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By Liwaaddine Fliss
I recently spoke to a senior African delegate at the United Nations Headquarters about the challenges related to the continent’s debt. Beyond the diplomatic aspect of our exchange, I was moved by the candid nature of our conversation and sensed the frustrations we shared on the escalating debt challenges impacting our continent. In his country, the issue has fuelled social unrest and deepened poverty as the government struggles to provide basic services. Our brief but vivid encounter provided a stark reminder of the pressing need for innovative and durable solutions to tackle the root causes of Africa’s debt challenges.
Rising Debt Services: A Growing Burden for Africa
In the aftermath of COVID-19, global financing conditions have tightened, casting a long shadow over many African economies by restricting access to international capital markets, tightening fiscal space, and escalating debt service. The numbers are staggering: in 2024, debt servicing costs for African countries soared to nearly $90 billion, a staggering figure that strains national budgets and limits critical investments in healthcare, education and infrastructure. By April 2024, 25 African countries were in debt distress. The burden of unsustainable debt is stifling growth and development across the continent.
The Impact of Currency Volatility on Africa’s Debt
Over 70 per cent of Africa’s debt increase in 2023 was due to currency depreciation, making external debt costlier to service and endangering financial stability. In 2023, more than half of African countries experienced currency depreciation, with changes as large as nearly 40 per cent (e.g., the Egyptian pound, Ghana cedis, and Sierra Leonean Leone). For its part, the Malawi Kwacha currency depreciated by 25 per cent in 2022 and an additional 44 per cent in 2023. Although the international community conducted multiple debt relief initiatives, they were not successful in tackling currency volatility, the root cause of the issue. As this challenge remains unaddressed, African countries have limited options to mitigate its impact. Borrowing in local currency (LC) from international financial institutions (IFIs) could catalyze a durable solution to Africa’s indebtedness. Unfortunately, this borrowing instrument is not widely available or offered by these IFIs.
The Potential of Local Currency Lending
LC lending offers numerous advantages in the African context. It shields countries from the adverse impacts of currency depreciation, providing a stable financial environment. It enhances debt sustainability, making repayment obligations manageable and predictable, crucial for African countries already in debt distress. Additionally, it allows for a more predictable allocation of domestic resources, thereby increasing the country’s fiscal space. Furthermore, it provides African countries with the opportunity to build long-term financial resilience and develop the debt sustainability needed to achieve the Sustainable Development Goals (SDGs).
Despite the compelling rationale for LC lending, over 80 per cent of loans provided to low-income countries (LICs) and lower-middle-income countries (LMICs) by Multilateral Development Banks (MDBs) and IFIs are in hard currencies, predominantly US dollars. By not engaging in LC lending practices, IFIs, especially the MDBs, are fully transferring currency risk to African countries’ under-capacitated national debt management officers. This practice exacerbates financial vulnerabilities, as concessional loans, despite their favourable conditions, are typically denominated in major hard currencies. As a result, LICs find themselves grappling with increased debt servicing costs, even when the interest rates on the concessional loans remain low. The challenge becomes more pronounced when these countries heavily rely on exports, as fluctuations in global commodity prices may directly influence their revenues.
Making Local Currency Lending Work
To mitigate exchange currency risks, it is essential for MDBs, especially the African Development Bank (AfDB) to scale up direct LC lending. Here are some strategic options:
- Assume the Currency Risk: MDBs could take on the currency risk themselves, alleviating the financial pressure on LICs. This strategy allows these countries to focus on their development goals without the added burden of managing currency volatility. Additionally, this approach can enhance the creditworthiness of LICs, making them more attractive to investors and lenders.
- Hedge Currency Risk: Partnering with specialized financial institutions to hedge currency risk can distribute such risk, reducing the potential impact on any single entity. This method can also be more cost-effective, as specialized institutions often have better tools and expertise. While the AfDB offers synthetic LC Loans in 15 African currencies depending on its ability to efficiently fund itself in those currencies, there is a need to expand the offering of such tools to the rest of African countries.
- Borrow Internationally and On-Lend in LC: By borrowing in stable international currencies and on-lending in local currencies, MDBs can shield LICs from the adverse effects of foreign exchange market volatility. This strategy allows these countries to access global capital markets indirectly, benefiting from potentially lower interest rates and better terms.
The Way Forward: Scaling-up Local Currency Lending
To encourage the scalability of direct LC lending, MDBs should standardize currency indexation and risk-mitigation clauses in concessional loan agreements. Setting up annual targets to increase the adoption of LC and hedging in LC lending is critical in encouraging a gradual shift towards stable financial practices. MDBs should provide institutional support for National Debt Management Offices to improve their skills and capabilities in managing and implementing LC and hedging strategies effectively. The IMF should review its Debt Sustainability Analysis (DSA) to provide preferential treatment for LC and hedged borrowing, incentivizing African policymakers to select LC lending and hedging. African governments, with support from MDBs, should focus on developing their domestic capital markets to provide more financing tools in local currencies. This will improve market liquidity, increase the availability of hedging instruments, and allow MDBs to expand their local currency operations while managing risks.
Scaling up direct local currency lending by MDBs is a strategic imperative for addressing the unique financial challenges faced by African countries. The Summit of the Future and the upcoming 2025 Financing for the Development Forum are the ideal opportunities for the representatives of African member States to advocate for adopting this approach, which could sustain their debt, achieve long-term economic stability and growth, and shape a brighter future for Africa.
Returning to my conversation, as our chat was winding down and the African diplomat prepared for his next meeting after a rich exchange on policy options that could turn the tide against Africa’s debt challenges, his perspective was resolute. We are at a crossroads, he said, but I know there are sustainable solutions. His voice carried hope and resilience, and I could not help but make the connection with the messages and recommendations in the 2024 flagship of the United Nations Office of the Special Adviser on Africa (OSAA), “Unpacking Africa’s Debt: Towards a Lasting and Durable Solution.” We have an opportunity to support the development of Africa-led solutions to the continent’s debt challenges. Let us redouble our efforts.