Debt Sustainability and Direction of Trade: What Does Africa’s Shifting Engagement with BRIC and OECD Tells Us?

Abstract

This chapter provides a comparative assessment of the contribution of Organization for Economic Cooperation and Development (OECD) member countries and Brazil, Russia, India, and China (BRIC) to the evolution of sub-Saharan Africa (SSA)’s foreign debt sustainability. Using data for the period 1970–2014, the analysis shows how external demand for SSA goods and services by OECD and BRIC has helped to lower debt-to-exports, debt service-to-exports, and debt-to-GDP ratios, and in turn, impact growth. Results reveal that debt levels across SSA rose from ‘relatively’ low levels to unsustainable levels starting in the late 1980s to early 2000s. However, since mid-2000s, SSA countries have witnessed external debt sustainability.

Appendices

Appendix 1

Contribution to Debt Sustainability (OECD Vs. BRIC)

We examine the Contribution of OECD and BRIC to debt sustainability in African countries via exports as follows. Suppose Debt _it represents the debt owed by country ‘i’ at time ‘t’, Export _it = Gross value of exports by country ‘i’ at year ‘t’, Export _{BRIC it} = Value of exports to BRIC by country ‘i’ at year ‘t’, and Export _{OECD it} = Value of exports to OECD by country ‘i’ at year ‘t’; we could represent the debt-to-exports ratio in the ‘hypothetical scenario’ of no exports to OECD as (in %);

$$ \left(\frac{{\mathrm{Debt}}_{it}}{{\mathrm{Export}}_{it}-{\mathrm{Export}}_{\mathrm{OECD}\ it}}\right)\ast 100 $$

(20.2)

We could then assess the contribution of OECD countries to the debt sustainability of African countries (via export channel) by comparing the above hypothetical ratio (Eq. 20.2) with the actual debt-to-exports ratio. In a similar fashion to Eq. 20.2, we capture the debt-to-exports ratio in the ‘hypothetical scenario’ of no exports to BRIC. We also examine the hypothesis that the relative contribution of the OECD (via the export channel) to African countries’ debt sustainability is higher than that of BRIC. We approach this as

$$ \left(\frac{{\mathrm{Debt}}_{it}}{{\mathrm{Export}}_{it}-{\mathrm{Export}}_{\mathrm{OECD}\ it}}\right)>\left(\frac{{\mathrm{Debt}}_{it}}{{\mathrm{Export}}_{it}-{\mathrm{Export}}_{\mathrm{BRIC}\ it}}\right) $$

(20.3)

This would mean that the OECD countries play a bigger role to debt sustainability measured against exports (at year ‘t’). However, we will also look at the historical evolution of the contribution of BRIC and OECD to debt sustainability on the above measure. This is important to do since there is a presumption that BRIC are playing an increasing role as compared to OECD.

We also analyze if the contributions of BRIC and OECD to debt sustainability enables SSA countries to meet the specific debt sustainability requirements of the DSF. We will do so by testing whether the DSF debt targets (thresholds) are still met in the ‘hypothetical’ absence of exports to BRIC or OECD. Given the heterogeneity of developing countries on the bases of policy strength and institutional qualities (Fig. 20.3 in section ‘Debt Evolution and Sustainability Framework’), the DSF sets three categories of debt sustainability thresholds for debt-to-exports ¹² :

$$ {\left(\frac{{\mathrm{Debt}}_{it}}{{\mathrm{Export}}_{it}}\right)}_{\mathrm{Threshold}}=\left\{\begin{array}{c}100\%\mathrm{if}\ \mathrm{weak}\ \mathrm{policy}\ \left(\mathrm{CPIA}\le 3.25\right)\kern5em \\ {}150\%\mathrm{if}\ \mathrm{medium}\ \mathrm{policy}\ \left(3.25<\mathrm{CPIA}<3.75\right)\\ {}200\%\mathrm{if}\ \mathrm{strong}\ \mathrm{policy}\ \left(\mathrm{CPIA}\ge 3.75\right)\kern4.25em \end{array}\right. $$

(20.4)

