The Return of Macroeconomic Imbalances: Adapting to Life on the Edge

June 27, 2022

Thank you for the warm welcome and the opportunity to address you all this evening. As we say in the region, all protocol observed.

Abraham Maslow famously said: if the only tool you have is a hammer, it is tempting to treat everything as if it were a nail. There is a tendency for us at the IMF to put macroeconomic imbalances at the root of all economic ills.

But this really is the case this time: in the wake of the COVID-19 pandemic and the consequences of Russia’s invasion of Ukraine, macroeconomic imbalances, as elsewhere, have returned as a first order challenge for most African countries. And they are pushing countries close to the edge.

In my remarks this evening, I will reflect on what this entails, how it challenges some of the preconceptions we have, and the policy options.

Part I: The post-1995 takeoff

It is hard to escape headlines about accelerating inflation and slowing economic activity anywhere in the world these days.

This audience knows better of course. But while this is popularly believed to be a standard feature of African economies, for a remarkably long period macroeconomic imbalances have been relatively contained in most countries. The period up until the late 1990s was a difficult one for countries, marked by high public debt, high deficits, and double-digit inflation. Growth was disappointingly weak and real per capita incomes did not improve between the mid-1970s and the mid-1990s.

However, the tide eventually turned in the late 1990s, with three key factors helping to improve economic conditions significantly:

  • Deep domestic reforms. African policymakers were instrumental in turning the situation around. The winds of reform, discipline, and relative political stability swept across the continent. Some countries like Uganda undertook orthodox policies; other countries like Ethiopia took a more heterodox approach.

I need to say a word or two about the important role played by past attendees of this Roundtable—the likes of Benno Ndulu and Emmanuel Tumusiime-Mutebile. Not an attendee as far as I know, but Newai Gebre-ab of Ethiopia was also an influential character. All three passed recently and are a huge loss to the region. I had the great privilege of working closely with Newai and Tumusiime, and interacting with Benno. How good it would be to hear their thoughts on the conjuncture. But I am digressing a bit …

  • The second factor was a more supportive global environment. Africa benefited from global economic tailwinds, including strong growth from trading partners, loose global financial conditions, and growing exposure to a surging Chinese economy.
  • The international community’s willingness to help. Finally, the region received generous amounts of financial assistance from external partners that were committed to the idea that support was critical to accelerate development. The efforts culminated with the HIPC initiative, which provided tremendous relief to developing countries and freed up fiscal space that allowed them to undertake much-needed human capital and infrastructure investment.

As a result, sub-Saharan Africa is a much-changed place. It goes without saying that poverty remains unbearably high, the fruits of strong growth in some countries have accrued disproportionately to the better off, and far too many people are still impacted by conflict. But there has also been much progress and transformation. And I am not talking about skin-deep changes such as shiny new buildings or better sky-lines, but fundamental progress that has shifted the opportunity set of a generation.

Part II: Imbalances are back with a vengeance

Unfortunately, the region finds itself facing troubling macroeconomic imbalances once more. Fiscal positions have deteriorated over the past decade, with median public debt gradually doubling back to around 60 percent of GDP. And, with supply chain disruptions and the Russian invasion of Ukraine, double-digit inflation has returned for several countries, such as Angola, Ethiopia, and Zambia, precipitating food shortages and hurting the most vulnerable.

And my fear is that those very same three factors that helped the region take off during the 2000s have now either reversed or greatly diminished:

  • A more difficult domestic climate for reforms. As I noted earlier, for a long while, growth was begetting more growth, there was more fiscal space, and development outcomes were moving in the right direction. But as fiscal space has diminished and the political environment became more boisterous, the appetite for reform has waned in recent years. The heavy economic toll exacted by the pandemic and the surge in commodity prices are going to make conditions even more difficult. The risk of heightened destabilizing social unrest in the months ahead is very high. After all, what an increasing share of urban poor are grappling with is the inability to feed their families today over improving the livelihood of their offspring down the road.
  • From global tailwinds to global headwinds. The era of low rates has ended. We are seeing tighter financial conditions and increased financial market volatility, which is putting further pressure on indebted nations, as ever costlier borrowing is eroding fiscal space. In addition, geo-political fragmentation—an ongoing phenomenon amplified, though not generated, by the war in Ukraine—is disrupting trade and investment flows, dislocating global value chains, and raising production costs. And as a result, Africa finds itself on a path of economic divergence from the rest of the world.
  • Sharp cuts in aid budgets. Budget support from the international community to sub-Saharan Africa is in secular decline. And this decline is staggering: as a percent of recipient GDP, OECD official development financing has declined from about 4½ in the 1990s to 2½ more recently. And even more troubling are the increasingly more frequent signs that humanitarian assistance too is being compressed. To be clear, I am very proud of the unprecedented way in which the IMF moved to support countries in the wake of the pandemic—financial support to sub-Saharan Africa that has amounted to some $50 billion since March 2020. But its effectiveness would be greater still if it was complementing rather than partly offsetting declining support from other development partners. And the effect of lower grant and concessional financing to the region has seen countries slashing spending and/or being forced to turn elsewhere—to more costly borrowing, financial repression, or inflationary monetary financing. All of these worsening imbalances further.

