NS4301 Summer Term

Africa: External Developments of Importance

Key Themes for 2015

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Geopolitical Risks Intensifying

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Assessment of Key Risks

• The current consensus forecasts and scenarios are sensitive to a series of possible shocks/adverse developments.

• Adverse developments in one or more areas might result in increased instability and/or negative linkages leading to lower growth rates:

1. Eurozone Crisis

2. Instability from Oil Price Decline

3. African Debt Problems

4. China Hard Landing

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Key Risk I: Eurozone Crisis I • The current crisis in the Euro-zone can be easily traced

back to a fundamental flaw in the Zone’s economic model:• The model concentrated monetary policy in the European

Central Bank (ECB) while leaving fiscal policy to individual member states – inherently unstable arrangement

• It denies member states monetary policy levers with which to help their recoveries

• Also makes deficit-funded stimulus harder as monetary policy can be used to keep borrowing costs low.

• The EZ is not an optimal currency area – the common monetary authority is likely to act in ways that help some countries but not others.

• The ECB has pursued tight monetary policy that may prevent inflation in high-growth states like Germany but could also be worsening the recession in Greece, Spain and other struggling states.

• Rigid labor markets prevent adjustments common in the United States.

• Also Europe still lacks key elements necessary for a common currency to work – Joint European Bank Regulator and a system for dealing with troubled financial institutions, unconstrained independent, central bank

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Eurozone/US Recovery

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Key Risk I: Eurozone Crisis II

• In Europe much of current stability is due to

• The pledge of the European Central Bank (ECB) to defend the euro “at any cost”

• New financial instruments to defuse debt, and

• The start of a banking union

• However fiscal adjustment remains unsupportive; unemployment is high in the core economies and continues to increase in Southern Europe

• The ECB is under increasing pressures to move toward US-style large-scale bond purchases – controversial whether this will make any difference

• At the national level, many of the troubled countries have the option of cutting spending or not cutting – both with major downsides.

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Key Risk I: Eurozone Crisis III

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Key Risk I: Eurozone Crisis IV

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Key Risk I: Eurozone Crisis V

1. Cut spending – pretty sure to deepen the recession

• Probably means more unemployment (already well over 20% in Spain)

• May push wages down to more competitive levels – history suggests this is very hard to do.

• Even so, lower wages will just make people’s debts even harder to repay

• Meaning they are likely to cut their own spending even more, or stop repaying their debts

• Lower wages may not even lead to a quick rise in exports if other European economies markets are in a recession too

• In any case, can probably expect more strikes and protests and more nervousness in financial markets (causing even higher interest rates) about whether you really will stay in the euro

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Key Risk I: Eurozone Crisis VI

2. Don’t cut spending• Risks a financial collapse

• Amount borrowed each year has exploded since 2008 due to economic stagnation and high unemployment

• But if economies are chronically uncompetitive within the euro

• Markets liable to lose confidence in you – may fear that economies simply too weak to support increasing debt load

• Meanwhile other European governments may not have enough money to bail you out, or are legally/politically constrained from doing so

• European central bank has said its mandate doesn’t allow it to provide unlimited bond purchases

• Clearly only way out of crisis is a coordinated approach involving creditors and debtors and international institutions such as the IMF

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Eurozone: Reason for Optimism

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Countries at Risk: Greece I

Strengths (+) and weaknesses (-)

•(+) Euro area membership

• European financial assistance has protected the country against a chaotic government default.

•(-) High public debt

• A history of weak fiscal discipline, combined with the long economic contraction since 2008, has resulted in a very high gross public debt ratio of 177% of GDP in 2013.

•(-) Weak competitiveness

• Rising labor costs in the years ahead of the crisis have resulted in a weak export growth in recent years.

•(-) Poor institutional quality

• Greece is lagging other European countries in several indices of institutional strength, like the rule of law, ease of doing business and the corruption index. 13

Countries at Risk: Greece II

• Developments since the Greek elections, Fall 2014

• The recovery that Greece was experiencing last year has ground to a halt, and

• Turned into what is very likely a new recession.

• The rhetoric out of Athens and the confrontation with its European partners has

• Scared the private sector, and

• Triggered a massive capital outflow.