The assessment we make can be stated as

$$ \begin{array}{l}\left(\frac{{\mathrm{Debt}}_{it}}{{\mathrm{Export}}_{it}-{\mathrm{Export}}_{\mathrm{OECD}\ it}}\right)\hfill \\ {}\times >{\left(\frac{{\mathrm{Debt}}_{it}}{{\mathrm{Export}}_{it}}\right)}_{\mathrm{Threshold}}\mathrm{and}/\mathrm{or}\left(\frac{{\mathrm{Debt}}_{it}}{{\mathrm{Export}}_{it}-{\mathrm{Export}}_{\mathrm{BRIC}\ it}}\right)>\hfill \end{array} $$

(20.5)

That is, we argue that in the absence of export links to OECD or BRIC, country ‘i’ will not achieve the DSF targets since this will lead to high debt-to-exports ratios. We will also conduct an analysis for ‘debt service-to-exports’ and ‘debt-to-GDP’ ratios in a similar fashion to the analysis we make for the debt-to-exports ratio above (Eqs. 20.2–20.5 above). Within the framework of the GDP channel, we examine the contribution of BRIC and OECD to debt sustainability in SSA countries via GDP growth as indicated in Appendix 2. However, we use different thresholds for ‘debt-to-GDP’ ratio for the three categories of policy/institutional qualities in SSA economies. The debt-to-GDP sustainability thresholds (as in IMF-WB DSF) are given as:

$$ {\left(\frac{{\mathrm{Debt}}_{it}}{{\mathrm{GDP}}_{it}}\right)}_{\mathrm{Threshold}}=\left\{\begin{array}{c}30\%\mathrm{if}\ \mathrm{weak}\ \mathrm{policy}\ \left(\mathrm{CPIA}\le 3.25\right)\kern5em \\ {}40\%\mathrm{if}\ \mathrm{medium}\ \mathrm{policy}\ \left(3.25<\mathrm{CPIA}<3.75\right)\\ {}50\%\mathrm{if}\ \mathrm{strong}\ \mathrm{policy}\ \left(\mathrm{CPIA}\ge 3.75\right)\kern4.25em \end{array}\right. $$

(20.6)

In the absence of trade and investment links to OECD or BRIC, we hypothesize that country ‘i’ will not achieve the DSF targets since this will increase the debt-to-GDP ratio—by depressing its GDP.

Appendix 2

Determining the Contribution of OECD and BRIC to SSA’s GDP Growth

Our estimation of the contribution of export growth to GDP growth is based on the basic national accounts identity, namely:

$$ {Y}_{it}={C}_{it}+{I}_{it}+{G}_{it}+\left({X}_{it}-{M}_{it}\right),\kern1em i=1\dots k\kern0.5em \mathrm{and}\kern0.5em t=1\dots n $$

(20.7)

where

Y _it = National income of country ‘i’ at year ‘t’

C _it = Consumption of country ‘i’ at year ‘t’

I _it = Investment of country ‘i’ at year ‘t’

G _it = Government expenditure of country ‘i’ at year ‘t’

X _it = Exports of country ‘i’ at year ‘t’

M _it = Imports of country ‘i’ at year ‘t’

If we differentiate the above equation with respect to time (t), we will get the following expression:

$$ {\overset{\sim }{Y}}_{it}={\overset{\sim }{C}}_{it}+{\overset{\sim }{I}}_{it}+{\overset{\sim }{G}}_{it}+\left({\overset{\sim }{X}}_{it}-{\overset{\sim }{M}}_{it}\right) $$

(20.8)

where${\overset{\sim }{Y}}_{it}=\frac{{\mathrm{d}Y}_{it}}{\mathrm{d}t}$ and so on for the other terms.

