Trade & Development Finance Brief

African Export-Import Bank Banque Africaine d Import-Export Transforming Africa s Trade Trade & Development Finance Brief Volume 2 Issue 2 July 2018 In this Issue Trade War and Implications for Africa The Emergence of the Asian Infrastructure Investment Bank and Africa Volatile Cocoa Market Underscores the Importance of Afreximbank s AFRICOIN Initiative FDI Trends and Implications for African Economies Trade War and Implications for Africa Over the last few months, trade war, which is an economic conflict resulting from extreme protectionism, has taken several forms and targeted several products. Triggered by the US Administration to address trade imbalances with its major trading partners, the government imposed tariffs on solar panels and washing machines earlier this year and subsequently a 25 percent tariff on steel imports and a 10 percent tariff on aluminium imports, with threats to impose several other tariffs. Other countries retaliated, Canada, China, the EU, India, and Mexico in particular which together accounted for 80 percent of the U.S. trade deficit in Afreximbank Trade & Development Finance Brief Volume 2 Issue 2 1

2017 have imposed retaliatory tariffs on US products, with China, the EU and Mexico also filing complaints against the US at the WTO. This month, the US Administration further escalated trade tensions by levying tariffs on US$34 billion worth of Chinese goods. China immediately retaliated with tariffs on US$34 billion worth of US goods leading to another threat to impose further duties on Chinese goods worth US$200 billion. The US has also threatened to implement a 20 percent tariff on cars from the EU, although, this latest threat appears to be somewhat abated following concessions by the EU to buy more US liquefied natural gas and soybeans. The US is the largest market for EU car exports, amounting to US$41 billion in 2017, with Germany alone accounting for over half of this value. The US also took measures to protect its trade interests in Africa by suspending duty-free access to all AGOA-eligible apparel products from Rwanda. This followed the decision by Rwanda to follow through on an East African Community decision to outlaw the importation of used clothes and shoes across the East African region to boost industrialization and stimulate manufacturing production in member states. The East African Community is one of the most important markets for the US used clothing industry. While the first threat could derail the new growth momentum in the EU after years of anaemic growth which followed the 2008 global financial crisis, the second could undermine ongoing efforts to deepen economic integration and promote structural transformation in East Africa. The spectre of a trade war is raising global uncertainty and could derail the global growth momentum which has been broad-based. Already, the International Monetary Fund s (IMF) World Economic Outlook cautions that rising trade tensions between the United States and the rest of the world risks lowering global growth by as much as 0.5 percent by 2020, most notably through trade and investment channels but also by disrupting global supply chains. In addition to a possible drag on global growth, the actions by the US to redress trade imbalances also hold significant implications for Africa. China and the EU, which are the prime targets of US protectionist policies are also Africa s largest trading partners, together accounting for over 44 percent of total African trade in 2017. The impact on Africa could be especially pronounced given that the region has become heavily dependent on China in recent years. For instance, IMF research analysing Africa s increasing exposure to China has shown that a 1 percent decline in China s domestic investment growth is associated with an average 0.6 percent decline in Africa s growth. The extent seems to be even more pronounced for resource-rich countries, especially oil exporters. Conversely, efforts by the US to redress trade imbalances may also present opportunities for Africa, as manufacturing companies, especially Chinese, could relocate to Africa to take advantage of lower labour costs and preferential access into the US market afforded by the African Growth and Opportunity Act provided these benefits are retained under the current US Administration. Afreximbank Trade & Development Finance Brief Volume 2 Issue 2 2

