ORIGIN OF DEBT IN ARICA

Outline

1. Origins of Debt in Africa
2. Commodity prices
3. Expanded access to sources of lending
4. Public sector borrowing
5. Second oil shock, world recession and terms of trade deterioration
6. Interest rates
7. Response in private and official lending
8. Summary of the key causes for the African debt crisis

Origin of Debt in Africa

The roots of the problem stem from certain developments in the 1970s compounded by the adverse developments of the early 1980s. A review of the 1970s with a focus on debt, brings out the following:

Commodity prices

In the wake of the first oil price shock, most major primary exports of Africa experienced an international commodity boom, followed by a sharp bust. The governments of the affected countries generally responded to the price increases by sharply increasing public expenditures, complementing the revenue increases accompanying the export boom with external borrowing.

For instance:

•there were sizeable price increases in cocoa (1973-75), coffee (1976-77), tea (1977), groundnuts (1974), sugar (1974-75), sisal (1973-75), phosphate (1974-75) and uranium (1975-79), followed by sharp price declines. Almost all oil importing countries were affected: Burundi (coffee), Central African Republic (coffee), Ethiopia (coffee), Gambia (groundnuts), Ghana (cocoa), Ivory Coast (coffee and cocoa), Kenya (coffee), Madagascar (coffee), Malawi (sugar), Niger (uranium), Senegal (phosphate, groundnuts), Sierra Leone (coffee), Tanzania (coffee, sisal), Togo (phosphate). The governments of the affected countries tended to respond by sharply increasing public expenditures.

Expanded access to sources of lending

•The international banking system had evolved after the first oil shock to play a larger role in "recycling" the OPEC surpluses. The Euromarket became an important source of financing for a number of African governments which had never borrowed in it before. During this period, international banks, suppliers and official export promotion agencies increasingly put together coordinated packages for major public investment projects.

e.g.

•The Euromarket became an important source of financing for a number of governments which had never borrowed in it before, e.g., Senegal, Togo, Kenya, Zambia, Liberia, as well as the oil exporting countries; only Ivory Coast had used the Euromarkets previously, but for much smaller amounts.  Major Euroborrowings also were undertaken by-private entities, primarily mining companies, e.g., in Guinea and Niger.

Public sector borrowing

•Many of these public projects were unproductive, ill-conceived or mismatched with the financing maturity structure.

•There are a number of examples of public investments in nonproductive categories whose external financing continues to be burdensome. Large scale commercial borrowings were used to finance conference centers, administrative

    buildings, new capitals, and university centers.

In the "productive" sectors, many of the externally financed projects proved to be economically unviable. Ill-conceived projects include luxury hotels, oil and sugar refineries, and steel mills. Certain major agricultural projects proved unviable because of the weak administrative framework.

World price trends also weakened the viability of many projects in both the agricultural and mining sectors. Ambitious infrastructure projects were often externally financed at terms much shorter than the profile of returns. These include hydroelectric projects, airports and highways.

When the second oil price shock hit in the late 1970s, most countries were poorly positioned to absorb it, given their higher level of debt, its less concessional structure, and the inflexibility of public expenditures.

New developments in the 1980s

     New developments of the 1980-83 period, aggravated the situation.

The world recession contributed to a decline in export earnings which was only slightly offset by the EEC Stabex and IMF Compensatory Financing facilities.

   (Stabex was the EEC's system for stabilization of African, Caribbean and Pacific countries' export earnings from 44 agricultural products, including all the major exports except tobacco. Transfers to the least developed countries are made in the form of grants while others are interest-free loans of two years' grace and seven years' maturity. These amounted to about $751 million for 1978-82)

•International real interest rates rose to high positive levels, reflected in most international bank and short-term debt immediately and in fixed rate suppliers' and non-concessional official credits with a lag. Countries often delayed implementing programs for adjusting to these negative developments, initially financed with non-concessional external debt. In addition, a severe drought inflicted many regions of Africa.

•

The financial situation grew increasingly difficult. By 1983, disbursements and official grants to oil importers had fallen sharply while the oil exporters dominated by Nigeria sought massive financing to compensate for the collapse in oil prices in 1982.

Widespread debt servicing difficulties emerged during this period, as evidenced by a large number of official and private bank debt reschedulings and an accumulation of arrears. These developments in the 1980s have resulted in sharply deteriorated economic conditions as well as prospects for most of

   sub-Saharan Africa.