If we represent the net exports part of the right-hand side equation (i.e.${\overset{\sim }{X}}_{it}-{\overset{\sim }{M}}_{it}$) with${\overset{\sim }{NE}}_{it}$, we may present the above equation as:

$$ {\overset{\sim }{Y}}_{it}={\overset{\sim }{C}}_{it}+{\overset{\sim }{I}}_{it}+{\overset{\sim }{G}}_{it}+{\overset{\sim }{NE}}_{it}, \kern1.25em i=1\dots k\ \mathrm{and}\ t=1\dots n $$

(20.9)

For further analysis, we may again rewrite the above left- and right-hand side terms as follows:

$$ \frac{{\overset{\sim }{Y}}_{it}}{Y_{it}}=\frac{{\overset{\sim }{C}}_{it}}{C_{it}}\frac{C_{it}}{Y_{it}}+\frac{{\overset{\sim }{I}}_{it}}{I_{it}}\frac{I_{it}}{Y_{it}}+\frac{{\overset{\sim }{G}}_{it}}{G_{it}}\frac{G_{it}}{Y_{it}}+\frac{{\overset{\sim }{NE}}_{it\ }}{NE_{it}}\frac{NE_{it}}{Y_{it}},\kern1em i=1\dots k\ \mathrm{and}\ t=1\dots n $$

(20.10)

In this setting, the ratios $\frac{C_{it}}{Y_{it}},\frac{I_{it}}{Y_{it}},\frac{G_{it}}{Y_{it}}$ and $\frac{NE_{it}}{Y_{it}}$ represent the shares of national income accounted by consumption, investment, government expenditure, and net exports, while the ratios $\frac{{\overset{\sim }{Y}}_{it}}{Y_{it}},\frac{{\overset{\sim }{C}}_{it}}{C_{it}},\frac{{\overset{\sim }{I}}_{it}}{I_{it}},\frac{{\overset{\sim }{G}}_{it}}{G_{it}}$ and $\frac{{\overset{\sim }{NE}}_{it\ }}{NE_{it}}$ represent the growth rates of the respective variables. The four right-hand side additives of Eq. (20.10) represent by how much GDP would grow following a growth in any of these parts. For instance, $\frac{{\overset{\sim }{NE}}_{it\ }}{NE_{it}}\frac{NE_{it}}{Y_{it}}$ or $\frac{{\overset{\sim }{NE}}_{it\ }}{Y_{it}}$ represents the growth in GDP as a result of a corresponding growth in net exports, while $\frac{{\overset{\sim }{X}}_{it\ }}{X_{it}}\frac{X_{it}}{Y_{it}}$ or $\frac{{\overset{\sim }{X}}_{it\ }}{Y_{it}}$ represents the GDP growth attributable to growth in gross export value of goods and services. By splitting net exports by its destination in to BRIC, OECD, and the rest of the world (ROW), we can make comparisons about the relative importance of these trade partners to SSA countries’ GDP growth. That is:

$$ {\overset{\sim }{NE}}_{it}={\overset{\sim }{NE}}_{\mathrm{OECD}\ it}+{\overset{\sim }{NE}}_{\mathrm{BRIC}\ it}+{\overset{\sim }{NE}}_{\mathrm{ROW}\ it},\kern1em i=1\dots k\ \mathrm{and}\ t=1\dots n $$

(20.11)

Notes on Contribution of Exports to GDP Growth

Lin and Li (2002) argue that the basic national income identity-based analysis underestimates the effect of exports on GDP growth since increases in exports can also have an effect on consumption, investment, and imports. To ascertain this argument, we run regressions using a simple bivariate model (Eq. 20.1) of consumption, investment, and imports versus exports, which shows the trade elasticities for SSA countries.

$$ \log \left({Z}_{it}\right)={\beta}_0+{\beta}_1 \log \left({X}_{it}\right)+{\varepsilon}_{it},\kern1em i=1\dots n\ \mathrm{and}\ t=1\dots T $$

(20.1)

where

Z _it = [C _it , I _it , M _it ]

C _it = Consumption of country ‘i’ at year ‘t’

I _it = Investment of country ‘i’ at year ‘t’

M _it = Imports of country ‘i’ at year ‘t’

X _it = Gross value of exports by country ‘i’ at year ‘t’

The above model is estimated via pooled least squares (PLS) and fixed effects (FE) models, where the latter regressions are intended to control for country heterogeneity within the sample. The dataset is an unbalanced panel of 45 countries in SSA, over the period of 1960–2014. For the list of countries included in the panel regressions, see Table 20.3 in Appendix.