The Emergence of the Asian Infrastructure Investment Bank and Africa Amid increasing discontent with the political instrumentalization of existing Multilateral Development Banks, most notably the World Bank, the IMF, and the Asian Development Bank, and the resistance by Western nations to give a greater voice to developing and emerging market economies, China championed the establishment of the Asian Infrastructure Investment Bank (AAIB). The Bank was established in October 2014 and officially launched in January 2016 with an authorized capital base of US$100 billion. China is the largest shareholder of the Bank, with more than 26 percent of the capital, but other major regional shareholders include Russia, while non-regional shareholders include some of the largest countries in Europe, such as Germany, the United Kingdom, and France. A number of African and Middle-Eastern countries have also joined the Bank. The total number of regional, non-regional and prospective members stood at 87 as of July 12, 2018 and is likely to increase further. Of the current 87 Members, 37 are non-regional members and prospective members from Africa, Europe, Latin-America and Oceania. Three African countries (Egypt, Ethiopia and Madagascar) have joined as nonregional members while Kenya, South Africa and Sudan are among prospective members. The AIIB s expansion is indicative of China s emergence as a global power that is taking on more global responsibilities in an increasingly multi-polar world. The establishment of the Bank challenges the global finance order and provides a valuable financing alternative to existing Bretton Woods Institutions, namely the World Bank and the International Monetary Fund. Indeed, the rise of AIIB is likely to have significant implications for the global financial architecture and Africa s development, including through change in risk perception and access to capital which has been constrained by political conditionalities associated with lending from traditional global development finance institutions. The recent signing of an MoU between the African Development Bank and the AIIB potentially paves the way for a similar arrangement with other institutions and for a much broader engagement that could improve the availability of infrastructure financing to accelerate the pace of regional integration on the continent and structural transformation of African economies through support to critical sectors and industries. The AIIB is already playing a key role in the development of infrastructure in Africa, directly financing large infrastructure projects in a region where the infrastructure financing gap is huge in excess of US$130 billion a year and has been undermining intra-regional trade and the process of structural transformation of African economies. Afreximbank Trade & Development Finance Brief Volume 2 Issue 2 3

Volatile Cocoa Market Underscores the Importance of Afreximbank s AFRICOIN Initiative Cocoa prices rose sharply from US$1,809/tonne on December 22, 2017 to a high of US$2,914/tonne on May 1, 2018 in New York, reminiscent of the bull market of H2-2013 that lasted three years. The gain of over 61 percent (281 percent annualised) was primarily driven by concerns of a potential shortfall in output in the 2017/18 season, with estimates for a deficit of up to 200,000 tonnes. Cocoa prices were also lifted as speculators bought back market contracts they had sold during the 2016/17 season as a large surplus characterised a sluggish market. The rally in the New York market also reflected concerns over the quality of beans delivered to the London exchange, with the London market flooded with low quality beans which participants were reluctant to take. These developments created an arbitrage opportunity for other African supplies to be delivered to New York. However, the rally seems to have come to a sudden halt with prices dropping by 23 percent since May 1, 2018 to US$2,245/tonne as concerns over the weather and output fade. Nevertheless, the downside in prices has been limited with the International Cocoa Organization forecasting a tightly balanced market this season. Similarly, industry giants are boosting their global grinding capacity as optimism on demand, even from producers like Indonesia and Brazil, grows. Indonesia, the third largest cocoa grower is now a net importer because of the expansion in domestic processing. Likewise, firm demand is emanating from Brazil, traditionally the 7th largest producer where increasing processing capacity has prompted the country to reopen its market to beans from Côte d Ivoire. According to Brazilian cocoa grinders, around 60,000 tonnes is likely to be imported from Côte d Ivoire and Ghana to avoid interrupting their grinding season. Developments in the cocoa market over the past two seasons, including price volatility, export defaults and the profitability of processing underscores the importance of the Bank s African Cocoa Initiative (AFRICOIN). The initiative allows producing countries in Africa to move from a model based mainly on exporting raw cocoa beans, with little value retained, to one where cocoa beans are processed in Africa before being exported. The initiative has been effectively supporting the cocoa industry in countries such as Côte d Ivoire, Ghana, and Nigeria and could be extended to other commodities within the region. Increasing domestic value addition and manufacturing capacity can be a panacea for price volatility as a decrease in the price of raw cocoa could be associated with an increase in profits at another stage of the value chain, particularly as the consumer price of processed goods rarely drops proportionately. For instance, in 2017 while the market for cocoa beans was heavily bearish, cocoa butter prices soared, boosting processing margins and sending the combined ratio (which measures profitability) to its highest level in more than a decade. By increasing local processing, AFRICOIN could mitigate risks associated with global volatility and sustain growth in a sector that is critical for growth and poverty alleviation in a number of the Bank s member countries. Afreximbank Trade & Development Finance Brief Volume 2 Issue 2 4

