Global Financial Turmoil—How Does it Affect Sub-Saharan Africa?speech by Antoinette M. Sayeh, Director, African Department, IMF
At the 14th Conference of Financial Institutions
Second Generation Financial Sector Reforms, November 6-7, 2008
President Kikwete, Minister Mkulo, Governor Ndulu, Ladies & Gentlemen:
It is a great pleasure for me to join you here in Arusha. This conference takes place in difficult times for the world economy. What started as a localized problem in the sub-prime mortgage market in the United States has turned into the most serious global financial crisis since the 1930s. Its center of gravity remains for now in the advanced economies. But its impact is increasingly being felt throughout the world. What I would like to do today is provide you with a perspective from the IMF on global events. How will the financial crisis affect global growth? What will be its impact on Africa? And how should economic policies respond?
The global financial crisis started with the bursting of the housing bubble in the United States over a year ago, which was prompted by a rise in defaults in subprime mortgages. Bank losses on these mortgages, and particularly on the related heavily-securitized credit derivatives, put a lot of stress on the financial systems in advanced economies. This was exacerbated by a broadening of credit quality concerns and unanticipated contagion to—and additional losses on—other financial assets. High leverage and rising uncertainty about the ultimate distribution of risk caused confidence in the banking sector to collapse, leading to a virtual closure of interbank and money markets and a sharp retrenchment of credit.
The United States and several European countries have responded with massive liquidity injections by central banks and the mobilization of public resources to recapitalize banks, insure deposits, guarantee money market transactions, and buy back troubled assets. These steps, and the increased coordination between major financial centers, are welcome and necessary. The IMF itself is also providing financial support to the economic programs of a number of countries most heavily affected.
Despite these efforts, the impact of financial sector distress on global growth will likely be significant. The IMF's World Economic Outlook released in October estimated that advanced economies would see economic growth falling to an average of ½ percent in 2009. With several countries now facing a recession that may turn out to have been an optimistic projection.
Some were hopeful that contagion to emerging market economies would remain limited. However, events of the past few weeks indicate clearly that there has been no decoupling of these economies. They are now also at the center of the deleveraging storm, and heightened risk aversion has already led to a sharp decline in capital flows to emerging economies. As investors have rushed towards the safest assets—notably U.S. treasury securities—equity markets in emerging economies have sold off sharply, bond spreads have widened, and domestic currencies have come under severe pressure. Ample reserves, low levels of sovereign debt, and sound economic policies will help some countries weather the storm more easily than in the late 1990s. Others are facing a more difficult situation. But all will be faced with reduced growth prospects in 2009.
Sub-Saharan Africa remains less integrated in global financial markets and the direct impact of global financial turmoil is likely to be less severe than in the advanced and emerging economies. But Africa is not immune from global events. And in the short term, many countries in Sub-Saharan Africa are more vulnerable since the food and fuel price shock caused higher inflation and rising current account deficits.
Africa is likely to be affected through three principal transmission channels:
• Lower global growth, already a reality, is likely to reduce the demand for African exports, exert downward pressure on commodity prices, and curtail the flow of remittances from abroad;
• The tightening of global credit conditions is likely to lower foreign direct investment flows and reduce or reverse portfolio inflows as investors flee into more liquid or safer assets. Trade finance flows may also be affected;
• Finally, banking systems may be weakened through a decline in the quality of their credit portfolios, losses on other financial assets, such as deposits with troubled foreign correspondent banks, or capital repatriations by troubled parent banks—which are often foreign-owned.
The IMF's Regional Economic Outlook for Sub-Saharan Africa, published in early October, already pointed to an expected slowdown in real GDP growth in 2008-09 by about ½ percentage point over its level of 6½ percent in 2007. Based on continued weaknesses in international financial markets and weak data from developed and emerging market countries—including South Africa—it is highly likely that this forecast will need to be revised downward.
