I had a recent conversation with a senior risk professional at a global multi-national company. The company’s operations include at least eight African countries across north, east, and the southern African regions. My contact made a comment that surprised me, he said, “Africa is one of the most stable parts of the world for us right now. Right now, we are consumed with Greece, Argentina and Venezuela. When things calm down we can sit down, but right now I’m on 24 hours local Greece issues…”
For once, Africa is not the world’s biggest problem.
The most apparent thing to note is that African markets are not correlated to each other. In contrast to the Eurozone, African markets provide natural diversification of risk to participants with exposure across the continent. Africa also provides interesting opportunities for investors to allocate funds based on the relative economic attractiveness of one region or country over another. Investors can therefore isolate countries with an uncertain economic outlook with limited risk of contagion. In the first quarter of this year Market Atlas observed substantial investment outflows from Nigeria during the election period and oil price slump earlier this year. At the same time the Kenyan stock market experienced net inflows and rising valuations. In the second quarter, we observed a reversal of this trend as noted in an article written by Akin Sawyerr, Market Atlas’ Chief Strategy Officer. The conclusion of the Nigerian election and stabilization of oil prices eliminated some of the short-term uncertainty in the Nigerian economy.
While African countries are relatively stable in an otherwise cloudy world economy, Greece’s unfolding tragedy should be looked at with caution by African leaders. There are two key lessons that can be drawn from the Greek experience.
Unsustainable fiscal policies are a red card
Greece has to choose between two difficult options. The first option is to stay within the Euro currency regime and continue a crippling reform program that has led to deep spending cuts in health and other social programs (malaria and HIV cases have risen since austerity measures were put in place). Option two is to exit the European monetary union and reintroduce Greece’s old currency, the Drachma.
Greece’s current problems stem from the 1999 introduction of the Euro common currency. Common currencies are beneficial because they reduce trade costs to member countries and support the increase of trade amongst members. On the other hand, currency unions often lead labor costs to rise for the smaller economies in the currency zone. Rising labor costs in Greece made their exports increasingly more expensive causing budget deficits to rise to 15 percent of GDP in 2009 from 5 percent of GDP in 1999. To further complicate matters, reports of fiscal mismanagement, deception, and corruption in the Greek government also surfaced in 2009, further increasing Greece’s borrowing costs. Greece abdicated its ability to manage its own currency by joining the European Monetary Union which removed its ability to devalue its currency. A devaluation would have allowed Greece to increase demand for domestic goods, reduce its trade deficits, and grow its way out of its problems through increased foreign demand for its cheaper goods.
On the African continent one need not look any further than Ghana for a cautionary tale about a country that is walking down the path that Greece has taken. Ghana’s debt to GDP ratio increased dramatically to 68.41 percent in 2015 from 46.83 percent in 2012. The failure to curb spending on civil service salaries is one of the main contributing factors to the deterioration of fiscal situation. Ghana needs to take substantial measures to address its fiscal imbalances in order to avoid a Greek like situation in the future.
On the whole, African governments need to take a second look at their fiscal policies and make the necessary adjustments stay on sound economic footing. Additionally it is key to keep in mind that a number of African countries have gone to the Eurobond market to raise substantial amounts of capital. While this seems like a good idea, a number of the projects funded by some of these Eurobonds have not produced the expected economic results. Further the pricing of these bonds could be impacted by fluctuations in the value of the Euro after a Greek referendum. It is important for countries that have gone this Eurobond route keep a healthy level of reserves to cope with future economic headwinds.
GDP diversification is a necessity
While the politics of the austerity measures imposed by Greece’s creditors are up for debate, it is without question that Greece’s GDP is not adequately diversified. Tourism (a mainstay of the Greek economy) is a great industry, but a country needs more than one source of income. African countries that rely on one key export for a majority of their revenues are vulnerable to the same challenges facing Greece and are thus further susceptible to pressures from external debt holders.
Nigeria, with its reliance on oil revenues to generate foreign exchange and support the government budget, is a country that must be wary. Though Nigeria’s economy has significantly diversified, oil still forms over 80 percent of government revenue. Over the past year, the country has experienced first-hand what a sharp drop in oil prices can do to its finances and its ability to provide basic services. African governments must identify secondary and tertiary sources of income outside of their primary revenue generating industries and focus on developing new sources of revenue for their economies to better weather cyclical downswings in primary industries.
But even more important is the social contract between the government and its citizens. Having a strong tax base and high compliance with tax collection helps keep elected officials accountable. Alternatively citizens who do not pay taxes tend to overlook government affairs which makes waste, abuse and corruption easier to get away with. When corruptive pressures win, the economic impact can be grave; from ballooning civil service payrolls, to a lack of capital investment in infrastructure and wasteful government policies that benefit the politely connected.
A number of African economies experienced crippling debt levels throughout the 1980s. The vast majority of these countries received debt relief from external debt holders that returned them to stronger fiscal standing. African countries will do well to avoid returning to the challenging economic environments that many experienced in fairly recent times. African countries must take heed not to kick the can down the road, and make difficult fiscal decisions while there is time to structurally adjust incrementally.
So what does the Greek crisis mean for African markets? Here too, we find two possible areas of impact on vulnerable economies.
CFA Franc countries could be adversely impacted
The Market Atlas Africa Currency Index has noted that the CFA Franc is overvalued by 15 percent compared to the U.S dollar. An overvalued exchange rate tends to depress domestic demand and encourage spending on imports. This can be particularly problematic during periods of sluggish growth. The CFA Franc is pegged to the Euro and is directly exposed to any potential devaluation that may occur should Greece leave the Euro currency. Depending on the way Greece resolves this crisis, the Euro could stand to lose up to one third of its value.
Additionally, the U.S. Federal Reserve is sending signals that it is ready to begin raising interest rates. With European rates already at negative levels in real terms, a rise of US excess reserve deposit rates by 0.25 percent will widen the spread between US rates and Euro rates, resulting in a stronger dollar. When coupled with the fact that central banks in Europe and Asia are all in monetary easing mode, the dollar will have more room to appreciate on a global basis. This will put further downward pressure on the Euro that could be accentuated by a Greece exit. The knock on effect would be a negative impact on the economic competitiveness of the 14 countries that use the CFA Franc and the region’s ability to keep trade levels up while Europe is in recession.
African markets will still be competitive for yield seekers
Greece will decide its destiny and the European Community will act accordingly after today’s referendum. Global investors worried about the outcome can take solace in the fact that African markets will still offer competitive yields on a long-term basis. The Federal Reserve will gradually raise interest rates to avoid pushing the anemic US economy into recession and this will give long-term investors continued opportunity to remain exposed to African economies and benefit from higher yields, and portfolio diversification.
African markets are still relatively attractive places to park capital, but African governments need to take a measured approach to ensuring their fiscal policies do not derail the economic growth story of the last 20 years. The alternative could be a path much worse than the drama playing out in Europe that would make the current Greek nightmare look like a Mediterranean dream.
