Chart 1: Global growth versus average growth in Sub-Saharan Africa, 1980-present

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1 Africa Razia Khan, Regional Head of Research, Africa, , Standard Chartered Bank, United Kingdom, Previous global economic downturns have impacted Africa with a lag While green shoots of recovery are seen elsewhere, African economies have been hit through a number of different channels Commodity price recovery is necessary, but not suffi cient, to restore rapid growth Financial-sector reform is a prerequisite for fi nding homegrown solutions to the crisis Financing the future The repeated downgrades to Sub-Saharan African growth forecasts underscore the region s vulnerability to the global crisis. Increasingly, though, the question is not just how deeply Africa will be impacted by the crisis, but also for how long. In its latest Regional Economic Outlook ( REO April 2009), the IMF attempts to quantify the link between global developments and average growth in Sub-Saharan Africa, by comparing world growth (weighted by the relative importance of trading partners) against the average growth rate in Sub-Saharan Africa (40 of the region s 48 economies are included). Chart 1: Global growth versus average growth in Sub-Saharan Africa, 1980-present According to the study, a 1ppt slowdown in GDP growth in the rest of the world leads on average to a 0.5ppt slowdown in Sub-Saharan Africa. Of this, a 0.2ppt deceleration tends to occur contemporaneously, while most of the impact a 0.3ppt decline in the growth rate is seen the following year. However, the results only explain a small amount of the variation in growth among countries in the region, and that domestic factors matter too. In particular, it is diffi cult to estimate overall African growth in the current environment because of the characteristics specifi c to this downturn. All economies, not just a select group, are impacted by the 11

2 crisis. For Africa, it is not only the traditional commodity price channel (affecting export earnings, fi scal balances, and FDI) that matters. The nature of the fi nancial crisis, and any drying up of external fi nancing available to Africa, also risk prolonging the downturn. If the downturn were due solely to commodity prices, a relatively quick bounce-back in African growth might be anticipated. With apparent green shoots of recovery evident in Asia, commodity prices are already staging a recovery from earlier lows. However, the worry is that because a number of different factors are contributing to the slowdown in Sub-Saharan Africa, a quick return to previous growth rates of 6-7% may not be the most plausible scenario. In order to shed more light on this matter, in this month s regional overview, we examine the fi nancing constraints faced by Sub-Saharan economies, and their likely impact. Relative to other developing regions, Sub-Saharan Africa has fewer fi nancial linkages with the rest of the world. According to statistics released by the Bank for International Settlements (BIS), Sub-Saharan Africa receives less than 3% of total cross-border lending to developing regions. Yet these statistics belie the region s vulnerability. According to the BIS data, Sub-Saharan Africa saw the sharpest percentage contraction in cross-border lending to any region, when measured from the peak in Q to Q4, the latest data available. Chart 2: Cross-border lending to developing regions Chart 3: Decline in cross-border lending, Q2-08 to Q4-08 Sources: BIS, SCB Global Research Sources: BIS, SCB Global Research Given perceptions of the relative risk of African economies, this sharp decline in cross-border lending is not entirely surprising. Africa, particularly frontier Africa, was a key benefi ciary of rising capital fl ows during the years of good global economic growth, easy availability of liquidity, and high levels of risk appetite. This applied as much to bank lending as it did to portfolio investment. But with the turn in risk appetite and, crucially, the process of deleveraging and repatriation, many non-traditional players in African banking were quick to exit the region. Interestingly, however, the withdrawal of foreign bank lending from Sub-Saharan Africa has not been uniform. Chart 4 provides a breakdown of the y/y and q/q changes in foreign claims for Q As might have been expected, in y/y terms, many of Africa s oil economies benefited from considerable growth in lending by foreign banks. But by the end of the year, many had been hit by a sharp q/q contraction in lending, most noticeably Nigeria. Within the West African sub-region, the regional expansion of Nigerian banks may have played a key role. A further contraction in cross-border lending to some of the region s smaller economies is probable, given recent events such as the tightening of regulations on regional investment by Nigerian fi nancial institutions (with supply of FX for this purpose being limited). 12

