting inflation down should be a priority for central banks.

On the fiscal side, it is going to be important for governments to think about how best to do social protection to alleviate the worst aspects of this on the most vulnerable households.

And then on the exchange rate side, there is so much uncertainty out there when there is a huge financing squeeze, and you don’t know how long it’s going to persist.

It is important to preserve reserves and allow exchange rate flexibility and insulate the real economy.

We have seen governments in the region roll out subsidies to cushion citizens from price shocks. To what extent are these subsidies effective?

Food and fuel are perhaps where we see the biggest pressure. On food, governments have to do what they have to do to make sure populations are well fed.

So, it is unavoidable, and all necessary measures should be taken, particularly in the medium term to make sure that adequate food is provided to everybody in that country. But you also want to work on the side of making sure you address the root causes of why you have food challenges, so working on the supply side is as important. 

On fuel, we see a lot more need for governments to support populations. However, experience across the world shows that fuel price subsidies are extremely regressive, which means you tend to benefit the richer more than the poorer segments of society and at a time when resources are highly constrained and in many cases, deficits are large, borrowing at fairly expensive rates to subsidise effectively richer households relative to poorer households is not practical or ideal.

In the case of fuel, eliminating subsidies is important. Of course, if you have such subsidies you want to eliminate them gradually. 

Central banks have failed to tame inflation despite hiking policy rates. Now, there is growing concern that further hikes could undermine growth. What’s your assessment of the effectiveness of monetary policy transmission across the region?

I don’t think central bank governors and officials need the IMF to tell them that when inflation is accelerating, monetary policy needs to be tightened. That’s straight. So, they are doing it because they know that’s the ideal – the optimal policy response. 

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It is important to not expect inflation to come down a month after policy rates have been adjusted, or two months after.

And again, for policymakers, given the imported nature of the inflation, it calls for a lot of judgement calls on how much you should tighten because the supply shock is not something you have a lot of influence over.

It is also crazy just how volatile fuel prices have been. We thought they were trending down and then after the Opec+ decision last week, you saw what happened to prices.

This is a challenge. This seeming persistent volatility of inflation is also something that we are observing in advanced countries. So, it is a period of a lot of uncertainty.

But you don’t want to overdo that tightening either. 

Are you saying we should give inflation time, and it will come down? 

The fact that inflation is high is worrisome. And I think everybody agrees that it needs to come down. So, the question is, how much should you tighten? Because if you overdo it also you can have repercussions to output.

Given all of the volatility around commodity prices for some of our countries, there are a lot of variables you have to look at.

But I think being that being hybrid-driven and responding and agreeing that inflation needs to come down quickly is key.

IMF’s lending to the region has come under scrutiny partly due to alleged mismanagement of funds by governments as well as conditionality attached to the financing. How do you view this criticism?

It is important to recognise the role of the IMF: Our role is to provide financing where countries are facing difficulty generating the financing they need from regular sources. What are the regular sources? Tax revenue or borrowing from financial markets.

When the pandemic hit, it impacted economies cutting off countries from global capital markets. This has raised the cost of funding and we had emergency procedures. We used a lot of emergency financing to support countries. We were the lender of last resort, the safety net provider for sub-Saharan Africa in particular. 

Because we didn’t have our regular programmes where we have sustained monitoring, we also put in place special procedures to ask governments to do audits that would show how exactly resources are used. And these audits are in the public domain.

With regards to the debate that was going on in Kenya, I’ve been struck by something I called the fiscal trilemma.

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First, everybody keeps highlighting the need for the government to address development. The needs that countries have spending on health and education and infrastructure, there’s a lot of pressure to spend more to address the development gaps.

That’s the first leg of the trilemma.

The second leg is that people are saying that they are overtaxed, but we don’t want to pay taxes. So, this is again a very important recurring debate in places like Kenya that there is still resistance to pay tax.

The third element of this trilemma is that everybody’s worried about debt. It’s too high. Why is Kenya borrowing from the IMF? If people are not going to pay tax and if you don’t want spending to be cut, how can you avoid debt? 

We provide countries with the cheapest possible financing that they can access at times like this so that over the medium term, they don’t have either rushed spending cuts or aggressive tax revenue so that they can stabilise their debt levels and find ways of addressing the tax challenges they face.

If the Kenyan government had not come to us, then the alternative is either deep spending cuts or tax increase. This is the challenge many of our countries are in and need to work on it.

There’s a looming debt crisis across the region. Why are countries struggling to pay back debt? 

Exogenous shocks have hit countries, and that has impacted the trajectory of economic output. It has raised the cost of financing and global volatility of commodity prices.

The reasonably strong global growth that we had before the pandemic has changed. All of their economic variables that would make sure that debt is sustainable are being impacted.

The second consideration is, was there something that country should have done better to avoid all of this? That is where there’s a weakness and I think it’s cross-cutting in East Africa.

Countries in the region were doing a lot to invest in all the right areas such as infrastructure, health and education. But they did not do enough to capture the rate of return on all of these investments through the tax system. If you look at tax revenue levels, they didn’t go up as much as they needed to.

How can countries address these issues to ensure debt is sustainable?

On the government side, it’s continuing to strike a balance between how much development need you can address. So moments like these when you have a big squeeze in funding, it is important to use as much concessional financing as possible to cover deficits, to reprioritise spending to make sure you get the best value for money.

There is also big work agenda on the tax side, which I think is by far the most important.

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What are the prospects for the region in 2023 and beyond? Which sectors are likely to drive growth and what are the risks?

I’m bullish about Africa and Eastern Africa because economies have moved forward quite a bit.

If you look at the penetration of technology, if you look at the labour force and just how skilled it is and compatible in some pockets with other global leaders, there is tremendous potential.

The key is making sure that the macroeconomic imbalances that have built up do not worsen and undermine growth, that inflation is tamed, and a lot of structural reforms needed to promote diversification.

It’s heart-wrenching to see just how persistent the droughts are. So, what can we do to alleviate things like that? What can we do to foster greater integration within the region, trade and lower the barriers?

Working on all of those things is important to unleash the tremendous potential that the region has.