The way out of Africa's debt doom loop

“All animals are equal, but some animals are more equal than others,” George Orwell famously wrote in Animal Farm, his allegory of Stalinism. But Orwell’s maxim could just as easily apply to the sovereign-debt crisis in Africa. Low-income African countries have the smallest share of global public debt but are more likely to be in debt distress or at high risk of it.

This paradox reflects a dysfunctional international financial system. Unlike advanced economies, which have highly developed local-currency bond markets, African countries are subject to prohibitively high interest rates and often cannot borrow from international investors in their own currency (the “original sin” of sovereign-debt markets). Instead, over 80% of African countries’ external debt is denominated in dollars or euros, which heightens their vulnerability to monetary-policy changes by a handful of systemically important central banks – and thus to a “debt doom loop” that only exacerbates their debt burdens.

Unless the policymakers convening next week for the annual Spring Meetings of the World Bank and the International Monetary Fund pursue reforms that address the inequities in the global financial system, a few privileged countries will continue to be more equal than others. Inaction would have negative consequences for macroeconomic stability, debt sustainability, global growth, and income convergence, and could undermine the World Bank’s institutional credibility as it embarks on a new mission “to end extreme poverty and boost shared prosperity on a livable planet.”

Amid increasing financial volatility, supply-chain vulnerabilities, and inflationary pressures, many African countries have already adopted difficult and unpopular policies – including removal of government subsidies and aggressive interest-rate hikes, despite widespread poverty and Great Depression-levels of unemployment – in a bid to escape the debt doom loop and foster macroeconomic stability.

For example, in Nigeria, where unemployment currently hovers around 30%, the central bank recently raised its main lending rate by 400 basis points, to 22.75%, to bolster the naira and tame inflation, stoked by exchange-rate pass-through resulting from the naira’s sharp depreciation against the dollar. This exchange-rate depreciation – which increases debt-service costs – has been further exacerbated by capital outflows, with investors chasing higher relative returns following interest-rate hikes by the US Federal Reserve.

The sub-investment grade of African sovereigns has further heightened the challenges of managing the debt doom loop. In fact, most African countries suffered large-scale procyclical downgrades at the height of the pandemic, which only further curtailed their access to global finance, considering the cliff effect. This, in turn, has raised refinancing risks and increased the likelihood of default.

The few African countries that could still tap capital markets faced significantly higher borrowing costs. An analysis of bond yields in 2022-23 shows that the borrowing rates for African countries (11.6% on average) are almost twice as high as rates for countries in Asia and Oceania (6.5%), nearly four times higher than in the US (3.1%), and eight times higher than in Germany (1.5%). These growth-crushing and default-driven borrowing rates set unrealistic expectations for return on investment. Given these figures, it is unsurprising that Africa has suffered from financial repression for decades.

Africa’s most recent debt doom loop began at the end of the commodity super-cycle in 2014-15, which led to widening fiscal and current-account deficits and rising external liabilities. Emergency government relief measures in response to the COVID-19 pandemic accelerated this trend, pushing debt levels to new highs. From 2019 to 2020, the number of African countries with public debt exceeding 60% of GDP – considered to be a threshold for sustainability – increased sharply, from 18 to 27, while public debt on the continent (both domestic and external) reached $1.8 trillion in 2022, up 183% from 2010.

But that still pales in comparison to the total debt of advanced economies such as France and Italy, both of which owe more than $3 trillion each. The European Union’s combined national government debt stood at $14.6 trillion in September 2023, while the US owes $34 trillion. Africa’s debt-to-GDP ratio was 62.5% at the end of 2022, far below the global average (92.4%) and well below that of the US (121.4%) and Japan (261.3%).

Moreover, Africa’s interest payments-to-revenue ratio – a key metric for assessing debt-servicing capacity – has doubled since the early 2010s and is now around four times the ratio in advanced economies, largely because of default-driven interests rates. Debt service has become the largest item in many governments’ budgets, with interest payments projected to consume nearly 40% of Nigeria’s revenue this year.

These shifts in the composition of public spending have reduced fiscal space, preventing governments from addressing critical social and environmental challenges and expanding growth-enhancing public investments. This is especially damaging for Africa, given that the continent has immense development needs and is already contending with widespread poverty and unemployment, escalating climate emergencies, and conflict and insecurity.

Moreover, the region has long suffered from a chronic infrastructure deficit that has impeded structural transformation to sustain heightened exposure to global volatility and narrowed governments’ capacity to crowd in private capital to diversify the sources of growth and reduce the imbalance between debt and exports.

Ethiopia – the latest African country to default on its debt – illustrates how the massive inequalities built into the international financial architecture have subjected African sovereigns and corporate entities to punishing borrowing costs. Although Ethiopia has one of the lowest post-pandemic debt-to-GDP ratios (33.8%), the combination of prohibitively high interest rates and the sharp currency depreciation has dramatically increased its external debt burden.

Given Africa’s remarkably small share of global public debt, the continent’s mounting debt crisis attests to the underlying problem: the lack of affordable financing. Providing African countries with the fiscal space to meet growth and development objectives requires fixing the global financial system. Although urgent, this is hardly a new idea: French President Emmanuel Macron made the case for “fairer financing rules” for African economies at the height of the COVID-19 pandemic, while recent summits and initiatives have called on multilateral development banks to increase financing capacity.

But the big question remains: Are all countries equal, or are some countries more equal than others? Whether the World Bank can fulfill its new mission will largely depend on the answer.