Policy options for African governments in 2023
The global economy is experiencing a broader and sharper than expected slowdown in growth, and inflation is at the highest it has been in several decades. Global growth is projected to fall from an estimated 3.4% in 2022 to 2.9% in 2023, then rise to 3.1% in 2024.
In Africa, GDP growth slowed to 3.8% in 2022 from 4.8% in 2021—and is projected to stabilize at 4% over 2023–24. The slowdown is informed by the slowdown in advanced economies and emerging markets, tightening global financial conditions, the rise in central bank rates to fight inflation, and volatile commodity prices. Rising food and energy prices are leading to increases in costs of living, and public debt and inflation are at levels not seen in decades. Africa’s public debt is now approaching levels last seen in the early 2000s, this time defined by the substitution of low-cost, long-term multilateral debt with higher-cost private funds, and exacerbated by the additional financial pressures created by the appreciating US dollar.
Drivers of public debt dynamics as a share of GDP, 2013–23
Source: Africa Development Bank, Africa’s Macroeconomic Performance and Outlook, January 2023.
The African Development Bank (AfDB) estimates that sovereign external debt declined marginally to 67% of GDP in 2022 from 68% in 2021 and will then settle at 65% – 70% in 2023 and 2024. 23 African countries are either in or at risk of debt distress (16 are at high risk of debt distress and 7 are in debt distress). More seriously, 19 of the region’s 35 low-income countries are in debt distress or at high risk of distress.
At the same time, the rising cost of food and energy, and the lingering effects of the Covid-19 pandemic are projected to exacerbate extreme poverty. An additional 15 million people were driven into extreme poverty in Africa in 2022 and poverty persistence will likely delay reversion to pre-Covid-19 poverty rates. Within this challenging context, there are three key macroeconomic tensions African governments will be grappling with in 2023.
Macroeconomic tensions African governments will be grappling with in 2023
Fiscal recovery versus economic recovery
Many African governments continue to face sustained fiscal pressure, and even if they are not in debt distress, sluggish economic recovery and tight global financial conditions will limit their ability to raise the capital needed for their spending requirements. Yet this comes at a time when economies need deep support from government to foster economic recovery from Covid-19, cushion households from rising costs of living, and address the increasingly disruptive effects of climate change which is particularly pronounced in some regions such as the Horn of Africa.
However, there are tensions between policies that foster fiscal recovery and those that foster economic recovery. Fiscal recovery policies include cutting spending and implementing policies to aggressively increase revenues for example. Economic recovery policies include increasing social security to support struggling households, pulling back on taxes, and even a demand-side stimulus through expanded cash transfers. These two policy needs are clearly at tension with each other.
The ‘informalisation effect’ of Covid-19 versus the push for more revenue
Studies by FSD Kenya found that ‘larger’ formal businesses were more likely to close in the first two years of the pandemic than micro informal firms. This finding is corroborated by the AfDB which found that firms in the formal sector faced a higher chance of business closure in Africa than in other regions.
Factors informing this include the fact that businesses operating in formal commercial premises (pre-Covid) have higher fixed cost such as the rent/ lease costs compared to informal businesses operating from more flexible arrangements such as open markets or hawking. Further, informal firms had higher flexibility in managing operational costs (such as relying on family members rather than employees to help them run the business) and access to social network finance that could provide the low-value capital to keep them afloat. For larger firms, after they had exhausted their savings and the support provided by social networks, the absence of access to formal finance and liquidity to support meant they had little option but closure.
The ‘informalisation effect’ of Covid-19 is at tension with efforts by governments to ‘formalise’ the informal sector and expand the reach of national government tax efforts to this segment.
The cost of spending more versus the cost of limiting spending
There is a fiscal cost (and potential multiplier effect) to spending more to provide critical social security and income support, as well as foster firm recovery. Yet there is also a cost to limiting spending in the form of increased economic and welfare costs linked to raised poverty levels, lower productivity, and reductions in firm and household welfare. Given that 15 million people were driven into extreme poverty in Africa in 2022, and that poverty is likely to persist, the costs of limiting spending are real and will mature quickly.
The good news is that there several fiscal opportunities available to African governments to address these challenges.
Fiscal policy opportunities for 2023
There is an opportunity to broaden what is prioritised in the public eye to get a more holistic sense of fiscal health and debt carrying capacity. A narrow public focus on debt-to-GDP ratios is limiting and intellectually incomplete in determining the true debt carrying capacity of a country.
The basic data points that ought to be regularly tracked and publicly reported on by governments are the following ratios: Debt-to-GDP, Revenue-to-GDP, Export-to-GDP, Revenue-to-debt servicing, and Exports-to-debt servicing. These 5 data points provide a more holistic sense of countries that approaching or are in fiscal danger, the speed at which debt stress can mature to a crisis, and key remedial steps that can be focused on for holistic fiscal recovery/health. So, for example if debt-to-GDP is going up, yet revenue-to-GDP is stagnant or declining, that is a clear and early signal that the country’s debt carrying capacity is weakening.
A good initiative in this regard is the recently launched partnership between United Nations Conference on Trade and Development (UNCTAD) and the Macroeconomic and Financial Management Institute of Eastern and Southern Africa (MEFMI) which will focus on technical assistance and software provision to improve the recording, reporting and monitoring of public debt.
