Friday, January 9, 2009

Why East Africa will be hit hard by this recession

Most observers seem to be of the impression that the recession in Western countries will be severe and prolonged. There seem to be far less agreement on how the financial crisis and the resulting recession will impact East Africa (Kenya, Tanzania, Uganda, Rwanda and Burundi). Many commentators point out that East Africa, and indeed most of Africa except South Africa, is not sufficiently interlinked with the rest of the world for there to be much of an impact.

I think, however, there are some very good reasons to believe the impact on East Africa will be severe. For one, foreign exchange and trade balances will be adversely affected as follows:

Likely to be reduced as donor countries struggle to finance bail out packages. Does anyone expect Iceland to give monetary aid this year? According to US officials "the financial crisis could imperil US aid available for Africa after 2010" [Business Monthly, Jan 2009].

Foreign investment
The entrance of private equity firms in the African market is an example of how the world investor community has turned to Africa in recent years. With sky-high commodity prices and unsaturated consumer markets, Africa is fertile ground for expansion. In times of crisis, however, the risky assets go first, and East African investments surely classify as risky.

The African diaspora is huge and spread across the world, with many working in the US and UK. When firms downscale, foreign workers will often be the first to go. In Uganda there is already talk of severely reduced remittance levels. In 2008 the total was USD 1 billion (or nearly 10% of GDP!), but will be a lot lower in 2009 [Daily Monitor, 05.01.2009].

Lets assume an average Western family is having to 'tighten the belt' with say 15% in the next couple of years to counter the effect of falling asset prices, etc. If you rank an annual family budget for a year in order of importance, that luxury safari trip to Tanzania will surely be on the wrong side of that incoming 15% spending cut. Uganda receives about 200,000 foreign tourists per year, Tanzania 800,000 and Kenya 1,600,000, there will be fewer in the next two years.

The main East Africa commodity exports are coffee, tea, cotton and flowers. Prices for all these commodities are already substantially down. Furthermore, the recession increases the likelihood of new protectionist measures from the regions trading partners, blocking out African products.

The flip side

There are reasons for optimism, however:

The East African economies are commodity based, which is, in spite of falling prices, more recession proof than being based on consumerism (US), financial services (UK, Iceland) or real estate (UK).

Already down
If you climb a ladder and it fall apart you are better off standing at the lower rungs. Or put another way: If you are at the bottom you have no where to fall. Or another way: If you are a subsistence farmer you are per definition not part of any market and will not be impacted by any market corrections. The majority of East Africans are subsistence farmers.

Positive momentum
GDP growth in Uganda was 6.0% in 2008, Tanzania 6.9%, Kenya with 6.3%, Rwanda 6.0% and Burundi 5.5% [] – making East Africa one of the growing regions in the world.

No financial crisis
There will be no local financial crisis as no East African banks held toxic assets and there was no property bubble, or indeed practice of giving out mortgages (A mortgage is typically paid back in 5 yrs or even less, with significant security).

Low export levels
Export levels are low anyway, so a slow down will have a limited effect. Total export was 15% of GDP in Uganda's GDP and 14% of GDP in Kenya vs. 40% for a high-export country like Germany [CIA World Factbook]. Regional trade (within East Africa) has been promoted, facilitated and growing in the last few years.

China is likely to continue its push into Africa with undiminished determination (ref. recent resource intensive investment plans announced by the Chinese government).

The net effect of all these 'known unknowns' is obviously impossible to predict. And then there are always the 'Rumsfeldian' unknown unknowns, which always seem to be even more unknown in Africa.. In sum I think the adverse effects will outweigh positives.

My guess

• Trade deficits will increase substantially (that’s a given), which will increase cost of debt and undermine independence (Germany failed to get full subscription on a government bond issue on 07.Jan in a debt market poised to be flooded by sovereign debt issues in 2009 – I refuse to believe a country like Uganda can issue bonds in such market conditions)

• Unemployment will increase significantly (from a high base/floor)

• Dependence on foreign aid will increase (loans to plug trade deficit and increasing budget deficit – where the hole is already huge in the case of Tanzania and Uganda)

• China and India will play an even large role in Africa. On a world wide basis this will boost the anticipated power shift from east to west

Prepare for impact

If this above holds true, the result will likely lead to a step back from the Washington Consensus, with more state intervention and more reliance on aid and NGO's. The commodities will still be up for grabs by China, but so it seems will the East Africa's heart and minds, by those who give aid conditional on faith and ideology.

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