Riding the Covid-19 economic storm

Although so far the health impact of Covid-19 on Africa has been surprisingly mild, the economic costs will be heavy. Ronak Gopaldas presents a forensic analysis of the challenges Africa must overcome if it is to navigate its way out of the crisis successfully 

The economic fallout for the continent from Covid-19 is likely to be severe and enduring. This burden falls heavily on countries with a high dependence on commodity exports to China, weak sovereign balance sheets, high debt burdens, and volatile currencies, among other external fragilities.

In only a few months, the rapid spread of the powerful Covid-19 virus rattled global markets and severely hit the world’s growth outlook. The shock disrupted production, trade and global supply chains.

African economies, which supply vast resources to China’s manufacturing sector, face a grim outlook. Several African industries already show signs of financial distress. The early victims are mining and tourism, travel and accommodation.

African economies are ill-prepared to absorb the financial and economic fallout of the pandemic, especially its longer-term implications for growth.

This pandemic is generating a series of powerful shocks to the world’s economic, political, and security structures. Its impacts will lead to heightened fear and uncertainty at multiple levels.

To understand the likely impacts (short, medium and long-term) of these shocks on the African continent, it is necessary to unpack outcomes at the first (macroeconomic), second (sectoral) and third levels (political and societal). This article follows the logic in the outline below:

First level – the macroeconomic impact of Covid-19 on Africa.

1. Financial markets (equities, bond yields, currencies, commodities).
2. Trade and consumption (supply and demand side shocks)
3. The real economy and policy responses (growth, employment, inflation, rates).

Second level – the sectors that will bear the brunt of the fallout from the shocks.

Third level – emerging political, societal, behavioural and security issues.

Global level – The short, medium and longer-term implications of the pandemic.

1. The economic impact of Covid-19 on Africa

African countries are highly exposed to movements and events in the global economy. It is in the financial markets that their borrowing costs and currencies are determined and where their commodities are priced, based on supply and demand dynamics.

Although the continent has thus far been resilient to the Covid-19 outbreak from a health perspective, the opposite holds true when considering the economic effects.

While the financial market impact is almost immediate, the economic consequences are likely to be deeper and last significantly longer. Limited flexibility on the policy front combined with an overarching structural vulnerability to the external environment mean that Africa’s economic road ahead is going to be a bumpy one.

a. Financial markets

African bourses and currencies have been particularly hard hit. African debt yields have rocketed as investors demand a premium to hold the riskier instruments, making the issuing and servicing of debt far more expensive and capital market access difficult, cramping their already limited fiscal space.

At the same time, gross government debt across sub-Saharan Africa has jumped to nearly 60% of GDP since the 2008 Global Financial Crisis (GFC), unsustainably ramping up interest payments.

The bulk of African economies are highly dependent on commodity sales (oil, gold, coal, iron ore – predominantly to China) to generate foreign exchange revenue and are running considerable current account deficits, historically stabilised only by foreign exchange revenue generated through exports.

With foreign portfolio flows drying up, and insufficient domestic funds to bridge the shortfall (low import cover ratios), further currency weakness is likely.

The implications are twofold: first, African debt bondholders now demand a premium, thus driving up funding costs. Then, weaker currencies mean that the costs of repaying and servicing debt on bonds issued in foreign currency (euro bonds) rise dramatically.

Rating agencies have been swift to act, with South Africa, Nigeria and Zambia all pushed deeper into sub-investment grade territory, with outlooks remaining negative. Several African countries are already approaching lenders, among them the IMF and World Bank, to secure funds to fight the pandemic.

While this is unlikely to lead to a balance of payments crisis or sovereign default over the shorter term, especially if transient, it constricts any already constrained fiscal headroom governments may have to shield their economies against the health and economic impacts of Covid-19.

b. Trade and consumption

The large developed markets vie for political, economic and trade influence on the continent. China is now Africa’s biggest trade partner ($150bn), followed by the EU and US.

Africa’s growth performance is inextricably dependent on Chinese demand and investment. The continent now confronts a scenario of falling export volumes and value, coupled with the potential for a prolonged pause in investment – Africa’s immediate economic concern.

Over the longer term, and more worrying, is that what Africa experienced with China is now occurring with the EU and US as Covid-19 shuts down Western markets.

This is before factoring in a fall in Africa’s output capacity, which is yet to be impacted by quarantines, work stoppages and the general disruption to business. African imports from these markets will reflect falling demand for developed market output of finished goods.

Intraregional trade, which accounts for just 17% of African country exports, cannot bridge the gap. This reflects the risk of export concentration.

While the argument for regional free trade integration remains sound. the African Continental Free Trade Agreement (AfCFTA), set to commence mid-2020, will likely be delayed.

In addition, the increased likelihood of falling trade volumes, travel restrictions and possible border closures will inhibit regional cooperation, and African countries may turn inward.