Expenditure: Better quality spending
The first obvious step to improving expenditure quality is to have a keen eye on allocations to recurrent versus capital/ development expenditure and push to ensure that spending has productive intent. Here the challenge is in setting credible targets for development/capital expenditure given historical challenges in execution.
And that is where the real work lies–in budget execution and absorption. African governments have an opportunity to focus on budget absorption capacity to ensure that debt with productive intent is indeed productive. It is surprisingly difficult to find comprehensive and consistent data on development/capital-recurrent split in budget execution by African governments, but the box below provides a sense of how grim it is.
Examples of capital/development performance in Africa
To be fair, this situation is not unique to Africa, but the implications are serious for Africa given the scale of debt being incurred for productive purposes. Continued attention can be directed to building capabilities in government arms with low capital execution rates, improving planning processes for capital investment projects, and addressing the age-old challenge of corruption.
Revenue: Capabilities, harmonisation and the business environment
The United Nations Economic Commission for Africa (UNECA) points out that low domestic resource mobilisation is due to factor such as weak and inefficient tax administration systems, prevalence of tax incentives, and leakages in revenue collection and weak enforcement; for example approximately 50% of VAT revenues are not collected.
Additionally fiscal decentralisation matters when it comes to revenue mobilisation because there are varying degrees of devolution of revenue mobilisation and spending powers to lower levels of government in many African countries such as Kenya, Nigeria, South Africa, Uganda, Senegal, and Ghana. This is important as informal firms, who are assumed to be completely outside the tax net, often pay tax to sub-national governments often in the form of fees and charges. In Kenya, for example, informal firms are subjected to CESS charges by county governments as well as charges linked to the use of county government markets. So, in some countries, informal firms are already in a type of ‘tax net’ and it cannot be assumed that tax base expansion efforts will secure revenue from ‘untaxed’ informal firms.
The game changer for informal firms will be a focus by African governments on improving the business environment in which they operate so that informal firms face lower costs and are more profitable. This will create space for firms with the inclination to formalise (often linked to securing larger procurement opportunities) to do so.
Tracking business environment metrics for predominantly informal firms such as government compliance requirements; quality and scale of service delivery from government (roads, water electricity etc); state and conditions of business premises; market access; labour needs; access to financial services etc can provide actionable insights that improve the business environment for informal firms. This focus will create conditions where informal firms can remit more to sub-national tax authorities (where they exist) and graduate to national government compliance.
Action to improve tax administration by national governments is well covered and so will not be repeated here. But there is room to strengthen the political will and tax administration capabilities to address illicit financial flows which are estimated to cost African economies $83 billion in lost revenue annually. African governments can also improve non-tax revenue growth and will frankly need to address the gnarly issue of tax justice to foster improved tax compliance.
Debt: Relief, rescheduling, restructuring, and resilience
The pressures around debt will be resolved through the 4 Rs: Relief, rescheduling, restructuring and resilience. Debt relief action will likely be marginal given the preponderance of private sector creditors in the composition of debt. But countries such as China have already acted. In August, China announced it would waive 23 interest-free loans with maturity by the end of 2021 for 17 unspecified African countries worth an unspecified total amount. Debt relief and forgiveness will likely be focused on bilateral creditors who will expect a soft power return from African governments given the reality of global geopolitics and Great Power Competition.
Debt rescheduling had already started with the Debt Service Suspension Initiative (DSSI) which was established in May 2020 and expired at the end of December 2021; the potential savings from the DSSI in all 38 eligible African countries is estimated at more than $13 billion. While the DSSI has alleviated significant immediate liquidity pressures on African economies, it was shallow with the potential savings from the moratorium representing only 24.5% of total debt service payments of African countries for 2020 and 40.1% for 2021. Further, the rescheduling is leading to lumpier payments in a context where revenue mobilisation is still weak. There is an opportunity to rethink the termination of the DSSI framework and reinstate it with one that provide incentives to attract the participation of commercial creditors who have signalled no appetite to engage with their borrowers thus far.
Debt restructuring processes have already started for some African economies including Chad (under The Common Framework), Zambia, and plans for Ghana well underway. More African countries will likely enter restructuring talks, even pre-emptively. This process may be stymied by concerns with the slow speed and limited reach of restructuring efforts, as well the impacts of restructuring on credit ratings and future credit raising efforts.
Finally, the integration of climate resilience considerations will show up more than in previous debt crises. Interesting ideas such as debt-for-climate swaps (partial debt relief operations conditional on debtor commitments to undertake climate-related investments) are already being given serious attention.
Innovative initiatives such as the Debt Relief for a Green and Inclusive Recovery Project suggest a comprehensive approach where large scale debt write-offs are linked to commitments by debtor countries for policies that will enable green recoveries along climate resilient and green development paths. The key to make resilience efforts meaningful and effective for African economies in debt distress is to: a) Anchor the climate priorities of countries into debt restructuring and fiscal policy paths going forward; b) Ensure efforts centre realities of African economies; and c) Ensure initiatives are implemented with supportive structures and so that climate requirements do not become bottlenecks in the implementation of climate debt reform.