Finance: Research, Policy and Anecdotes

This past Tuesday, I participated in a virtual roundtable, organised by ODI, on “Covid-19 and Africa’s financial sector”.  Herewith a short summary of my own remarks and what I have learned from others: It is clear that the effect of COVID-19 on the financial sectors in Africa (as in other developing regions) will be different than in advanced countries, as well as their role in getting through the crisis and helping the recovery. First, the role of the informal economy across the region makes outreach to large part of the population much more difficult.  Second, lockdown strategies such as in Europe are less realistic and effective given that a large share of the population is vulnerable to fall back into poverty and governments do not have the tools and channels to support them easily during an economic lockdown. Finally, independent of the direct impact of the COVID-19 pandemic, there will be a significant fall-out from lower global trade, (in some countries) from falling resource prices and flight to safety in global capital markets.

To assess the possible impact of COVID-19 on Africa’s financial sectors, I started with a simple SWOT analysis:

Strengths: on average, African banks are well capitalised and liquid; they have a limited exposure to the real economy; many countries have a diversified population of banks, with regional banks playing an important role and being less likely to retrench than global banks during a crisis

Weaknesses: given the economic structure of most African countries, African banks have a concentrated asset portfolio and are thus more exposed to sector-specific shocks (e.g., natural resources, tourism etc.); there is a high dependence of many borrowers and therefore also banks on international trade finance; finally, the fact that African banks have a limited exposure to the real economy, also limits their role in helping the real economy through the crisis and beyond

Opportunities: the increasing mobile phone and mobile money account penetration has made it easier for people to send money between friends and within families, thus have improved informal sharing risks; this also makes pushing out support payments by governments much easier.

Threats: with the crisis in advanced countries and across the globe, there is the risks of dramatically reduced capital inflows, including remittances; there is a risk of increasing and unsustainable sovereign overindebtedness and therefore a high risk of sovereign and (consequently) bank rating downgrades; finally, some countries have seen a consumer credit boom in recent years, based on mobile money accounts, which might now be followed by a bust

Given this SWOT analyses, what are financial sector policies that can play to the strengths and use opportunities, while reducing weaknesses and addressing threats?

First, using mobile phone networks to push out support payments can be an attractive option given that tools as in advanced economies (e.g., furlough schemes, tax refunds) are not appropriate for economies with an important role for informal economies. One example where this has been done is Togo.

Second, making it easier to use mobile money for payment purposes is important. Several central banks have already lifted ceilings for such transactions and have reduced fees. This will facilitate informal risk sharing and an ease the shift away from a cash-based economy.

Third, anti-cyclical regulatory policies can be useful to prevent lending retrenchment by banks.  In Europe, regulators have provided capital relief, eased loan classification rules, delayed implementation of Basel III reforms and postponed stress tests.  While some of these policies might be less relevant in developing countries, they can support lending. As important as banks, however, are microfinance institutions and other bottom-of-the-pyramid financial institutions. Here, the proper approach depends critically on the regulatory framework – where these institutions are deposit-taking and thus have access to central bank liquidity, such liquidity support can be critical if their deposit base becomes volatile and credit demand increases; where such institutions are outside the financial safety net other support mechanisms have to be considered, e.g., through development banks, indirect support by the central banks through commercial banks or donor support.

Fourth, credit guarantee schemes have become popular, as I discussed in a previous blog entry. A recent analysis by my former colleague Hans Degryse for Belgium has shown the need to tailor such a scheme carefully to the needs of the real economy. And I am increasingly sceptical that more debt (even at negligible interest rates) is what most firms need right now. Grants, equity participation or some kind of mezzanine funding might be more useful.

Fifth, it is important to address the wave of loan defaults by households and firms that might not be able to repay given the economic crisis. Black marks in the credit registry will shut many of them out of credit markets for a long time; a certain degree of forbearance is called for, even though there will certainly be abuse by borrowers that can actually repay. Dealing with wide-spread insolvency of smaller will be difficult given the deficient insolvency frameworks that most countries have and using simplified crisis-specific frameworks will be critical.

Finally, many countries in Africa will see a dramatic increase in debt/GDP ratios, both because of higher debt burdens (tax revenues will decrease and expenditures increase) and because of shrinking GDP. Add adverse exchange rate movements and you will get easily to unsustainable sovereign debt levels. Unlike most advanced countries, it will be difficult for most African countries to expand fiscal policy aggressively, even in local currency markets, given limited absorption capacity. And unlike in advanced countries, where expanding money supply even through “printing money” is unlikely to lead to high inflation in the current circumstances, I would be concerned about this in many developing countries. Support from international financial institutions is thus critical!  And sovereign debt restructuring is certainly back on the agenda, this time with a rather prominent role for China.  (After having written this, I found this interesting piece by Rabah Arezki and Shanta Devarajan who make similar points).

So, not all is bleak, but there are a lots of worries!  Africa has made a lot of progress in the past decade, including in the financial sector – now, is the time to not lose this progress.

29. May, 2020