Africa-EU Economic Relations in Light of the Global Financial and Economic Crisis

Africa-EU Economic Relations in Light of the Global Financial and Economic Crisis By Sanoussi Bilal and Melissa Dalleau Economic and Trade Cooperation Programme of the European Centre for Development Policy Management (ECDPM), Maastricht and Brussels (www.ecdpm.org) sb@ecdpm.org Paper prepared for the Bremen Africa Conference 2010 on The Impact of the Global Financial Crisis on Economic Reform Processes in Africa, Bremen, 28-29 January 2010 DRAFT FOR DISCUSSION January 2010

Table of contents 1 Introduction...2 2 The effects of the global financial and economic crisis on sub-saharan Africa...3 2.1 Overall impact...3 2.2 Fiscal effects of the crisis and sources of deficit...5 3 EU measures to support SSA in addressing the GFEC...9 3.1 The EU response: Principles and measures identified...9 3.2 V-FLEX: EU flagship measure to address fiscal financing gaps...10 4 Adjusting the EPA process and accompanying support...15 4.1 Define the challenge: complex relationship between the GFEC and EPAs..15 4.2 Assessing the Challenges: EPAs, revenue losses and the global context...16 4.3 Taking up the challenge: the case for flexibility...19 5 Conclusion...20 References...22 1

1 Introduction The global financial crisis, which originated in developed countries in 2008, has turned into a global economic crisis whose effects are hard felt across the globe. Despite the expectation of many economists at the onset of the crisis, it has also swept to developing countries, often undermining the positive economic development achieved over the past few years. If during most of 2008 the crisis has mainly affected those few countries in Sub- Saharan Africa (SSA) that are relatively integrated to international capital markets (South Africa, Mozambique and Kenya, among others), its impact has spread to far more SSA countries over the course of 2009, mostly through real-economy channels. Deteriorated terms-of-trade, lower commodity prices with a greater volatility, lower demand for exports, net reduction of private capital inflows, collapsing reserves, as well as declines in remittances, tourism and potentially aid flows, are all keytransmission factors that have contributed to reduce Africa s growth prospects in 2009 (Kasekende, 2010; Bilal et al., 2009). The global crisis has also a repercussion on the relations of African countries with one of their main partners, the European Union (EU). In the context of the Cotonou Partnership Agreement between the African, Caribbean and Pacific (ACP) countries and the EU, a comprehensive economic and development cooperation framework is in place, which provides opportunities and instruments for the EU to support ACP countries, including SSA (with the exception of South Africa), including in their endeavours to address some of the consequences of the global financial and economic crisis (GFEC). In particular, the 10 th European Development Fund provides about 22.7 billion for the period 2008-2013. As the largest provider of official development assistance (ODA), but also the main trading partner of most African countries, and a primary source of migrant workers remittances, high expectations were placed on the support of the EU, which was quick to respond. Despite some positive and innovative propositions that can only be praised, the EU s response to the impact of the crisis on developing countries is far from being over-ambitious with few new resources made available. In addition, the EU and the ACP have initiated in 2002 the negotiations of economic partnership agreements (EPAs), several of which have been concluded, at least partially, between the EU and ACP regions or countries at the end of 2007, while negotiations continue in SSA towards final regional EPAs (Bilal and Stevens, 2009; Jones and Marti, 2009). This new economic and trade framework, which aims to set comprehensive free trade agreements (covering goods, services and a range of trade-related issues) between the EU and ACP (notably SSA) sub-regional groupings, should have far reaching consequences on the development prospects of African (as well as Caribbean and Pacific) countries and regions and their relations with the EU. In addressing the effects of the GFEC, EPA negotiations, conclusion and implementation can thus have significant consequences, in terms of both opportunities and challenges they provide. If the direct effects of EPAs are likely to be felt only in the medium and longer term, thus offering little immediate remedy to the current GFEC, they remain nonetheless important in the short run as well. Indeed, the crisis may alter the incentives to conclude an EPA or modify the scope of the agreement sought by some African countries and regions. It may also influence the incentives of some countries and regions to engage in (systemic, economic and institutional) reforms needed in parallel to an EPA. 2