• Greece has decoupled from the recent improvement in euro area activity,

• Indicated by the divergent evolution of the Purchasing Managers Index (PMI) brought on by uncertainty

• This is weakening the Greek bargaining position

• Eurozone finance ministers unlikely to blink

• There is a 30% risk of a catastrophic Grexit.

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Key Risk II Oil Price Decline I

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Key Risk II Oil Price Decline II

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Key Risk II: Nigeria

• Nigeria’s emergence as Africa’s largest economy due mostly to rapid growth in services

• However, country still depends on oil for more than 60% of state revenues and 90% of export earnings

• Compounding the problem is the escalating Islamist insurgency in parts of the North.

• Oil production is down – averaging well below its 2.4mb/d capacity due to massive theft and a lack of investment following five years of legislative paralysis over reforms for the industry – the result.

• Foreign portfolio investors have taken flight

• The government has slashed spending for 2015

• The stock market was down 23 percent in 2014 and

• The country’s currency has had a massive devaluation

• Infrastructure constraints will increasingly limit growth. 17

Key Risk II: Angola

• Low oil prices caused a 57% decline in oil earnings in January 2015 compared to same period in 2004

• Oil earnings account for:

• 95% of export earnings and 80% of tax revenues

• Revised budget cut by 25% or $1.8 trillion

• Capital expedites cut in half; recurrent by 20%

• Education and healthcare cut by 13.5%; transport by 75%

• Security left at 15.% of budget

• Budget deficit stands at 7% GDP and

• Current account deficit at 19% GDP – first deficit since 2009

• To cover shortfall government negotiating $ one billion in loans and is planning on borrowing $9 billion including a %1.5 billion dollar euro-bond to ensure progress on key projects

• Currency depreciating with a 40% black market spread.• Inflation projected at 9%, fuel prices to rise• Likely that rising living costs will cause protests and instability

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Key Risk III: African Debt I

Debt growing problem in Africa•Borrowing in dollars increasingly risky and expensive•As local currencies depreciate on softening commodity prices, repayment costs soar•Threatening added costs of up to 10.8 billion dollars•March 5, 2015 Ghana announced plans for a 1 billion ten year Eurobond to repay part of its debt maturing in 2017•Extremely low and increasingly negative bond yields in developed economies encouraging capital flows to Africa•Over past two years African states have issued 22 billion dollars in dollar denominated debt•Almost as much as total sovereign issuance across the region in past nine years

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Key Risk III: African Debt II

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Key Risk III: African Debt III

• In last several months investors becoming more cautious• Now oil exporters would have difficulty issuing debt on

favorable terms• In addition to possible slow oil price recovery, principle risk in

dollar bond market is threat of earlier than expected U.S. interest rate increase

• Markets could shift very rapidly with borrowing rates increasing sharply

• Would make it considerably more difficult for countries to access international capital at affordable rates

• Oil exporters will be hit the hardest – suffering high repayment costs due to currency volatility.

• The debt situation makes many African countries vulnerable to a fiscal crisis and internal unrest.

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Key Risk IV: China Hard Landing I

Overview:• China’s economy is currently going through a painful

transition to a more consumption based economy• The days of double digit economic growth clearly over• In the short run, slower growth is generating concern

about the nation’s near-and medium-term prospects• There is an up-side to the gradual slowdown over the

past several years

• Growth in the coming years will be both robust and more sustainable

• The structural reforms that are central to the 12th Five Year Plan (2011-2015) will become somewhat easier to achieve

• On balance it appears China’s economy is headed in the right direction, but still worrisome in the short-run

• However, key economic and political risks – including corruption, social inequality and lack of progress in governance reforms – must be addressed in order to assure long-term economic growth.

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Key Risk IV: China Hard Landing II

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Key Risk IV: China Hard Landing III

• The risk of a sharp slowdown in China remains elevated and will rise in the medium term as:

• Financial liberalization contends with

• Legacy debts from unproductive local government investments and excess residential real estate construction

• Scenarios in two stages. Outcomes at the intermediate stage can lead to any of the longer-term scenarios with various probabilities

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Key Risk IV: China Hard Landing IV

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