Part III: Welcome to the “gray zone” 

And in this context, what I have been struck by in recent years is the number of countries that have entered what I would call a “gray zone” of high imbalances. And I expect more to do so in the coming years.

Allow me to briefly elaborate on three features of this zone: extreme uncertainty, viability, and persistence.

Extreme uncertainty. I am talking here about the uncertainty related to the depth and severity of imbalances. Let me give you an example. In the early 2010s, oil prices stood above $100 per barrel, and we were projecting them to remain close to those levels over the medium term. But, instead, in 2014/15, they collapsed. They then fell further to around $30 per barrel during the pandemic. And at the time, we anticipated that they would remain very low for long. Now brent oil prices are back above $100 once again. This is what I mean by being in the “gray zone:” a zone where we are not sure how close to the edge countries are. Just two years ago, the public debt of several oil exporters in Africa was considered unsustainable at $40-$50 a barrel, but with oil prices back over $100, the issue in many cases is less solvency and more liquidity. There is much, much work we need to do to improve our macroeconomic toolkit to better help policymakers calibrate monetary and fiscal policies under such radical uncertainty.

Viability. African countries seem to be managing living on the edge for much longer than we have thought feasible. If I had to hazard a guess, it would seem to have something to do with somewhat higher public debt tolerance that has as yet to be accounted for sufficiently—perhaps related to greater access to domestic markets and better public debt management capacity. Again, there is much work to do to better understand the reasons.

Persistence. I want to be very precise here. It is not that I consider that being in the gray zone is ideal. Far from it. Having seen the extent to which unsustainable levels of public debt can drag on development progress and economic growth, my instinct is to advise policymakers to tackle macroeconomic imbalances head-on.
However, exiting the gray zone has become much more complicated in the current highly uncertain and febrile political environment.

  • Take a country with public debt of 70 percent of GDP (and one-third of sub-Saharan African countries have public debt at that level or higher). To bring debt back to lower levels of, say, 50 percent of GDP at a realistic pace of 1 percentage point of GDP a year, would take, at least, a decade of continuous tough fiscal adjustment.
  • Public debt reprofiling or restructuring can help. Indeed, where public debt is clearly insolvent deep debt restructuring is a must. But this too is not a silver bullet. For one, it almost always takes creditors time—as they go the various stages of grief—to internalize their losses. Moreover, in the current context of greatly heightened uncertainty around the economic outlook and complex creditor base, restructurings are taking longer still.
  • Therefore, many countries risk remaining stuck in the gray zone.

More broadly, these three features are not unique to Africa. They may manifest themselves more acutely in Africa at the moment due to the lower resilience of the region, but they are likely to become more prominent in advanced economies as well.

  • Take the point about policymaking under heightened uncertainty. Consider just how quickly the consensus on the central macroeconomic policy challenge for the G7 economies has shifted from the need to contend with secular stagnation and a low-interest rate environment for the foreseeable future to the emerging view now that a sustained period of high inflation and elevated interest rates are more likely for a while. Not so long ago, the public debt levels we now see in many economies were considered infeasible. With low interest rates higher public debt levels seemed more manageable. What now with the cost of borrowing rising?
  • Regarding my point on viability, I suspect that there will soon be a collective reconsideration of whether existing fiscal targets and anchors still apply in the current environment. Because countries will find it hard to act alone should they need to, and collective action to change current targets could move everyone to a new credible, stable equilibrium—one which may allow us to tolerate these imbalances for longer and buy time for reforms.

Part IV: Living on the edge: what does it really mean for policies?

So, if we accept that a certain level of imbalances may be sustainable for some time, countries will continue to “live on the edge”. But what should policymakers do to nudge their economies in the right direction without slipping off the edge and into the abyss? As policymakers are not living in a first-best world with low imbalances, what does the second or third best look like?

