Marcus Goncalves, Associate Professor of Management / Chair, International Business Program, Nichols College, Dudley, MA. USA
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Subjects of Interest
- Frontier and Emerging Markets
- International Affairs
- Private Sector Development
How Africa can manage threats of stagflation 06 Oct 2015
Sub Saharan Africa remains one of the world’s fastest growing regions. However, worrisome macroeconomic conditions are becoming very apparent. A set of idiosyncratic threats, stemming from both external and domestic factors, are threatening SSA’s economic stability. The upsurge in volatility in the international financial marketplace, and the lower growth in export markets, is also becoming a major catalyst for external risks in the region.
Africa’s significant dependence on Chinese trade only aggravates its overall economic situation, as China too, struggles to restructure its economy and prevent a hard landing. China’s economic slowdown is actually rippling across several African economies, in particular the Republic of Congo, Angola and Mauritania, who rely on China for almost half of their exports. Sub Saharan African policymakers, consequently, need to respond appropriately and be swifter in their policy development regarding China’s engagement.
China, nonetheless, is only one of the many factors slowing down Sub Saharan Africa’s economies. The economic growth in the region slowed down in the first quarter of 2015, largely due to a series of downside risks including the destructive impact of the Ebola epidemic, which has crippled the economies of Guinea, Liberia, and Sierra Leone. The impact of violent insurgencies such as Boko Haram in Nigeria, Cameroon, Niger, and Chad; the Somali civil war impacting Somalia and Kenya; the unrest in Central African Republic and Burundi; and the South Sudanese civil war, just to name a few, are also a challenge to the economies of the sub-continent. In addition, depressed commodity prices, and the overall volatility of global financial markets have added to the instability in the region.
Take South Africa, for instance, which has experienced a substantial deceleration of gross domestic product (GDP) growth, mostly due to strikes in the mining sector, shortages of electricity, and investors’ increasing lack of confidence in its markets. Another example is the decline in oil production in Angola, which has brought its economy almost to a halt.
These challenges are contributing to a significant rise of youth unemployment across the continent. In fact, this situation seems to be even more complex, as the youth activist Martin K.N. Kollie, in an article for New Ghana last July, argued that “African youth are [being] used as scapegoats by greedy politicians to fuel violence and civil crisis as a result of unemployment.” According to Kollie, among the challenges undermining genuine development, “youth unemployment stands out to be the root cause of violence and civil unrest in Africa.”
It is, therefore, crucial that the continent’s leadership take prompt action, by looking for ways to achieve economic stability while avoiding a continuous economic downturn throughout the Sub Saharan Africa region. In my opinion, it is time for African leaders to start thinking seriously about policies that can reinvigorate their economies and bring them to a more sustainable path. To this end, African policymakers should consider the adoption of a balanced monetary policy able to promote an influx of capital into the real economy, as many Western economies, and China, have been doing.
Central banks throughout Sub Saharan Africa have, instead, resisted this global trend by tapering monetary policy to ward off inflation threats as their currencies slump against the dollar. From north to south, Sub Saharan African currencies have been amongst the worst hit by a decline in investor sentiment toward emerging and frontier markets. Central banks in South Africa, Ghana, Angola, Kenya and Uganda have in fact increased interest rates this year in order to ease pressure on their currencies. Only Botswana has decided to go the opposite direction by cutting its benchmark interest rate for a second time this year. By injecting more capital into the economy, it is hoped that a more liberal monetary policy may be able to assist Africa’s money-thirsty small and medium-sized business, as Botswana expects.
For such monetary policy to have a chance, however, African governments would have to conduct an overhaul of their financial systems. Otherwise, they may end up in the same situation the eurozone faces right now: a relatively liberal monetary policy, but without a fiscal one. One aggravating factor is that, overall, SSA’s financial and banking systems, charaterised by small-size and low intermediation, remain underdeveloped. Hence, access to finance in the region is still among the lowest in the world, which restrains the region from achieving its full growth potential.
