AFRICA: Growth to suffer despite insulated banks

Analysis

Sub-Saharan Africa has enjoyed five years of accelerated growth, reaching almost 7% last year. While the IMF envisages growth slowing to 6.1% this year, it sees a recovery to 6.3% in 2009. However, the current financial turmoil in Europe and America, coupled with sharp declines in most commodity prices, clouds this outlook.

Financial sector impacts. The direct impact on African banking has so far been limited even in the two largest economies, South Africa and Nigeria. This apparent insulation is explained by African banks' relative lack of integration into the global system:

• Most banks are locally owned, and the parents of the foreign-owned institutions have tended not to be the worst affected.
• The interbank markets are relatively small and local.
• Demand for, and availability of, more sophisticated -- securitised or derivative -- financial instruments is limited, and most loans originated by the banks remain on their balance sheets.

Consequently, African banks hold little in the way of the flawed mortgage-backed assets that have so undermined European and US banking systems:

1. South Africa. That this is true also of South Africa -- which boasts the most sophisticated financial sector -- is due to the remaining vestiges of exchange controls that continue to limit the acquisition of foreign financial assets. Only two financial institutions -- Investec investment bank and Old Mutual life company (now headquartered in London) -- have been forced to write down assets exposed to the US sub-prime problem. However, the proportionate size of these write-downs was modest. Beyond that, there are no major signs of impaired liquidity or bank capitalisation. More specifically:
   • money-market rates have remained stable;
   • the interbank lending market has been functioning normally; and
   • there has been no recourse to the Reserve Bank for additional facilities.
2. Nigeria. Nigeria's monetary authorities were moved to reduce credit conditions in mid-September with significant cuts in the Central Bank's monetary policy rate, and the commercial banks' cash reserve and liquidity ratios, although there was no clear evidence of liquidity shortages in the system. Public concern has centred on the security of Nigeria's 63 billion dollars of official reserves, 90% of which are held in dollar-denominated assets, but again there is no evidence that these assets are impaired (see NIGERIA: Yar'Adua's challenges continue to grow - October 8, 2008).

Securities markets. Several African stock markets have fallen sharply this year, although Ghana's has risen more than 60% -- showing the importance of local rather than global factors.

Only in the case of South Africa, where the all-share index has fallen some 30% since May, have global developments played a significant role, with non-residents reducing their shareholdings this year by a net 20 billion rand (2.4 billion dollars) by the end of September (see SOUTH AFRICA: Economy slowing but may avoid recession - September 17, 2008). Even here, local conditions -- particularly the large current account deficit and the increasingly uncertain political situation -- have also been relevant. Although foreigners have remained net purchasers in the bond market, the rand has weakened sharply in the past 10 days, thus reducing expectations of early cuts in interest rates.

The collapse in equity values has significant implications for black economic empowerment (BEE) deals struck at the market's peak and that rely on debt finance or third-party funding (see SOUTH AFRICA: BEE deals continue despite uncertainty - May 5, 2008). High-profile deals potentially in trouble include Imperial, MTN, Barloworld, SASOL and Old Mutual. Some banking BEE deals -- including Standard Bank, Absa and Nedbank -- could also be derailed.

Real economy impacts. The benefits of Africa's growth surge have accrued more to oil-exporting countries than to oil-importers, who constitute the majority. The IMF outlook is predicated on the maintenance of relatively high prices for most commodities, including oil, metals, grains, coffee, cocoa and cotton. The report therefore foresees only modest consequences from the financial upheavals for most of SSA's oil-importing economies, with high oil and food prices still being offset by higher export prices -- although it does acknowledge the likely worsening of poverty problems in the more vulnerable states as a result of food-price inflation, with The Gambia, Ghana, Mauritania and Swaziland among those at highest risk:

1. China's role. A crucial question for Africa is the extent to which China's growth impetus will be affected. Sino-African trade has risen more than 62% in the first eight months of this year to 74 billion dollars, although this dollar increase is attributable more to higher commodity prices than higher trade volumes. Many African policymakers believe -- with some justice -- that economic links with China will protect their economies from the worst ravages of the coming global recession. However, recent growth in the trade is not sustainable, as Africa department officials in China's ministry of commerce concede (see CHINA/AFRICA: Hosting AfDB part of evolving aid agenda - May 15, 2007).
2. Commodity price effects. If the slowdown does extend significantly to China, and if the recent falls in international oil and other commodity prices are sustained or extended, the impacts will again be differentiated:
   • For oil exporters, the terms of trade will deteriorate sharply and growth will slow. However, unless the oil price falls below these countries' budget reference points, serious fiscal or balance of payments problems are unlikely.
   • For oil importers, the terms of trade effects will depend on the balance between lower oil and grain prices on the one hand and lower metal and other export prices on the other hand. Consequently, a number of African economies -- especially those with limited foreign-exchange reserves -- may encounter difficulties in sustaining growth anywhere near recent levels over the next few years.
3. Other channels. There are several other channels through which Africa's growth prospects may be impaired:
   • Remittances from diaspora communities, which have become an important source of foreign exchange and household incomes in numerous African countries, will be adversely affected by the slowdown.
   • Reductions -- or, worse, reversals -- in private foreign capital inflows, which have been buoyant in recent years, will threaten Africa's current substantial infrastructure development programmes, although this may apply less to Chinese-funded projects.
   • The World Bank warns that if cutbacks spread to foreign aid programmes then the quality of life for many Africans, including those on AIDS treatment, is likely to worsen, as is the gap between rich and poor countries in general.
   • A number of countries face rising inflation and other macroeconomic imbalances, including current account deficits, budgetary strains and reduced employment. While not directly related to the global financial upheavals, the less benign global environment will be unhelpful in addressing these problems.