Let me sketch out some ingredients of a policy agenda for countries in this situation.

Ingredient 1: Think longer term.

  • This is an old one. But for countries subject to high imbalances, the premium on upfront structural reforms is now higher than ever.
  • Why are structural reforms so important? Because strong growth is the most critical remedy to eliminate imbalances, and, in particular, reduce debt ratios. Historically, large improvements in fiscal positions have taken place in the context of high growth. A growing economy means a growing tax base and greater revenue potential. For an average African country, an additional 1 percentage point of GDP growth could reduce the debt ratio by about 10 percentage points of GDP after 8 years (the average length of growth upswings in developing economies), provided that additional revenues are saved. This reduction in debt is double that of a typical fiscal consolidation (5 percentage points of GDP).
  • What type of structural reforms do I have in mind? For many countries, growth will need to come from the private sector. With increasing fiscal pressure and mounting debt, it will be vital for many to pivot from government-led growth models to those driven by the private sector. And this will require vital reforms to improve the business environment.

Ingredient 2: Be more selective.

  • Limited policy space and more difficult access to financing mean that policymakers will have to be that much more selective on spending and investment. And limiting inefficiencies and waste through stronger PFM—for example, more robust expenditure controls, arrears management, and procurement processes—will help create space and channel funds to those areas with the greatest returns.
  • Being more selective will also be essential to ensure that economic imbalances do not disproportionality hurt the most vulnerable segments of the population. Stronger and more targeted social safety nets are key tools to combat the triple threat of poverty, hunger, and diseases.  

Ingredient 3: Focus on risk prevention.

  • Another corollary of living on the edge is greater risk tolerance, be it a collective decision or a necessity. Afterall, countries with high imbalances have to function with thinner buffers, which means that they are more vulnerable to shocks.
  • Just as in football, some countries maintain a lean defense against some risks. This may be a sensible strategy for those with limited resources and prone to unpredictable external shocks.
  • But, for these countries with lean defenses—that is, a limited ability to absorb shocks—it is vital to build resilience to help minimize exposure to risks. Take the case of climate shocks, where countries can prevent excessive costs ex post by investing in adaptation measures ex ante. Financing adaptation and resilience to climate change will be more cost-effective than frequent disaster relief.

Ingredient 4: Get support.

  • This fourth ingredient is one that needs to be provided by the international community.
  • At a time when the economic troubles facing most countries are in large part due to exogenous rather than domestic and policy-induced reasons, official development assistance needs to increase significantly—not decline as is currently the case. Indeed, against the backdrop of the huge improvements in development outcomes that we have seen over the years when ODA was elevated, I find reduction in assistance quite astonishing. Having been on the frontlines for many years now, I can tell you that development support has played a huge role in facilitating the development progress that we saw in the region over the years.
  • More troubling still is that even humanitarian assistance seems to be declining in many instances. I was in N’Djamena a few weeks ago. And it was heart-wrenching to hear from UN officials that even assistance for child malnutrition has been reduced markedly by development partners in the face of sharply rising under-5 malnutrition rates—the country is suffering from a severe drought and now the consequences of high international food and fuel prices.
  • The international community is playing with fire. It is being short-sighted to an extreme degree. In the next decade, at least half of the new entrants into the global labor force will come from sub-Saharan Africa. It will be to the strong detriment of the global economy if we don’t invest now in the region.

Closing Thoughts

So let me leave you with a few final thoughts:

First, imbalances are back and this creates a very difficult situation for policymakers in the region, with more uncertainty, more social tensions, and ever-decreasing policy space to respond.

Second, we have to rethink traditional policy prescriptions to meet the imbalances we are facing. And this is something we must not be afraid to do. Many economic targets and anchors of the past now seem unrealistic and obsolete. Thinking through these issues will help countries living on the edge to undertake much-needed reforms and eventually move away from it.

And finally, despite the difficult path ahead—marked by constraints, imbalances, and growing challenges—I remain deeply optimistic about the region’s prospects. I returned to my country in 1992 as a would-be technocrat at a similarly difficult time for the region. And if anybody had said to me then that Accra, Kampala, and Addis would 30 years on look anything like what they do today, I would have thought they were under the influence of more than just a cup of strong Ethiopian coffee. And of course, the changes as I said go well beyond just the shiny new buildings that we see in these cities: there has been fundamental development progress that has shifted the opportunity set of a generation. I have no doubt that, from this stronger foundation, progress over the next 30 years will be more remarkable still. But only if, as the generation of policy makers from the 1990s did, we take the necessary bold decisions.

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