In Africa, as well as in many emerging economies, a major reason why small and medium-size businesses struggle to access loans is that the financial system defers to Big Business, which makes it very difficult for small businesses to secure loans on favourable terms. Applying for loans in Sub Saharan African banks is often a slow, frustrating and disappointing process. In general, these financial institutions are typically antagonistic to risk and, therefore, averse to loaning to small and mid-size businesses. Not surprisingly, according to South Africa’s Small Enterprise Development Agency (SEDA), the chances of a small and mid-size business owner getting a loan are not very good.
Despite the lack of loans to stimulate local economies, in my opinion, it appears that the root cause for all these conflicting economic policy resides in the peculiarities of the imbalance in the Sub Saharan current macroeconomics, which faces a dual threat of inflation and economic downturn. This is very different from the more proactive, and expansionary, fiscal policy and prudent monetary policy employed about a decade ago or so, when investment demand was overheated and there was insufficient consumption. Africa’s current risk is of stagflation, meaning the risk of persistent high inflation combined with high unemployment and stagnant demand in the economies across the region.
One just needs to look back over the last few years to notice that SSA has been displaying some stagflation symptoms. As commented earlier, high unemployment, at least in theory, means that earnings fall, as a result of the classical supply and demand curves. Employment then theoretically increases as investors pour money into labour-absorbing industries to capitalize on cheap labour. In the case of Sub Saharan Africa, however, formal salaries in the region have been actually increasing even as unemployment has remained high, and labour laws have contributed to a relatively inflexible labour market.
It seems, the main reason the African continent has been able to avoid the stagflation curse is that inflation has been contained by a combination of a Western style monetary and fiscal policy, global factors, and a good portion of luck, or China’s foreign direct investments. But the need for liberal monetary policy is imminent, as SSA economies can’t continue to count on China. Even more importantly, the continent must avoid the settling of stagflation at all cost. For now, SSA governments have been responding to the lack of growth and employment problems through traditional economic policies and measures, such as the lowering of interest rates, although inconsistent across the region, and increasing government spending, the typical Western response. This balancing act, however, is now being threatened by a combination of factors that are pushing inflation up, which could mean a stagflation issue in the very near future. The liberalization of a monetary policy, in my opinion, is the most viable alternative.
For a liberal monetary policy to be effective, however, policymakers in the region need to liberalize their financial systems. Financial liberalization can stimulate economic development. Asian economies have generally been much more successful than African nations in liberalizing their financial systems. The generally more successful economic performance of Asian economies over the last two decades has reinforced and expanded the benefits of financial sector reforms.
But, if financial restructurings are to thrive, they must be realized in a suitable macroeconomic, financial, and institutional environment. Trailing financial liberalization, the market determination of interest rates should result in moderate positive real interest rates. Consequently, an increase in the resources available to the financial system should occur, as bank deposits providing a competitive interest returns should attract more savings from funds that were formerly held outside the formal financial segment. Not only should governments allow much greater penetration to private capital in the industry, but it should also encourage the establishment of small and community-oriented financial markets.
Moreover, positive real interest rates should be able to provide an incentive for borrowers to invest in more productive activities, thereby improving the productivity of the economy as a whole. Subsequently, financial liberalization could lead to an increase in both qualitative and quantitative financial intermediation by the banking system. Financial liberalization can, consequently, stimulate economic expansion across a range of possible channels. Since the financial system performs the vital function of raising funds for, and channeling funds to, productive investments, successful financial liberalization can usually be an important component of Sub Saharan Africa’s strategy for economic growth.
Policy priorities should include the need for budget restraint for some countries in the African continent and a shift of spending to increasingly productive ends, such as infrastructure, which is an acute constraints across the entire Sub Saharan region. Project selection and management could also be improved with the implementation of greater transparency and accountability in the use of public resources.
Another measure to promote financial liberalization would be to reduce the overall corporate tax.
Above all, African future investment strategies should have long-term objectives, such as improving the competitiveness of Africa’s economies and promoting domestic consumption. For instance, by investing in education infrastructure for its less developed countries and regions, African economies could achieve multiple goals, including the improvement of skill level of its labour force and reducing regional wealth disparities.
African governments need also to coordinate its monetary and fiscal policies to ensure the efficient use of capital and proper channeling of investments into the desired sectors and industries.