Focusing solely on the economic and development relations between Sub-Saharan African countries and regions with the European Community in the context of the ACP-EU framework, this paper discusses some of the direct consequences of the global economic and financial crisis on SSA and the instruments and mechanisms in this framework to address them. The paper argues that, beyond ad hoc mechanisms and measures aimed at cushioning the direct social impact of the crisis, as proposed by the EU, flexibility and commitments, notably within the context of EPAs, are key-elements to support development efforts to address some of the consequences of the GFEC on African countries. Indeed, while EPAs are no immediate remedy to the crisis, they could further add to the difficulties encountered by some African countries, unless some flexibility is introduced in the EPA negotiations process and appropriate development support measures are promptly adopted and implemented The discussion is structured as follows. Section 2 highlights some of the key effects of the GFEC on SSA countries, and group of countries therein, notably in terms of their growth prospects and fiscal imbalances. Section 3 then reviews the response of the EU as articulated in the Communication of the European Commission on the support to developing countries in coping with the crisis and focuses on the establishment of a new instrument to address fiscal financing gaps in the ACP, the Vulnerability FLEX. In Section 4, more systemic aspects of the Africa-EU economic and trade relations are considered, as embodied in the setting of EPAs, with special attention to the fiscal dimension of EPAs in terms of loss of tariff revues. Section 5 brings the discussion to a close. 2 The effects of the global financial and economic crisis on sub-saharan Africa 1 2.1 Overall impact If a year ago, economists and observers showed some optimism regarding the likely impact of the global financial and economic crisis (GFEC) on African economies, figures and analyses made available in 2009 have clearly swept those away. Indeed, although most African countries seemed to have avoided a recession in 2009 (Kasekende et al., 2010), main macroeconomic indicators have undeniably worsened since the beginning of the crisis. First, despite the low degree of financial integration to international markets of most African countries, Sub-Saharan African economies have not been immune to contagion effects spreading through financial markets. Kasekende et al. (2009) found that for some African markets, such as Nigeria, the impact of the crisis through financial market was worse than for some developed countries, with investors losing on average within six months more than half of what they had invested at the end of the summer 2008, (Kasekende et al., 2009). Secondly, and most importantly, the global financial and economic crisis has hit Africa through real-economy channels, such as lower remittances, lower commodity prices with a greater volatility, and deteriorated terms of trade (see Section 1.2 below). 1 Unless specified otherwise, most of the statistics and figures provided in this section come from the latest IMF staff estimates (IMF, 2009). See also Bilal et al. (2009) for an earlier succinct assessment. 3

The combined negative impact of these two shocks has put an end to many years of positive economic performances (Kasekende et al., 2010; IMF, 2009). While Sub- Saharan Africa (SSA) was growing at an annual rate of nearly 6½ percent in the years leading up to the global financial crisis (2002 07), the IMF (2009) projects that in weighted-average terms, growth will drop to just 1% in 2009. In terms of real GDP per capita therefore, Africa will record negative growth in 2009, as illustrated in Figure 1. Aggregate data, however, hide some important geographical disparities, with growth in oil exporting countries 2 and middle-income countries (MIC) 3 being particularly impaired by the global economic downturn (Figure 2). Figure 1. Revisions of GDP per capita growth in sub Saharan Africa in 2009 Source: IMF and te Velde (2009) as reported in Bilal et al. (2009). Figure 2. Real GDP Growth in SSA Source: IMF, 2009- Regional Economic Outlook: Sub-Saharan Africa, October 2009 2 Angola, Cameroon, Chad, Congo, Equatorial Guinea, Gabon, and Nigeria 3 Botswana, Cape Verde, South Africa, Namibia, Mauritius, Lesotho, Swaziland and Seychelles 4

2.2 Fiscal effects of the crisis and sources of deficit The financial and economic crisis has considerably worsened the fiscal positions of African economies, already negatively hit by the effects of the food and energy crises. According to recent IMF data, the overall fiscal balance (excluding grants) in SSA was projected to worsen from a surplus of 0,3% of GDP in 2008 to a deficit of 6,4% in 2009 (IMF, 2009). However, once again, there are major differences between categories of countries, as illustrated in Figure 3. Low-income countries (LIC) and fragile states are less negatively impacted, respectively because of their lower degree of integration in the global economy and the likely growth effect coming from post-conflict reconstruction (IMF, 2009). It is also interesting to compare the structure of the fiscal imbalance. Figure 4 shows that while fiscal revenues fell and government expenditures increased for all types of SSA countries, the fiscal deficit is mainly due to increased government expenditures in MIC 4, and fragile states, whereas is lowincome and oil exporting countries, the loss of government revenues is the predominant factor. This is also the case for SSA as a whole. Figure 3. Overall Fiscal Balance, Excluding Grants (central government, % of GDP) Source: IMF, African Department Database, September 2009 and World Economic Outlook database, September 17, 2009, as compiled in African Regional Economic Outlook, October, 2009 4 The sizeable swings in middle income countries fiscal balance are likely here to result from discretionary stimulus adjustment measures to counter the economic downturn due to the crisis (IMF, 2009; Kasekende, 2010) 5