FDI Trends and Implications for African Economies Despite the rise in remittances, FDI remains the largest external source of finance for developing economies and plays a key role in economic growth through technology transfer. Since the 2008/9 global financial crisis, the growth in FDI has largely been driven by dynamics of flows to developed economies. Amidst the slight recovery which followed the aftermath of the global crisis, FDI flows have not yet returned to their pre-crisis levels. And the sharp decrease witnessed in 2017, when FDI to advanced economies fell by 37 percent to US$712 billion from US$1,133 billion in 2016 led to further decline in global FDI flows, now at US$1,430 billion, down from US$1,668 billion. In contrast to developments in advanced economies, FDI flows to developing economies has remained stable, growing from US$519.2 billion in 2009 to US$671 billion in 2017. The growing share of FDI flows to developing economies in a context of a sharp decrease to advanced economies has narrowed the gap between developed and developing economies (figure 1). FDI Inflows by Region (US$ billion) 1600 1400 1200 1000 800 600 400 200 0 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 Africa Developing Asia Latin American & Caribbean Developing Economies Developed Economies Source: UNCTAD: World Investment Report (various issues) Going against the trend in developing economies, FDI flows to Africa continued to slide, reaching US$42 billion, down 21percent from 2016. Africa recorded a sharp drop in FDI even though the region is already the lowest recipient of FDI across the developing region, accounting for just about 6.3 percent of total FDI to developing economies, against 70.9 percent in Asia and 22.5 percent in Latin America and Caribbean regions. Within Africa, the sub-region s most affected by the sharp decline were natural resource and primary commodity exporters, reflecting in particular, the lingering effect of the end of the commodity supercycle and the direction of FDI inflows to Africa. Natural resource exporters remain the main recipient of FDI inflows into the region. In this context and not surprisingly, the largest decrease was observed in West Africa (11 percent) to US$11.3 billion, Central Africa (22 percent) to US$5.7 billion and Southern Africa (66 percent) to US$3.8 billion (Figure 2). The decline of FDI inflows to North Africa and East Africa was much Afreximbank Trade & Development Finance Brief Volume 2 Issue 2 5

smaller, a 3 percent decline to US$7.6 billion in East Africa and 4 percent decline to US$13 billion in North Africa. The slump was consistent across the three largest economies with South Africa recording the sharpest drop, 41 percent to US$1.3 billion; followed by Nigeria, 21 percent to US$3.5 billion; and Egypt, 8.8 percent to US$7.4 billion. However, Egypt remains the largest recipient of FDI inflows followed by Ethiopia which received nearly half of the total FDI inflows to East Africa (about US$3.6 billion). While Egypt and Nigeria remain the primary destinations for FDI in North and West Africa respectively, Mozambique has overtaken South Africa to become the largest recipient of FDI in Southern Africa. The Congo Republic was the largest recipient of FDI in Central Africa (figure 2). 20 15 10 5 0 Figure 2. FDI Inflows by Sub-region (US$ billion) 2016 2017 Source: UNCTAD: World Investment Report, 2018 Against the trend across the region, FDI picked up in a number of countries, most notably in Morocco where it rose by 23 percent to US$2.7 billion, and Kenya where it increased by 71 percent to US$672 million. The increase in FDI inflows to these countries is due to the relatively strong growth performance in a number of sectors, including the information and communications technology (ICT) sector in Kenya and the automotive sector in Morocco. While the recovery in commodity prices could reverse trend and boost FDI inflows into the region, the resilience of non-commodity exporters such as Morocco, Kenya and Ethiopia clearly shows that the diversification of sources of growth and trade may be a more reliable path to sustainably attract FDI inflows into the region. Indeed, the Asia region which accounted for over 33 percent of total FDI in 2017 has drawn on strong performance and opportunities in manufacturing and high-tech industries to consistently attract foreign investment. Perhaps the African Continental Free Trade Area Agreement, which provides the opportunity to accelerate the diversification of sources of growth away from commodities, could change the dynamics of FDI flows to the region while at the same time reducing volatility. Afreximbank Trade & Development Finance Brief Volume 2 Issue 2 6

Follow us on twitter @AfreximResearch Disclaimer This document was prepared under the supervision of the Research and International Cooperation Department of the African Export-Import Bank (Afreximbank), and is not necessarily definitive, current or authoritative. Data used in this document was gathered from reliable sources, but the analyst(s) and the publishers of this document do not hold themselves responsible for the accuracy or completeness of data used. The document provides the opinions, analyses and conclusions of the Research Department only and is provided without any warranties of any kind. Afreximbank does not accept any liability for any direct or remote loss or damage arising out of the use of all or any part of the information contained in this document. To subscribe to the Brief please submit your contact details to Research@afreximbank.com Afreximbank Trade & Development Finance Brief Volume 2 Issue 2 7