On the consumption side too, the outlook continues to deteriorate. Weaker economic activity induces a rise in unemployment levels across almost all sectors, reducing not only import activity but placing downward pressure on demand for locally produced goods.

Hardest hit will be the consumption of durable and semi-durable goods. Many consumers are likely to adjust their purchasing habits to include only essential items. Arresting the slide will be exceedingly difficult within the limited fiscal space available to most African countries. Looser monetary policy will not represent sufficient intervention.

c. The real economy and policy responses

The global economy was under pressure before the outbreak of Covid-19 as the trade war between the US and China weighed on growth.

The outbreak already has economists slashing growth forecasts, with some suggesting it may tip the world into recession. The AU expects continental growth to contract by between 0.8% and 1.1% in 2020, 20m jobs to be lost and an additional $130bn required to fight the pandemic.

Sub-Saharan Africa weathered the GFC relatively well, avoiding an outright recession and going on to outpace global growth. The ‘resilience’ was largely supported by unprecedented quantitative easing and record low rates in developed markets, which forced investors into higher yielding, riskier assets in growth markets like Africa. This tailwind, however, may not be available this time around.

The key difference in policy response between the previous financial shock (GFC) and the current (Covid-19), is that at the time of the GFC, developed markets were able to pull both monetary and fiscal levers. World growth was high and commodity prices were elevated for an extended period, providing both capital and rate buffers.

These buffers were drawn down to varying degrees in the decade-long recovery. In today’s Covid-19 case, emerging markets have some capacity to lower rates, but little capacity to provide fiscal stimulus, while the opposite applies in developed markets.

Most African countries have narrow tax bases, weak tax collection mechanisms, and a heavy reliance on commodity revenues. These sources are likely to come under significant pressure, placing further strain on thin financial resources.

With most African countries running fiscal deficits, their policy flexibility is limited to cutting interest rates, at best a modest intervention. Few if any African countries have enough fiscal space to counter the slowdown that threatens to impact nearly every sector.

Unfortunately, Africa can no longer rely on Chinese benevolence and investment, as the Chinese economy is rapidly decelerating and turning more inward.

Nigeria and South Africa – two of Africa’s biggest economies, which generate half of its GDP – now register near-zero growth. This greatly increases the likelihood that fixed investment growth on the continent will grind to a halt, leading to rising unemployment and widespread social disaffection.

2. Which sectors will face brunt of impact?

Since the financial and economic impact of Covid-19 is set to rattle both the supply and demand side for goods and services, there appear few, if any, places to hide. The resulting shocks will be broad-based.

Many African economies will see an increase in the unemployment rate, due to demand-side disruptions for commodity-orientated African and emerging market exports to China.

Manufacturing and services companies supplying commodity producers will come under pressure to reduce services or fees. Many will be forced to leverage output efficiencies through reduced hours, headcounts, or wages. Africa’s major industry sectors are expected to be impacted in the following ways:

Mining and minerals

For Africa, mining is one of the most exposed sectors across almost all minerals. Iron ore (South Africa), copper (Zambia) and oil (Nigeria, Angola, Ghana) are hardest hit, both in terms of demand and price. Commodity disruptions are likely to take time to unwind, as once capacity levels normalise with demand, inventories of raw materials will need to be run down.

Aviation, tourism and hospitality

The travel and tourism industry will also be particularly hard-hit. Visitor volumes, not just from China, but from other destinations, will continue to plummet. Suppliers to this value chain – booking agents, venue owners, tour operators, hotels and real estate – will suffer.

Flights within the continent and from external destinations were effectively halted in efforts to contain the spread of the virus. Ethiopian Airlines, easily the continent’s most successful carrier, started retrenching and furloughing (placing on paid leave) many of its workers.

The International Air Transport Association (IATA), tentatively estimated that the financial cost to African airlines could amount to $40m. Industry figures are much worse. Ethiopian Airlines has already lost $550m. African airlines are collectively $4.2bn down, and the international aviation industry is $52bn in the red.

Many state-owned airlines are already in dire financial straits. This shock could threaten their existence. State-owned South African Airways and SA Express are grounded. The government terminated all commercial flights, and both carriers face possible liquidation.

In addition, many business travellers and tourists have been forced to cancel or at best postpone their travel plans, impacting accommodation and tourist bookings.

Numerous African and international conferences were abandoned. Conference hubs in Morocco, South Africa, Kenya and Mauritius depend heavily on events to generate income for SMEs.

Collectively, these events generate billions of dollars, not just for event hosts, but for accommodation and catering providers, tour outfits and the travel industry. Those countries that rely heavily on tourism income – such as South Africa, Mauritius, Madagascar, Kenya, Tanzania and the Seychelles – will be hit the hardest.

Retail and financial services

For Africa in particular, retail and financial services are important drivers of economic growth, and small and medium sized enterprises are significant employers. The demand shock and resulting negative impact on growth will be acute in the retail and financial services sector.

