African Economies Face Down European Storms

As the eurozone crisis rumbles on, African economies are taking a beating through reduced trade and aid. But overall, growth and investment trends are holding steady, and new opportunities opening up

Paralysis in the eurozone is a global problem. As the European Central Bank repeatedly tries to recapitalise the banking system – notably in Italy, Spain, Greece and Ireland – a wider array of countries have been taking note. US president Barack Obama said the crisis was "scaring the world". A recent HSBC report sees the BRICS entering a worrisome slowdown. G20 members, notably Japan, even sent money to the IMF to protect 'bystanders' from the fallout.

Africa may be calling on those funds. Given the isolation of the continent's banking sector, there was little direct impact from the first-wave crisis at the fall of Lehman Brothers, although intangible effects – in the form of nervy market sentiment – did deter some investors. Such inflows had become lifelines. Liberia and the Democratic Republic of Congo showed the highest exposure to foreign direct investment shocks in 2010, with an FDI inflows to GDP ratio higher than 20 percent, followed by Niger at 17 percent.

The eurozone crisis will affect African countries as a knock-on effect of fiscal consolidation in Europe, which translates into declining demand for African exports of goods and services as well as declining remittances, FDI and aid flows; through financial contagion in the form of spillovers through financial intermediaries and stock markets; and through a drop in the value of currencies pegged to the euro.

"Mozambique, Kenya, Niger, Cape Verde and Cameroon are among the most vulnerable African countries to the eurozone crisis," says Isabella Massa, an economist at the Overseas Development Institute. "This is due to the fact that these countries are highly dependent on eurozone trade flows. Cape Verde, for example, relies on the EU for over 90 percent of its exports." Mozambique and Cameroon are highly vulnerable also because of their strong financial linkages with Europe, she adds. European banks represent over half of total bank assets in these countries. "Mozambique is also highly dependent on aid flows from Europe, especially from Portugal. Cameroon and Niger are also likely to feel the effects of the eurozone crisis through a depreciation of the euro to which their currencies are pegged".

The International Labor Organisation is predicting 22 million out of work over the next four years in Europe. This in turn depresses demand for developing countries' exports, as well as potentially reducing remittances. This concern is relevant for countries such as Gambia and Nigeria which depended on remittances for more than 10 percent of their GDP in 2010, and for which the EU is the main source of those funds. Recent evidence shows that remittances from Nigerians have more than halved in 2011 partly because of the eurozone crisis.

Tourism, an excellent source of foreign exchange with a positive investment-to-employment ratio, is down. Virgin airlines recently scrapped its London-Nairobi route in part due to insufficient demand (although a spate of terror attacks and instability in the region is not helping). Morocco is also suffering, since Western European tourists account for over 70 percent of its annual visitors. Total visits fell 10 percent in the first quarter of the year according to official data (although, again, the Argana terrorist attack in April 2011 contributed to this downturn as well).

While these drops in services are painful, they are not precipitous. Overall, sub-Saharan Africa's trade in services as a percentage of GDP fell from 12.5 percent in 2005 to 11.2 percent in 2010; while international tourism as a percentage of GDP fell from 7.7 to 6.9 over the same period.

Finally, aid flows are in question as European governments struggle with high debts, and public support for foreign assistance potentially wanes. While African governments are keen to re-brand the continent as a self-sustaining powerhouse, aid flows still buttress state finances – especially in smaller states like Burundi, Malawi, and Rwanda.

European development aid is down 1.5 percent, with Spain and Greece cutting back significantly – in the case of Spain, by nearly a third. Fourteen member states posted a decline in 2011, the first such drop in nearly a decade. Those ring-fencing their spending, such as the UK, have brought lending into line with strategic objectives; for Britain, this is reflected in a growing focus on 'fragile states' viewed by the government as potential hot-spots for terrorism.

This decline matters for Africa, where public finances are are under duress as hard-won fiscal buffers – which allowed some countercyclical spending when the global economic crisis first struck – are now largely spent.

Ambiguous effects

Yet for all this doom and gloom – some real, some predicted – the overall economic outlooks for Africa published by the IMF continue to be positive, even while they point to downside risks. For the sub-Saharan region, output last year grew by 5 percent, with low-income countries and oil exporters among the world's top performers.

Where growth slowed, this was often related to internal troubles – political crisis in Côte d'Ivoire, the Sahelian drought – rather than eurozone effects. The IMF's baseline prediction for 2012 sees output keeping momentum, with natural resource production and West African recovery pushing growth to 5.5 percent overall and some countries poised for phenomenal results – notably Sierra Leone, which should hit a world-leading 34 percent.

"All our evidence, both anecdotal and empirical, is that investors are increasingly interested and active in Africa," says Michael Lalor, director of the Ernst and Young Africa Business Centre. "This is as true for investors from many of the developed markets as it is for the Chinese and Indians. Over the past 4 years, and through the global crisis, FDI projects into Africa from the US and UK, for example, have grown at a compound annual growth rate in excess of 20 percent."

As Europe's economy languishes, African economies have even greater impetus to diversify their trade and investment partnerships, a process already underway among the likes of South Africa. "We're seeing a slowdown in growth of exports," notes Peter Attard Montalto, emerging markets economist at Nomura. "From the end of last year, exports were growing 30 percent year on year in nominal terms, but are now down to 5 percent or so".

South Africa began looking beyond eurozone countries in around 2007, focusing on exporting to Asia and the rest of sub-Saharan Africa, which are still seeing bumper growth, he notes: "Those countries are seeing less of a slowdown, which is helping to maintain some momentum". But Africa's middle-income countries are still more sensitive to contagion effects, and South African firms are risk-averse, reflected in tepid hiring; a significant problem in an economy with such high unemployment rates.

Some direct eurozone fallout has uncertain effects. Exchange rate changes, for instance, are ambiguous. Countries with currencies pegged to the euro – such as those in West Africa's Communauté Financière Africaine (CFA) zone – have actually increased their export competitiveness in world markets, while those with dollar-linked exchange rates suffer due to appreciations of the dollar against the euro.

Commodity prices may follow some upward trends in Africa's favour. Gold prices tend to rise during times of crisis, for example, as a result of the flight to secure assets. And the wider changes in the global economy, notably a commodity-hungry Asia, provides a strong antidote to Europe's sickness.

While perception effects have deterred nervier investors, the eurozone crisis has also – and perhaps helpfully – blurred the rigid distinction between 'core' and 'frontier' zones. This prejudice has proven catastrophic for emerging markets in previous crises. The Asian financial crash in the late 1990s, for example, saw a modest and localised crisis gather enormous momentum, with harsh consequences for Asia, as investors pulled out their capital from high risk emerging economies and into the 'safety' zones of Europe and the US.

Today, the rich world offers low growth and high risk – the worst of all possible worlds. Brazil, after four years of tepid growth, is now seeking to raise its game in Africa, with high-level state visits, notably from the trade and industry minister. South-South FDI flows more broadly have been on the rise in both relative and absolute terms, proving more resilient to global shocks. The eurozone crisis looks like another step on the road to a new world order.

African Economies Face Down European Storms

As the eurozone crisis rumbles on, African economies are taking a beating through reduced trade and aid.