Figure 4. Government revenues and Expenditures in SSA, Change between 2008 and 2009 Source: SREO, 2009 (based on IMF, African Department database). This can be explained by three main reasons. First, from 2008 to 2009, both export demand and commodities prices decreased considerably under the combined effects of the oil and food price shock (see Figures 5a and 5b) and the outburst of the financial crisis, thus leading to the decline of commodity-related revenues, which account for a significant part of budgetary revenues in many SSA countries (IMF, 2009b; IMF, 2009). The trade balance of many SSA countries is expected to significantly deteriorate as a result of the crisis, falling from an average of 8.6% of GDP in 2008 to 1.6% of GDP (IMF, 2009) 5. A number of countries have therefore faced both deteriorating fiscal and current account balances (Kasekende et al. 2010). The most striking illustration of these twin deficits concerns oil exporting countries whose fiscal balance and external current account balance have declined respectively from a surplus of 6,2% and 14% of GDP in 2008 to a deficit of 6,1% and 1,5% the following year (IMF, 2009), as shown in Figures 3 and 6. Recent studies have found that commodity-related revenues, linked to the volatility of commodity prices and the fall in export demand (see Figures 5a and 5b), have been the primary driver of fiscal outcome in 2009, creating thereby important challenges to those countries where such revenues represent an important share of total revenues, such as Angola, Botswana, Chad, Gabon (Berg et al., 2009; Kasende et al. 2010). As Bilal et al. (2009) point out, the overall impact on trade for each African country thus greatly depends on the composition of its trade balance; countries with more diversified exports [being] on average less exposed to the current economic downturn. 5 The share of exports in percentage of GDP is expected to fall from 41% to 31.2% in SSA (IMF, 2009). 6

Figures 5a and 5b. Evolution of Commodity Prices and export demand Source: IMF (2009). Figure 6. Current Account (including Grants) % of GDP Source: IMF, African Department Database, September 2009 and World Economic Outlook database, September 17, 2009, as compiled in African Regional Economic Outlook, October, 2009 Secondly, on top of these commodity-related revenue losses, tighter economic and financial conditions in developed countries have also impinged on the capacity of SSA economies to finance their spending by raising funds externally, as well as their capacity to compensate for it by relying on domestic financing (Berg et al., 2009). In June 2009, remittances from migrant workers to their countries of origins were predicted to decline from between 4.5% to 8% over 2009 (Ndikumana, 2009). Such a decline could have a significant impact on consumption in those countries where remittances account for more than more than 10 % of GDP value, such as Lesotho (European Commission, 2009b). 7

The decline in the flows of FDI and portfolio investment has also drastically cut into government revenues and so has the decline of tourism activities in some countries such as Uganda and Botswana (European Commission, 2009). The main trends of current and capital inflows, as detailed in the most recent IMF Regional Economic Outlook for the region, are presented in Figure 7. Figure 7: Net current and capital inflows Source: IMF (2009)., Regional Economic Outlook: Sub-Saharan Africa (SSA). Finally, the fiscal space of most SSA countries has also been indirectly impinged on through the action of automatic stabilizers associated with slower economic activity (Berg, et al., 2009 ; Kasekende et al., 2010). The combination of the above-mentioned macroeconomic effects of the crisis on Sub-Saharan Africa have already led to a reduction of employment opportunities and an increase in poverty and malnutrition for the most vulnerable people, representing therefore a threat to the progress towards the Millennium Development Goals (MDGs) (Spalla, 2009) In light of the above, economic policy responses in Africa have varied greatly. While some have been pro-active and acted counter-cyclically by implementing fiscal stimulus package and insisting on growth-related policies, as in Mauritius (Makoond, 2009), others were simply not in the capacity to do so because of adverse macroeconomic conditions (Berg et al. 2009; Jones 2009; Te Velde et al. 2009). For the latter group, forced to fiscal adjustments, additional donor support appears critical. Not surprisingly, as the main trading partner of most ACP countries, the largest provider of ODA and the primary source of migrant workers remittances, high expectations were placed on the EU. 8

