Africa Dodges the Financial Bullet, but Recession Is Another Matter

After twenty-five years of initially spotty but increasingly widespread economic reform, significant debt relief, and notable improvements in governance (albeit with a long way still to go), Africa has enjoyed fifteen years of 5 percent average annual economic growth. Driven by both the huge run-up in commodity prices and concurrent surge in portfolio and private equity investment into emerging markets from 2003 to 2007, the annual growth rate has exceeded that 5 percent average by another point or two for most of this decade. Even as commodity prices peaked earlier this year and began their descent, Africa seemed well positioned to maintain its strong performance and continue to build on its recent success.

When the crisis hit the developed world’s financial markets and quickly spread to the world’s emerging markets at the end of the summer, Africa looked poised to escape relatively unscathed. The remoteness and small size of African financial sectors insulates them to some degree from the systemic problems underlying the meltdown. Virtually no banks or other financial institutions outside of South Africa held U.S. or European subprime mortgage-backed securities or other risky derivative securities. Even in South Africa, by far Africa’s largest economy and the most integrated into the global financial system, exposure was quite limited. Many nations, including South Africa, have some vestiges of previously pervasive capital controls remaining in place. In addition, tight regulation by national (and in the case of West Africa, regional) supervisory authorities and restrictions in some countries on foreign ownership of banks have served to limit the impact of the financial crisis on Africa.

The Limits of Isolation

Africa’s small "frontier" stock markets held up well compared to both developed and larger emerging markets through the middle of 2008. While they were all well off their peaks, at that point they appeared to be truly "decoupled" from the rest of the world.  However, when the financial meltdown reached full intensity late in the third quarter of the year, hedge funds were forced to liquidate positions and repatriate capital in the face of growing redemption demand, and the contagion turned into a generalized retreat from all risk. Africa’s markets were swept into this global rout and any sense of decoupling disappeared. South Africa’s Johannesburg exchange, by far Africa’s largest, had by mid-November fallen about 31 percent this year in rand terms. But translated into dollars, the decline was almost 65 percent; investors rushed to liquidate positions and bring capital home, resulting in a rapid currency depreciation. The largest direct impacts of the financial crisis in South Africa have been on the exchange rate and on the related rise in imported inflation as the higher costs of imports in rand terms have been passed on to consumers.

The indirect impact of the crisis on Africa, however, has been felt in the real economy for some time and could be quite severe if the global recession is an extended one. The United States, Japan, and some countries in Europe are already in recession. Thus, global demand for the oil and minerals that are the bulk of Africa’s exports has receded steadily the past six months, leading to sharp falls in prices, often in the 60 percent to 70 percent range. Demand for Africa’s nontraditional exports, such as fresh flowers and apparel, is also declining. The large commodity producers, such as Nigeria, Angola, and Zambia, will suffer the most, though raw, unprocessed commodities are almost every African country’s primary exports. Offsetting weak global demand for the continent’s exports, however, will be a significant decline in the price of petroleum products and a smaller but still important decline in the price of food,  both of which dominate African imports. On a continent where the bulk of individual consumption expenditure is for food, this is no small mitigating factor. Given the present financial crisis and bleak near- to medium-term global economic forecasts, the International Monetary Fund (IMF) nonetheless expects that real economic growth in 2008 on the continent will exceed 5 percent, while estimates for the growth rate in South Africa are in the 3 percent to 4 percent  range this year and 2 percent to 3 percent in 2009.

Fears of Ebbing Foreign Investment

In general terms, Africa’s limited integration into the globalized economy provides it a certain cushion against the impact of the world economic crisis. The other side of that coin, though, is that the necessary ingredients for sustained economic growth-- the rates of savings and investment as well as productivity and overall competitiveness--are still too low to allow the continent’s recent success to continue unabated in the face of a long global economic downturn. Quite simply, Africa must have substantial outside investment, both long-term foreign direct investment into new productive capacity, which would lead to job creation, and portfolio investment to finance current account deficits, if it is going to develop. A long global recession will delay a reversal of the negative flow of investment capital that has prevailed over the course of 2008.

Africa would also suffer if the global reaction to a prolonged economic slowdown led to a rise in protectionism in its developed country markets or if pressure on donor country budgets led them to decrease their foreign assistance allocations. Either eventuality seems remote at present, and African nations have made their voices heard in virtually every multilateral forum in articulating these concerns. South Africa, the sole African country that belongs to the G-20 group of nations that has emerged to deal with the global economic crisis, has shown that it is sensitive to the concerns of African governments.  But beyond repeating its long-standing calls for a larger voice on the executive boards of the IMF and World Bank, South Africa seems to be unsure where its fundamental interests lie. It thus adopted a low profile at the November G-20 summit in Washington, and is likely to continue to do so as its period of domestic political uncertainty continues.