Table 20.3 List of SSA countries included in the panel regressions in Table 20.4

The coefficients of exports in the three bivariate models (the elasticities of consumption, investment and imports with respect to exports) are all significant (Table 20.4). This goes to show that a boost in SSA exports to OECD, BRIC, or elsewhere in the world would augment not only imports but also consumption and investment figures. Therefore, the overall effect of exports on the economic growth would be larger in reality than what the simple national income accounting identity would tell us. This would specially be the case if the indirect positive impacts (of export growth) reflected in consumption and investment growth outweigh import growth. The implication of this being, rising exports to OECD and BRIC would play a vital role toward the dual policy targets of economic growth and debt sustainability in SSA economies.

Table 20.4 Effects of growth in SSA exports on consumption, investment, and imports

Notes

• 1. For more on the multilateral debt relief initiative for African countries, specifically the ‘Heavily Indebted Poor Countries’ (HIPC) initiative, see Easterly 2002; Ndikumana 2004; Cassimon and Essers 2013; Cassimon and Verbeke 2014.

• 2. BRIC constitutes Brazil, Russia, India and China. In years, South Africa has been added to the group to become ‘BRICS’. However, given the fact that South Africa itself is in our economic region of interest (i.e. SSA), we do not include it in the club of emerging powers. Rather, we consider it as part of SSA.

• 3. This paper uses the same definition and country list as World Bank and IMF in its use of the term ‘OECD’, i.e. Organization of Economic Development. This group of countries largely represents the world’s most advanced countries that have been SSA’s traditional economic partners. In its current form, the specific list of countries in the group includes; Australia, Japan, Austria, Korea Rep., Belgium, Luxembourg, Canada, Mexico, Chile, Netherlands, Czech Republic, New Zealand, Denmark, Norway, Estonia, Poland, Finland, Portugal, France, Slovak Republic, Germany, Slovenia, Greece, Spain, Hungary, Sweden, Iceland, Switzerland, Ireland, Turkey, Israel, United Kingdom, Italy, and United States.

• 4. External debt (also known as foreign debt) represents the gross debt owed to foreign creditors by a country. Public debt (alternatively termed as sovereign debt or national debt) signifies the debt owed by national governments.

• 5. The DSF uses ‘present value’ (PV) in its analysis of debt sustainability and in setting sustainability targets (thresholds). However, empirical studies often use nominal debt figures since adequate long-term PV debt data is not readily available. This study will also use nominal debt data which is available from the World Bank’s IDS database. Yet, the study will borrow the debt sustainability thresholds of the DSF as rough guidelines of sustainability.

• 6. The debt-to-GDP ratio is the ratio between a country’s government debt and its gross domestic product (GDP). A low debt-to-GDP ratio indicates an economy that produces and sells goods and services sufficient to pay back debts without incurring further debt.

• 7. GDP does not change proportionally to the changes in exports. It will take a simultaneous decline in consumption, investment, government expenditure and external demand (net exports) to comparatively skew GDP. Further, the fact that we are considering net exports (which theoretically have a zero value in a balanced trade scenario) to represent the external demand from either the OECD or BRIC means that there is a smaller deviation as compared to an alternative scenario where we might consider only exports.

• 8. Given the limitations of accessing continuous (and reliable) bilateral time series data, the above exercise did not include these dimensions in the basic debt sustainability analysis given in section ‘Debt Sustainability Through Export and GDP Growth’.

• 9. On bilateral data such as aid flows, Brautigam (2010) documents the difficulty of getting data from major emerging economies (e.g. Russia, China, India, and Brazil).

• 10. At the core of the discussion about what levels of ‘debt-to-GDP’ are sustainable for countries at different levels of economic development is also a debate about the complex link between the nominator (debt) and the denominator’s growth (i.e. GDP or economic growth). In this regard, there is a rich and ongoing discussion as can be seen from Panizza and Presbitero (2013, 2014), Eberhardt and Presbitero (2015), Megersa (2015), Megersa and Cassimon (2015).

• 11. The DSF is the current formal debt sustainability framework used not only by the IMF and WB, but also by governments and policy makers of developing countries and various multilateral institutions (see section ‘Debt Evolution and Sustainability Framework’).

• 12. See IMF and World Bank (2012) for the debts sustainability thresholds within the DSF analysis.