Don't forget Africa!

The world economy currently faces the most serious financial crises since the bust on Wall Street 1929. This makes a huge contrast to the period of 2002-2007 when we experienced an unbroken expansion paved with record high growth rates. The global production increased by 5 percent annually, and trade with twice the rate. As the golden years served to tie economies closer together, this also meant everyone was affected once the business cycle turned, writes Peter Stein. Nevertheless, he recognizes lights on the African continent, for example Botswana. We get daily reports on how the crisis, which began in the US financial markets, also affects Europe, Asia and Latin America. Rarely, the focus falls on Africa, the world’s least economically developed continent. The explanation might also be simply that. While Africa holds 14 percent of the world’s population, it only accounts for 3 percent of GDP, 2.5 percent of the global trade and 2.5 percent of incoming FDI (foreign direct investment). The financial flows into Africa mainly consist of foreign aid. The numbers mentioned above probably confirms the popular view of Africa as hopelessly undeveloped. That observation is not incorrect. Between the 1960’s and the year 2000, Africa could look back on more than 300 billion dollars of foreign aid and 30 years of economic. In 2008, the African real GDP was lower than that of 1978. Between 1970 and 1990, the African countries South of Sahara lost half of their shares of the global market to other developing countries. Incomplete view The picture painted above however lacks some colour. Africa consists of more than 50 countries with different history and economy. Between 2002 and 2007 (IMF: World Economic Outlook, January 2009), the annual growth rate in Africa was more than 5 percent. Such high numbers during so many years have never before been seen in Africa. The growth rate was comparable to that of many so called growth regions. This was something new. In spite of a rapid growth in population, many of the countries managed to increase their GDP per capita. The expression “economic growth miracle” is sometimes used for countries with an annual growth rate of more than 4.5 percent during 40 years. One of those miracles can be found in Africa, Botswana. The forecast for next year (IMF: World Economic Outlook, January 2009) predicts Africa as the world’s second fastest growing region. Currently, however, all prognoses are uncertain and it is possible that the crisis will hit soon Africa harder. Nevertheless, if the forecast is reasonably accurate, this would be the first economic decline when Africa does not fall uncontrollably. Thus, something has happened. The positive economic development in Africa is closely linked to the global increase in production, trade, capital flows and raw material. As countries with huge populations, such as China and India, have increased rapidly, due to growth models heavily relying on natural resources which can not be supplied domestically, there is a growing demand for African oil, natural gas, gold, platinum, aluminium, cobalt and nickel. The increased prices of raw material had the African exports yielding higher income as well as improved terms of trade. However, the African development could not be explained solely through the global boom benefitting the exporters of raw material. Countries scarce of natural resources have grown as rapidly as those where natural recourses are abundant. Many African countries have introduced economic reform. Among the countries most inclined towards reform are Botswana, Mauritius, Rwanda, Egypt and Ghana. Liberia, Mozambique and Sierra Leone are countries where the long drawn-out civil wars have been replaced by ambitious reform processes. By bringing inflation down to one digit numbers and creating order in state finances, the African economies have achieved a better macro economic stability. Better adapting the exchange rates to market value has been another important reform. For a long time, African countries had significantly over valued currencies. More realistic exchange rates have improved the profit margins for FDI. Several countries have deregulated markets and opened up to foreign investments. Meanwhile, there is an improved legislation on protection for entrepreneurs, foreign as well as domestic. These measures have made foreign companies realizing Africa’s great potential. For four years in a row, Africa has experienced record inflowing FDI, an increase from 29 to 45 billion US dollars between 2005 and 2008. In 2006, the private financial inflows were for the first time larger than the flow of foreign aid. While the over all global direct investments fell by 20 percent last years, the inflow to Africa increased by 17 percent. Such numbers should, however, be interpreted cautiously as the most significant inflow came during the first half of 2008 when most analysts still expected the price of raw material to rise further. Not much that may break So, how does the crisis affect Africa? No African capital markets (except for South Africa) are sophisticated enough to use the financial instruments which caused the crisis. In addition, the African economies are not credit based to any large degree. In African countries, in average 20 percent of the population hold bank accounts. Nevertheless, Africa may be hit indirectly. The region lacks the domestic dynamics – consumption and investments – needed to compensate for a global recession. Africa’s regional trade in 2008 accounted for about represent 8 percent of the international trade. In Asia, the corresponding number was 37 percent, the Middle East 11 percent, the North America 53 percent and Europe 77 percent. Out of Africa’s total exports, raw material accounted for 70 percent whereas industrial goods and services represent 22 and 9 percent respectively. More than 60 percent of the exports is aimed for the US and the EU, areas severely hit by recession. A global downturn implies a decreased demand for African natural resources. That in time leads to fluctuations in income, thus digging deep holes in the state budget. For raw material producing countries, the crisis serves as a brutal reminder that development in the long run is only achieved in diversified economies. Tighter global finaces are likely to cause a fall in FDI. In addition, hard times means a decrease in earnings sent home by Africans working abroad, a source of money which plays a significant role in many African countries. In those African countries that rely on tourism as an income, the global downturn will strike extra hard. Continued high prices on food In the slightly longer run, the financial stimulus packages in the US and Europe will cause the budgetary deficit to increase, thus increasing the need for financial resources. The competition for long term risk capital threatens to push aside investments in Africa. The most imminent challenge might be the continued high food prices. Due to a mismanaged agricultural sector, the African countries are net importers of food commodities. High costs of food implies a higher risk of inflation, a higher budgetary deficit to finance subsidized prices as well as negative trade balances. In addition, the increasing prices have a political dimension. Poor households tend to spend a higher share of their domestic budget on food and several countries have faced demonstrations due to the rising costs of groceries. Fragile Societies In the event of a deeper and more withdrawn international crisis, as well as more protectionist policies, Africa’s fragile societies are likely to suffer heavy damage. The African economies have, with a few exceptions such as Zimbabwe and Congo, made significant steps forward during the 2000’s. The rapid growth shows that Africa is not stuck in any poverty trap. Neither is it condemned to bad leadership. Botswana and Ghana serves as proof that the combination of a wealthy economy and a stable democracy is a possibility, also in Africa. It remains a secret, though, why Africa’s economically developed democracies have such difficulties to be used as role models. In spite of the business cycle, the Africa of today offers several profitable openings for business. At the same time, the challenges are enormous. In one way, the question on how the downturn affects Africa is an irrelevant one. If African countries are only able to grow during global peaks, the continent will never be able to develop. African decision makers must, as must all of us, sail through the storms also when exports are shaky and international investors increase the risk premiums. To develop, the African economies need to produce goods demanded for by the market. Thus, there is no quick fix for Africa’s difficulties. The problem is that the continent, due to 40 years of poor governing, since long has been a slow loser. Text by: Peter Stein, economist and CEO for the consultancy agency Stein Brothers AB