3 EU measures to support SSA in addressing the GFEC The EU was prompt to translate the commitments taken at the G20 summit in London on 2 April 2009 into concrete plans, with the released by the European Commission (EC), within a week of the summit, of a Communication on supporting developing countries in coping with the crisis (European Commission, 2009a). Although the Communication received only lukewarm support from the EU member states 6, it has outlined the possible lines of actions for the EU, summarized in Section 3.1. As a result, the EU has also developed one of the most concrete mechanisms to support ACP countries, with the establishment of an ad hoc Vulnerability FLEX instrument, presented in Section 3.2. However, the Commission Communication largely ignored the major framework for the ACP-EU trade and economic relations, the EPA process, which is simply referred to as a mean to mitigate the longer-term effects of the crisis. Yet, the GFEC does have some impact on ACP, and notably SSA countries, which deserve serious attention in the context of the EPA negotiations and implementation, as argued in Section 3.3. 3.1 The EU response: Principles and measures identified Adopted in April 2009, the Communication of the European Commission to support developing countries in coping with the crisis details a series of 28 measures comprising propositions of immediate actions, recommendations and long-term suggestions, not only to be undertaken by the European Commission and the European Investment Bank (EIB), but also to be considered by EU member states in their bilateral relations with ACP countries 7. Slightly modified, these propositions were echoed in the related-council Conclusion, published on 18 May 2009. In addition to exhorting EU member states to honour their ODA commitments, increase their efforts to mobilise additional development finance and present the actions they introduced in response to the crisis in developing countries (measures 1,2 and 8 to 10), the European Commission proposes, in its Communication, specific short-term to medium term measures to be directly implemented at the EU level. Among those, the EC proposes notably to accelerate the Mid Term Review (MTR) of its strategy papers and support programmes in 2009-2010 to reflect new needs and priorities, as well as to quicken disbursements through more flexible implementation procedures (measures 3-4). The Commission also suggest frontloading aid in a number of areas. For instance 3bn will be committed for budget support as a frontloading measure (i.e. 72% of all budget support foreseen for 2008-13). Moreover, in order to support social spending, the EC pledged to mobilise up to 500M for the most vulnerable countries, which would be channelled through the existing FLEX (a mechanism aimed at mitigating the adverse effects of instability in export earnings), as well as through a new ad hoc mechanism, the vulnerability FLEX mechanism (V-FLEX), designed to address the budgetary consequences of the crisis in ACP countries (see section 3.2) 6 The Council did not endorse, but only welcome' the Communication as a good basis for the EU response (see Conclusion of General Affairs and External Relations Council of 18 May 2009). 7 For a detailed account and assessment of the EU s response to the impact of the crisis in developing countries, see Woods (2009). 9