The global financial crisis is also being felt in the region's capital and foreign exchange markets. Exchange rates in many countries in Africa, including in this region, have come under severe pressure in recent weeks, and equity markets have fallen sharply in some countries, including in Côte d'Ivoire, Kenya, Nigeria, and Mauritius.
But all is not dire. There are also reasons to expect some resilience on the part of sub-Saharan African countries:
• Of course, reduced demand for African exports will dampen growth. However, the strong underlying growth trend of recent years has reflected in part improving domestic fundamentals—fewer conflicts, liberalization and reform, macroeconomic stability, and debt relief.
• While lower commodity prices will produce negative income shocks in exporting countries, they will also help reduce the import bill for net importers.
• Financial systems in sub-Saharan Africa are less integrated with global financial markets and thus less vulnerable to deleveraging. They are generally not exposed to risks arising from complex derivative instruments and have not relied substantially on foreign borrowing to finance their operations. As a result, financial institutions in the region have by and large remained unaffected and domestic money markets are generally functioning normally.
What are the implications of the current environment for economic policies? While the impact on Africa may be less severe, the risks are important and macroeconomic stability is at a premium. Circumstances differ sharply across countries and there is no single recipe. But I would like to suggest three key principles for economic policy makers in difficult times:
First, seize the opportunity to bring inflation down. Inflation remains above most countries' comfort levels as the impact of the global food and fuel price surge continues to linger. In principle, the sharp decline of commodity prices will provide a disinflationary impulse, reducing the need for monetary policy tightening. However, price rigidities and the build-up of inflationary expectations in some countries suggest that the process will not be automatic. In Tanzania, for instance, the continued persistence in inflation, in the face of a planned loosening of the fiscal stance, calls for caution on the part of the central bank to avoid an increase in inflationary expectations and second round effects.
Second, use available fiscal space judiciously. Many countries have created fiscal space in recent years through debt reduction and strong policies. Thus, where fiscal sustainability and financing are not immediate concerns and demand conditions are weak, some stimulus or smoothing of negative demand shocks may be in order. In Tanzania, the 2008/09 budget provides for such a stimulus. But where external financing for public spending is falling, or commodity price changes threaten medium-term fiscal sustainability, restraint is required. In any case, current market conditions are not conducive to a dramatic expansion of public investment programs funded on commercial terms. Therefore any planned access to international capital markets should be postponed to avoid prohibitive costs.
Third, increase vigilance and stand ready to react flexibly. The liquidity and usability of reserve assets and the availability of trade credit need to be monitored carefully. And governments should seek to identify banking system vulnerabilities, and develop plans on how to react should a banking crisis erupt.
Finally, I would also like to underline that, even though the circumstances and policies implemented in reaction to the crisis may vary sharply across countries, these should not derail the growth strategies that have been put in place in the past decade and have started to bear fruit. Sustaining the reform effort today, in spite of the crisis, will be crucial to boosting growth over the medium term and making headway towards the Millennium Development Goals.
For this reason, I welcome the focus of this conference on second generation financial sector reforms, a critical ingredient to sustained economic growth in Tanzania. And I see two broad objectives for these reforms.
• First, and this is even more relevant today, there is a need to strengthen financial stability by reinforcing prudential regulation and supervision. One important aspect is to extend supervision to key nonbank institutions, such as the fast-growing pension funds. More generally, promoting the early identification of vulnerabilities and improving the monitoring of risks is critical. Financial stability assessments, as currently under preparation, can be a useful vehicle for this purpose.
• Second, financial sector reforms should aim at enhancing the contribution of the financial sector to private sector development. Establishing an operational credit reference databank, for instance, will facilitate a healthy expansion of credit, and promote further financial deepening - a critical ingredient for sustained high growth.
In conclusion, the international environment will be more challenging, probably for some years to come. But challenges are always also opportunities. The high-level conference that President Kikwete and the IMF will be co-hosting in Dar es Salaam early next year will provide an important occasion to bring together policy makers from all over Africa and beyond to address these questions. I look forward to meeting many of you again on that occasion.