Shantayanan Devarajan, chief economist of the World Bank’s Africa region, says that Africa’ s banking system is not threatened by the current global financial crisis, but the region could see a decrease in private investment flows. Such a decrease would compromise the financing of many infrastructure projects on the continent. Devarajan proposes, however, that sovereign wealth funds may now turn to Africa as an attractive place to invest, given the upheaval in U.S. and European markets.
In a recent post on your blog, you talked about how the global financial crisis might affect Africa and the first thing you mentioned was the difference between African banking systems and the U.S. banking system. Is the fact that the African banking system is so nascent actually helpful in this situation?
Well it’s helpful in the dimension that there are very few subprime loans and credit default swaps and all these fancy derivative instruments that we have seen in the United States and in Europe that may have created some of the problems of the banking system. So African banks hardly ever take their loans and then turn them into other instruments, break them up into mortgage securities and trade them and things like that. So yes, in a sense, it’s a simpler system and therefore it’s less prone to the particular kind of downfall that the American financial system has been facing.
There was a lot of talk prior to this financial crisis about the idea that the rest of the world might be decoupled from the U.S. economy, but we’ve seen in the past couple of weeks that that’s not the case. If there was any region of the world that was to be perhaps more decoupled than another region, would you consider Africa to be that area?
No, because I think the decoupling has more to do with the effect of trade and financial flows on these regions. And that’s the second proposition that I made: Even though the banking system per se may not be threatened, because of the reasons I just mentioned, the potential shortfall in private capital flows could quite seriously affect Africa, because private capital flows [to the region] have been rising quite rapidly. In fact this is the fastest-growing region for private capital flows over the last three or four years. If these were to slow down, they could have both short-term and medium-term effects. In the short run, countries like South Africa are actually financing a very large current account deficit -it’s about 8 percent of GDP [gross domestic product] with private capital flows. So if the capital flows dry up, South Africa will have to contract its current account deficit. But in the medium term, our concern was the fact that these capital flows were financing much needed infrastructure investment in Africa and if they were to dry up there would be a lot of infrastructure projects that would be caught short of financing.
How likely is it in your estimation that those capital flows might dry up and what are the things that we could look for as indicators that that might be in the works?
Actually, there are arguments in both directions. I mean, one is that, almost ironically, Africa might be a place where some of this capital that was originally being invested in the United States and Europe could now be invested. For instance, these sovereign wealth funds had invested their money in the financial systems of the United States and they lost some money in that deal. So they may now be looking to Africa as a possible source of investment. In general, one of the reasons why private capital flows were rising in Africa was that the risks in Africa were somewhat uncorrelated with the risks in Europe and the United States, so there might be a possibility if you wanted to diversify your portfolio to invest in Africa.
But I think the other side is that the overall appetite for risk has gone down, and in fact, even the availability of credit has gone down. You can see that within the United States and Europe as well. So there are effects going in opposite directions, but I think the dominant effect is likely to be somewhat of a losing down of private capital flows. But, I think we haven’t seen it explicitly yet. We should be looking for things like some potential bond issues. For instance, Ghana was planning on issuing a $300 million sovereign bond, but the interest spread on that had grown so substantially that they are actually considering postponing it. So that’s a kind of indicator. When the spreads start increasing on sovereign bonds it’s an indicator that there might be a problem with capital flows.
Given this climate of uncertainty it almost seems like whether the monetary flows actually slow or not, this might cause some governments to take a second look at any potential infrastructure investments that they were about to make. If they were about to build a big port, they might pull back on that now because the climate seems so uncertain. Do you think that’s the case, or not?
They might pull back on that because the financing is not available. I think the profitability of the port or the bridge or the road is still very high because, as we know, Africa still has a huge infrastructure deficit. There is the problem that the funds to finance it might not be so easy to get. But then some governments might start looking for domestic sources of financing. And in fact, the Tanzanians are talking about floating a local currency bond because they think that the foreign currency bonds might be slowing down.
What do you see as the World Bank’s role in all of this? Is your role to facilitate these private investment flows to supplement places where you think such flows might be lacking? What is the bank’s approach?
I would say all of the above. The bank is involved in several different ways. One is trying to give these countries the best possible advice on how to manage these situations, because, as I mention in my blog as well, some African countries are facing serious macroeconomic imbalances quite independently of the financial crisis, mostly brought on by the fuel and food crises-such as Ethiopia having 60 percent inflation and so on. So we are trying to provide advice, just-in-time advice, to these governments on how to manage that. Secondly, we do try to supplement our financial assistance where possible to make up for some of these shortfalls, including using the whole range of bank instruments, including the IFC, the International Finance Corporation, which would be another way of replacing what would otherwise be private capital flows.
Do you anticipate that some of that kind of funding might need to go toward the agricultural sector?
With agriculture we are scaling up our program and we’re planning to lend about $700 million to $800 million this year. But that’s official aid, so I don’t think that should be facing a shortfall, because that’s government aid, that’s our aid money that’s already pledged. So this is really about the public-private partnerships for large infrastructure projects like electricity plants and things like that.
You mentioned there is a possibility that these sovereign wealth funds may turn to Africa. Have you heard of any instances of that happening so far?
No, this is purely speculation.
If you had to give some advice, though it’s difficult because we’re talking about so many countries, but would there be a set of policy prescriptions that you would have for African finance ministers that could better prepare them for, say, the next one to three years?
There’s no blanket prescription; it very much depends on the circumstances. For the ones that are facing the large macroeconomic imbalances, the advice is really that they should try to bring those balances down earlier rather than later, because otherwise it could be a very hard landing, so you want to smooth out that landing. But, for the slightly more stable macro-economies, I would tell them to try and look for other sources of financing if the private capital dries up.
And those other sources of financing would include a domestic issuance, like you suggested?
As well as places like the World Bank and other official sources that are already at their limit, but there might be a way to try to expand those limits.
Do you think that this financial crisis could precipitate some kind of intra-continental financing, if you will, more South African money going into Nigeria or money from Kenya going to South Africa?
Well, it could, but as I mentioned earlier, South Africa is one of the countries I’m concerned about. So they’re unlikely to be the source of financing.