Other elements of the EU s response include supporting the reinforcement of the EU- Africa Infrastructure Trust Fund by increasing the European Commission contribution with another 200m commitments in 2009, and inviting EU member states to supplement additional 300m to the Trust Fund (measure 16). Besides, 50 countries, more than 60 % of which are ACP States, will receive assistance from the Food Facility where approximately 1bn will be frontloaded (measure 17) 8. Finally, the EC made recommendations aimed at improving aid effectiveness both at the European level and international level (measures 8-11), as well as international governance and stability (measures 26-28). If the Commission was quick to provide propositions to help developing countries cope with the consequences of the crisis on their economies, its approach can still be seen as one of limited ambition. Half of the proposed measures seem indeed to be a mere reiteration of previous pledges. Whether they be designed to enhance donor coordination or relate to the reforms of the international aid architecture, suggested actions aimed at improving economic governance and aid effectiveness have indeed been on the international and EU development agenda for many years. Moreover, these initiatives, as necessary and commendable they may be, are no quick fix to the economic difficulties the current crisis has generated for African countries. As for those measures designed to provide an immediate response to the crisis, they simply seem to have missed the recommendations of many economists who were singing the praises and necessity of additional finance 9. As Woods (2009) emphasized in her briefing paper to the European Parliament, almost 99% of quantitative pledges come from pre-existing commitments, additional commitments being only provided in the context of the EU-Africa Infrastructure Fund. 3.2 V-FLEX: EU flagship measure to address fiscal financing gaps Among the short-term actions recommended in the Communication for a timely and targeted European action, the European Commission proposed to deliver 500million, preferably as budget support, through (i) the existing FLEX mechanism, and (.) the creation of an hoc Vulnerability-FLEX mechanism (V-FLEX) 10. V-FLEX is particularly relevant in the context of our present study, as it was specifically designed to address the actual and forecasted fiscal financing gap of those ACP countries hit hard by the economic crisis. It is aimed at swiftly providing grants that are complementary to the assistance of multilateral donors and to the funds already been given under general budgetary support. Used to top up the B-envelope of the National indicative Programmes (in conformity with Article 3(5) of Annex IV of the Revised Cotonou Agreement 11 ), allocations under V-FLEX, are to be drawn from the reserves of the 10 th European Development Fund 8 See answer given by Mr De Gucht on behalf of the European Commission to a written Parliamentary question on the effects of the global financial crisis and support for developing countries, 18 January 2010, (European Parliament (2010). 9 See Containing the Fall-out of the Global Financial Crisis in Developing Countries, Capacity4Dev.eu, 07/10/09, http://capacity4dev.ec.europa.eu/containing-fall-out-global-financial-crisis-developing-countries 10 European Commission, 2009a : measure 13 11 Europa Press Release IP/09/1920, 15 December 2009, Commission approves 230 million to cushion the impact of the economic crisis in 13 African and Caribbean countries 10

(EDF) 12. Given the limited amount of funds available ( 500M for two years) and in order to ensure ownership by ACP countries, V-FLEX was conceived as a demanddriven mechanism, to which eligibility is assessed on the basis of specific criteria 13. Firstly, except for fragile states which can benefit from a waiver, quantified benchmarks regarding government revenue reduction, depletion of foreign reserves and deterioration of the fiscal deficit are applied to ensure that special attention is given to the most vulnerable and less resilient countries 14. Secondly, given the modest scale of possible disbursement, the European Commission designed this mechanism so as to confine its action to being one of a donor of last resort. To be eligible, countries must show they have a residual fiscal financing gap, which is not covered by other donors or by foreign and/or domestic borrowing 15 ; the idea being for the EC to only step in, after other donors have done so. Thirdly, and still with regards to the limited amount of resources made available, the EC decided it was wise to focus on those countries where [V-FLEX] will make the most significant difference rather than risk dilution of its impact by distributing it evenly to all ACP countries 16. For this reason, a third criterion of eligibility, which lies in the capacity of the EC to close or significantly reduce the residual financing gap 17, was introduced. Preferably, support under V-FLEX is to be provided in the form of additional single payment to already existing budget support programmes, or, if necessary, through existing projects or programmes, including social safety nets (second-best position). This preference granted to budget support is not only consistent with the EU s willingness to act quickly, but is also in line with the EU s clear strategic preference for this instrument (ownership, aid effectiveness, programme-approach instead of projets, ). This preference, however, adds a fourth eligibility criterion to the above list, i.e. the capacity of the applicant ACP country to demonstrate a sufficient absorptive capacity through an ongoing budget support programme or an existing established social safety net or equivalent mechanism 18. If it is definitely too early to draw any kind of conclusions regarding V-FLEX overall performance some of its potentials might, however, be inferred from its very nature and design. This exercise appears all the more possible since the 2009 disbursement individual country-financing decisions have just been made public (see Table 1). First, some remarks arise from the four eligibility criteria. On the positive side, it is worth noting that contrary to FLEX, which only intervenes on the basis of data on past exports and is therefore not completely counter- 12 On this subject, it seems therefore that one of the most widespread criticism directed against V-FLEX and major concern of the European Parliament (see its resolution of 8 October 2009), namely that frontloading aid might create a funding gap in the future, can not be applied to the funds provided under V-FLEX as they come from nonearmarked reserves which were somehow made for such circumstances. 13 ACP-EU JPA, Replies to Oral Questions to the European Commission, 01 December 2009. 14 Ibid. 15 ibid 16 European Commission in its Replies to Oral Questions, in front of EU-ACP JPA, 01 December 2009 17 ibid. One will note that significantly reduce has been defined by the Commission as meaning a reduction of at least 50% of the residual financing gap 18 European Commission in its Replies to Oral Questions, in front of EU-ACP JPA, 01 December 2009 11

