Finance: The taps of credit run dry

As African credit markets begin to dry up, companies and governments anticipate a difficult year ahead, while the World Bank suggests that it may get involved in a new round of public-private partnerships

A new paradigm, it seemed, had come to pass. Previously, African banks had gotten fat by financing government deficits and had made healthy profits by doing little more than purchasing treasury bills and servicing a handful of major companies. But once macroeconomic stabilisation had worked its magic on inflation and interest rates started falling, the banks were at last being tempted into getting their hands dirty in the real economy. Newcomers targeting businesses’ cash flows finally started to undercut the old guard of lazy and self-satisfied institutions.

Goolam Ballim, the chief economist of South Africa’s Standard Bank (with a presence in 17 African countries), says there has been “more traditional textbook banking” emerging across the continent. This has occurred especially in the case of financing projects. “There are numerous examples of substantial projects in construction, energy, transportation and telecoms that have been founded on very orthodox financing methods,” he adds.

Interview with Donald Kaberuka
President of the African
Development Bank

When the world was first upended by the financial crisis, many in Africa were cautiously optimistic. African banks, outside a few unlucky South African insurers, were not exposed to the US housing market collapse. But sliding commodity markets and the fall-off in trade has begun to make life much more difficult.

African financial institutions may have been insulated from the credit crunch, but the subsequent downturn has not spared their customers. As African economies suffer, banks are seeing reduced demand. South Africa’s normally hectic summer season recorded a 1.75% drop in demand for credit for the private sector from commercial banks between December and January.

Falling demand could now be replaced by a lack of supply. In the era of cheaper money, getting a loan was increasingly easy, even in Africa. Credit cards in South Africa were perhaps a little too readily available. As in all cycles of irrational exuberance, poor decisions were made towards the end: loans were advanced to projects whose business plans had perhaps not been stress-tested as well as they should have. In this time of frozen credit markets, banks are risk-averse, to a point that they may well kill the green shoots of private-sector activity nourished by progress in African banking.

This would be a harsh blow, says Lionel Zinsou of PAI Partners, who advises the president of Benin, Thomas Yayi Boni, on economic matters. “As far as the private sector is concerned, it’s as important in Africa as in anywhere else to maintain the liquidity of this sector,” he says. “Compared to Europe and the US, corporates are accustomed to illiquidity in Africa as they have not had access to financial markets and banks. But the expansion and increasing professionalism of financial markets, to create liquidity for the private sector, are among the most creative moves in the last few years. It would be a shame to see the same credit crunch for the private sector in Africa as we have seen in other parts of the world, as it was just blossoming.”?

Nowhere has the growth in credit to the private sector been more dramatic than in Nigeria since the consolidation of its banking sector three years ago. World Bank financial sector analyst Ismail Radwan says: “If you look at the growth of private credit to GDP in Nigeria, it has been growing at a phenomenal rate since the recapitalisation exercise – 30-50% – and in 2007 it topped 100%.” This was mostly in sectors like oil and telecoms, rather than areas like agriculture, but it marked a significant shift in the economic life of the country.

That was then. Now there are signs that the Nigerian banks are going back to financing government rather than companies; government securities were 86% oversubscribed in the last quarter of 2008. Trade, which makes up a large part of financial activity in Africa, has already become harder, with importers finding it harder to open letters of credit. In general, foreign exchange has been hard to come by. The Nigerian attempt to control the auction of foreign exchange has highlighted the difficulties faced by economies on the peripheries, as money heads back towards safer climes.

Antoinette Sayeh, head of the Africa region at the IMF, says that most investors are “running to what they consider to be safe assets and are less willing to take the risks they should be taking”. She adds: “We are certainly concerned about that… It’s important on the macroeconomic and reform side, where we are involved with governments, that they continue to improve the business environment and continue progress on the structural front that has made Africa a more attractive place for investment, both domestic and foreign.”?

Interest rates may be heading down as the inflationary pressures associated with high commodity prices subside. Already South Africa’s Reserve Bank has dropped its rates to 14%, and the Bank of Botswana approved a cut, also to 14%. These moves may provide a boost to industry. But in Ghana, the central bank hiked the prime rate from 17% to 18% to try to contain runaway inflation, currently at 19.5%. This is despite the 20% drop in fuel prices since Christmas. Tony Oteng-Gyasi, the president of the Association of Ghana Industries, comments: “If government were to reduce its spending, the banks would have no choice but to look at people like our members. Right now the government is crowding out the private sector from the credit markets.”?

Feedback loops

Some take a more positive view. Standard Bank’s Ballim believes that it is simply not in the interest of banks to stop the flow. “I’m not so sure there is going to be a lack of lending,” he says. “Obviously lenders will be far more exacting in their criteria, but there is an increasing realisation that the credit taps can’t be switched off because the banks are simply then placing a noose around their own necks and can foster a negative feedback loop that harms the longevity of their businesses.” ?

World Bank Africa economist Shanta Devarajan points out: “We have to differentiate the secular trend towards greater intermediation in Africa from the short-term deflation in the economy.” Sceptics say that there just has not been that much credit extended, and therefore there is not much to be withheld.

Domestic investors have not entirely disappeared. Togo-based Ecobank announced in mid-February that it had raised $550m in a share offering that targeted mainly East African bourses, proving that the appetite among domestic investors is still there, even if international investors have vanished.

Pick a winner

The question is the same the world over: private-sector banks are running scared, but there are good businesses and projects out there that need financing – how then can governments pick winners? For Deverajan, there is a role for Africa’s central banks and finance ministries in Africa: “If there is a good infrastructure project that had already been designed, appraised, is ready to go – perhaps a public-private partnership – and the private sector pulled out just because of the current crisis, then there must be some way that the public side of the financial sector can provide some guarantee, some leveraging instrument, so that the private sector can come back. Maybe not an equity instrument, maybe a pure debt instrument. This is certainly a discussion we are having at the Bank, whether we can be involved at this level.”?

Companies will not be the only ones to suffer from a drying up of credit, but governments will too. Western stimulus packages will call upon large sovereign debt issuances, which will crowd out developing-country issuers, both public and private: “Many of the institutions that have provided financial intermediation for developing-country clients have virtually disappeared,” points out a recent Bank paper, estimating the financing shortfall for developing countries at between $270bn-$700bn.

The numbers are perhaps abstract, but the effects will not be. While debates in Britain revolve around bankers’ bonuses, and the US is faced with difficult choices about which banks to nationalise, economists suggest that the violent economic deceleration in Africa will have grim consequences. Based on similar downturns in the past, the impacts will not be limited to the economic sphere. With the levels of poverty that are found in Africa, past growth decelerations like this one have led to a stark increase in child mortality. The World Bank’s Deverajan argues: “People need to wake up to how Africa will be affected. There will be 700,000 more children dying before their first birthday”.