For nearly all households, consumption will be reduced to the essentials, leading to large-scale margin compression for retailers. They will in turn put pressure on landlords to choose between reducing rental charges or facing rising vacancy rates.

For financial service providers, the impact of higher unemployment, weak corporate activity and lower economic growth will result in tighter credit markets, rising defaults and a drop in endowment income.

3. Geopolitical issues

China is likely to face a political backlash once the Covid-19 dust settles, with many countries, most notably the US and UK, having accused it of covering up the extent of their death rate and raising the alarm too late.

The ambitions of its Belt and Road initiative are likely to be severely curtailed, not just by political retaliation, but also by lower global trade and foreign investment volumes. In such an instance, China would look inward to drive growth by raising domestic consumption and investment levels at the expense of foreign investment, leaving Africa particularly vulnerable.

On the African front, trading under the AfCFTA is likely to be delayed at best, as border closures wreak havoc on the flow of goods. Of great concern is that under the agreement, countries will not receive a tax windfall from imports and exports at a time when government finances are under severe strain. Any friction between signatories to the agreement resulting from this issue could jeopardise the entire continent’s free trade project.

Societal issues

Incidents of xenophobia, and sinophobia (anti-Chinese sentiments) in particular are on the increase, and are likely to leave a lasting impact on tourism both to and from China. Not only this, but Chinese goods could face similar discrimination, as buyers (justifiably or not) fear lingering coronavirus contamination.

Patterns of interaction among people may undergo radical shifts, as connections shift from the real to the virtual world. This will be true not only for our work life, but for our personal lives.

Environmental issues

If there is any upside to the Covid-19 crisis, it is for the environment. Recent atmospheric readings show a dramatic fall in CO2 emissions, and a break from the relentless march of industrialisation and deforestation by way of lockdown provides a reprieve for several species from hunting, poaching and the destruction of their habitats.

As a result of the outbreak, Chinese authorities banned the trade, sale and consumption of wildlife, an important step in saving several species from extinction.

But on a note of caution, the vilification and hunting of perceived virus-carrying species must be avoided.

Security issues

Governments, police and security forces will have to remain vigilant, stamping out any violence and intimidation of foreign nationals as a result of rising xenophobia and nationalism. It is important to expedite the legal processes to punish and discourage such behaviour.

Further, the military has been deployed in some countries to assist with the enforcement of lockdown restrictions. These forces are not sufficiently trained for maintaining public safety, and incidents of violence, intimidation and aggression against the media and citizenry are on the rise.

A worsening of the crisis from a health, economic and resources perspective could see civic mobilisation, revolt and a rise in violent stand-offs.

While trade under the African Continental Free Trade Agreement (AfCFTA) has yet to commence, any border closures, dramatic falls in trade volumes or flare-ups in xenophobia could push out free trade ambitions and curtail the acceleration of African growth over the medium term.

China closed its internal borders to prevent Covid-19 spreading. Doing this in Africa would pose extensive challenges, given the continent’s poorly policed and enforced movement. This approach also has the potential to generate social unrest unless carefully managed.

One asset the African continent has is its prior experience in dealing with viral outbreaks and contagion (for example, with Ebola, measles, cholera, Lassa fever and malaria).

It also has a disproportionately large youth population (60% of the population is below the age of 25). Early indications suggest that the severity of Covid-19 is lower for young patients, and that mortality rates are significantly lower for younger populations. This should alleviate some of the burden on already thin medical response capabilities.

4. The short, medium and longer-term implications

In the short term, a great deal depends on the ability to contain the virus, or at least, the time it takes to run its course. It is likely that medical and healthcare systems across the globe will remain under immense strain to treat Covid-19 patients.

The public healthcare systems of the region will require more financial resources. This will require raising debt or realigning budgets. Both would increase pressures on public finances and service delivery.

5. Conclusions

Covid-19 arrived when global economic growth was already under threat. The emerging pandemic will have severe consequences for health, especially for fragile African economies. The resulting shocks will lead to higher debt levels, bad loans, business closures, and the loss of many jobs in Africa. It may take several years for the continent to recover from the ensuing recession.

The wider and longer-term geopolitical consequences of these shocks are far from certain. The many inherent uncertainties and complexities will lead to unforeseen consequences. These raise challenging questions regarding leadership:

Many African leaders are of an age that may increase their susceptibility to Covid-19. Might a political and leadership shake-up be on the way in certain countries?

Can and will Covid-19 be used as an opportunity for incumbents to push out national elections scheduled for 2020 in an attempt to extend their rule?

Will Covid-19 see a realignment in global geopolitical relations, with African countries relying less on China for trade and financial support, as they have over the past decade?

Strategically and tactically, Africa is relatively ill- equipped and ill-prepared to deal with Covid-19. The emerging reality is that even if Covid-19 does not directly trigger a humanitarian crisis in parts of the continent, an ensuing global economic crisis might well do so. 

This article was also published by the NTU-SBF Centre for African Studies, Singapore.