3 Chart 4: Growth in foreign lending to African countries, Q4-08 Sources: BIS, SCB Global Research Elsewhere in Africa, the evidence is more mixed. While Zambia, Ghana, and Uganda reduced their borrowing from foreign banks in Q4-2008, anecdotal evidence suggests that the situation may have started to reverse, with developments related to the resource wealth of these economies being a key swing factor. However, this is unlikely to make an immediate difference to growth. In Kenya, the revival of cross-border borrowing is likely to have been dramatic. Yet this is partly on the strength of borrowing by state-owned companies, which threatens to crowd out other lending including to SMEs, which could provide a more immediate boost to domestic spending amid the downturn. With the credit environment and availability of foreign lending still relatively constrained, this shift of liquidity away from SMEs has had a marked negative impact on the economy. In response, the authorities have taken steps to boost liquidity reducing policy interest rates, buying foreign exchange, and engaging in reverse repos. It remains to be seen whether these measures will be suffi cient to avert a more pronounced downturn in other lending, and in growth. Kenya provides an interesting illustration of the hurdles facing other African economies. With liquidity from foreign fi nancial institutions more diffi cult to obtain, Africa will increasingly have to seek out homegrown solutions to fi ll the gap. However, varying degrees of fi nancial-sector development mean that some economies will be better-placed than others to meet the challenge of the withdrawal of cross-border liquidity. The four charts below provide a broad outline of the factors preventing more effective fi nancial intermediation in the region, as well as a snapshot of where Sub-Saharan economies stand. Charts 5 and 6 illustrate that Sub-Saharan Africa is characterised by a low level of fi nancial intermediation. Although there are some exceptions, narrow monetary aggregates dominate in most of the region s economies. Given the region s low deposits-to-gdp ratio, an inability to mobilise bank deposits may be a key constraint on fi nancialsector development (see Chart 7). Recent technological changes, including the rapid rise of mobile phone banking, may help to alter the picture by drawing the informal sectors into the formal economy, and bringing cash under the mattress into the banking system, where it can be intermediated more effectively. Still, based on the data below, it is doubtful whether this is happening rapidly enough to make a difference. Important constraints on effective fi nancial intermediation remain in place, including the absence of clear title to land, the lack of credit reference bureaus, inadequate legal infrastructure, and a host of other factors. Conditions vary between markets. A cursory examination of asset-to-deposit ratios across the region (again, there is much variance) suggests that a key constraint in some economies is the ability to mobilise deposits. In other economies, the problems are weighted more towards constraints on asset growth banks may be fl ush with liquidity, but there is little lending, and this may reinforce the lack of impetus to further mobilise deposits. 13

4 What is noteworthy is that these structural constraints failed to curb credit growth during the recent economic upturn (Chart 8). Although credit growth may not have been as healthy as in developing Asia, the trend for the Sub-Saharan African region as a whole was at least moving in the right direction. Nonetheless, there was still a marked disparity between the so-called fi nancially developing economies of Africa where credit growth was less impressive and the frontier economies, which were the benefi ciaries of sizeable foreign infl ows. This leads to an interesting question one that could potentially be key to the outlook for African growth. Was the success in raising credit growth rates in frontier economies primarily due to the (then) easy availability of capital, and the fl ood of capital infl ows that characterised the boom? Or did recent success have more to do with underlying structural changes and reforms that allowed for more effective fi nancial intermediation? The response is likely to vary by economy, but the coming months which will probably still be characterised by an external liquidity drought may provide a key test. The liquidity fl ight from African economies is likely to exacerbate the downside risks to growth. In light of this, the need to engage in fi nancial-sector reforms has taken on much more urgency. Chart 5: Africa is still largely a cash economy (M1 to M2) Chart 6: The region lacks the financial depth of other developing regions (M2 to GDP) Chart 7: Mobilising bank deposits is a key constraint (bank deposits to GDP) Chart 8: Financial-sector reforms are required to secure recent gains (private bank credit to GDP) 14

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