Second oil shock, world recession and terms of trade deterioration

•Unlike the first oil shock when export commodity price booms offset some of the balance of payments difficulties of the oil importers, the second shock was not accompanied by any such offset. Rather, the world recession starting in the late 1970s and extending into the early 1980s contributed to a decline in export earnings. Terms of trade for oil importers fell an average 11% between 1980 and 1982

Interest rates

•International real interest rates rose from low and sometimes negative levels in the 1970s to over 8% in the early 1980s.

•Interest service rose from 3% of exports of goods and nonfactor services in 1978 to about 9% in 1983, with the average real interest rate on all loans increasing from -7% in 1979 to over 6% in 1982 and 1983 and that for non-concessional

    loans from -5% in 1979 to 10% in 1982.

•The high interest impact was felt immediately through loans carrying variable interest rates, primarily international bank lending, and through

    short-term loans. The countries mainly affected were Niger, Zaire, Malawi and Kenya in the low-income group, Liberia, Senegal, Zambia, Zimbabwe, Botswana, Ivory Coast and Mauritius in the middle-income oil importer group and all the oil exporters.

Example of the effect of high interest rates on debt:

(Interest payments are recalculated for 1979-83 using real interest rates of 2% rather than those that prevailed in that period).

•Without the additional interest payments, public debt outstanding would have been lower by 16% for Ivory Coast, 11% for Zambia and 11% for Malawi.

Response in private and official lending.

The second oil shock caused considerable disruption in both the private and official financial flows to Sub-Saharan Africa.

For most oil-importing countries, disbursements and net flows of public and publicly guaranteed term loans rose sharply in the wake of the oil shock and then fell after 1980.

Total disbursements on loans to the oil importers peaked 'at $6.8 billion in 1980 and fell to $5.1 billion by 1983. Net flows to oil importers fell from $5.2 billion in 1980 to $3.5 billion in 1983, with net transfers decreasing even more.

There were major declines in both bilateral disbursements (from $2.1 billion in 1980 to $1.9 billion in 1983 and private financial disbursements (from $2.8 billion in 1980 to $1.5 billion in 1983).

Summary of the key causes for the African debt crisis

thoughtless and irresponsible over-lending by private and official creditors, during the commodity boom of the 1970s, without which

    irresponsible over-borrowing by African governments on this scale could not possibly have occurred;

the persistence of negative real interest rates during most of the 1970s in global financial markets caused by lax monetary and fiscal policies in industrial countries which made it economically rational for developing countries to borrow externally (rather than save or attract equity investment) for development and consumption;

the targeting of developing countries in general, and oil-exporting countries in particular, as major export markets to be provided with too-easy credit to facilitate the adjustment of industrial countries to the two oil-shocks (of 1973 and 1979);

the global monetary shock of1979-81, which aimed at ridding the world of inflation but had the collateral impact of inducing a deep and long recession, particularly in debt-ridden developing countries where the recession lasted for 70 months instead of 16 in the OECD world, and which caused commodity markets and prices to collapse;

over-reliance on external savings between 1979-83 by African governments' unwillingness to increase domestic savings and cut domestic consumption in the erroneous belief [encouraged in some instances (e.g. Zambia) by the international financial institutions – Ifls] that the commodity price collapse would be short-lived;

a prolonged and devastating drought between 1981-84 which severely impaired the continent's agricultural and cash crop production and resulted in extensive damage to output and to the financial structure of

   Africa's fragile economies;

the emergence of high, positive real interest rates throughout the 1980s which compounded Africa's debt servicing and debt accumulation burdens;

volatile exchange rate movements throughout the 1980s with US dollar depreciation between 1985-90 resulting in increasing the dollar value of Africa's outstanding debts, over a half of which were denominated in currencies or composites which appreciated against the US dollar

repeated official and private reschedulings, often on punitive terms in the early years of the debt crisis, which resulted in further increasing the outstanding level of debt while providing temporary, but totally insufficient, cash-flow relief;

poor and impractical advice by IFls and official creditors on the extent of debt relief African governments needed to negotiate and how they might adjust, coupled with poor management by the same governments of external debt records, policies and priorities resulting in several missed opportunities to improve· their situations;

the building up of egregious (excessive)arrears which creditors have tolerated to a point of doing more damage to restoring disciplined debtor-creditor relationships than if more sensible action to reduce debt and debt service burdens had been taken by them in the first place;

protectionism in the world's markets for agricultural products and low technology

   manufactures, which makes it particularly difficult for African countries to diversify and increase exports to hard currency markets, thus making it doubly difficult for them to earn their way out of the debt trap.