cyclical 19, V-FLEX acts more preventively since it is based on current and forecasted fiscal losses. In this sense, V-FLEX could well be more successful than FLEX in targeting those countries that became vulnerable following an external shock. Moreover, donor coordination appears to be at the centre of the EU s approach under this mechanism. By acting as a donor of last resort and by insisting on the identification of a residual financing gap as condition of eligibility, the EU ensures, at least on paper, that its action will be coordinated with those of other donors 20. In the design and management of the mechanism, the European Commission seems indeed to have worked closely with the IMF, which was involved from the drafting of V-FLEX requests by applicant countries (identification of the residual financing gap through the analysis of macro-economic data) to the presentation of the financing requests to the EDF Committee 21. The IMF is also likely to play an important role in the monitoring of the mechanism and in the second phase of the initiative (2010). Finally, given the tight deadlines, one can only praise the capacity of the European Commission to react swiftly, as it only took the EC a few months to design and implement this initiative, which can be expected to achieve a significant impact in terms of budgetary support in beneficiary countries (efficiency being ensured through the third eligibility criterion). If, therefore, the merits of this initiative should not be under-estimated, V-FLEX is however clearly insufficient to address satisfactorily the consequences of the crisis on ACP countries. On the down side, it is worth noting that V-FLEX is a very small facility in terms of aid disbursements. Whether or not it was the best way to strike a balance between efficiency and limited resources, it should be noted that the approach chosen by the EU leaves out many ACP countries from the potential benefits of such a mechanism. For the 2009 allocation, only 17 countries were considered eligible, among which 3 fragile states (Central African Republic, Sierra Leone and Comoros), which required a waiver on the above-mentioned criteria 22. Among those countries which cannot be considered eligible lie those whose residual fiscal financing gap cannot be substantially reduced by V-FLEX-assistance, but that might still need such assistance; these may include some of those which have potentially been the most negatively affected by the global financial crisis. Moreover, the preference granted to budget support programmes could also be questioned, as support to the latter comes with strings attached 23. As emphasized by Donald Kaberuka, President of the African Development Bank, if performance-based 19 For a discussion on FLEX and its shortcomings in the context of an external shock, see, for instance Griffith- Jones and Ocampo, 2008 20 The actions of other donors refer here primarily to multilateral organizations and their loan-based initiatives. Although Member States were invited to present the instruments they introduced in response to the crisis in developing countries in order to build a coordinated response at the EU level (see Commission Communication 2009/160 on Supporting Developing countries in coping with the crisis ; measure 10), there is little evidence that this was done as systematically as it seems to have been the case with the International Financial Institutions (IFIs). 21 European Commission in its Replies to Oral Questions, in front of EU-ACP JPA, 01 December 2009 22 In 2009, 26 requests were submitted, 17 were considered eligible and 14 were presented before the EDF Committee for disbursement in 2009. 13 requests were finally approved and most of the funds were transferred soon after by DG Budget (on the 16 th January, 160 million had already been disbursed). 23 A good illustration of this fact can for instance be found in the discussions that occurred in the EDF Committee regarding the case of Namibia, which was originally considered eligible, at least with regards to the first three criteria mentioned in the text. 12

allocation of funds is necessary to ensure a wise management of European taxpayers money, it could prevent those who need it in developing country to access it 24. It is also worth stressing that V-FLEX is an ad hoc mechanism, which has been created for a two-year period only. Somehow, it could be considered a feature of the EU s response to the crisis in developing countries, insofar as, like frontloaded assistance, or the acceleration of the MTR of Country Strategy Papers, it indirectly assumes a rapid global recovery from the crisis (Woods, 2009). Yet, it will probably take a few more years before many developing countries, especially in Africa, regain their pre-crisis growth level. Extending the duration and budget allocation for V-FLEX might be desirable. 24 Containing the Fall-out of the Global Financial Crisis in Developing Countries, http://capacity4dev.eu 13