Development, Economics and finance, Trade and industry, International relations | Asia, East Asia, The World

3 December 2019

With low savings and foreign reserves, some states in Africa are struggling to secure investment for their development, but a recently announced policy model from the west of the continent provides a potential way forward, Lauren Johnston writes.

“We have the capacity to assemble 5,000 vehicles a year but are producing just 300-500”, says Ma Qun, Ethiopia representative for China’s Lifan Motors. His struggle, however, is not local poverty, corruption, or even a lack of demand.

An enormous hurdle for Ma Qun’s business, and for Ethiopia’s development, is a lack of foreign currency. Since Ethiopia’s trade partners refuse Ethiopia’s Birr, businesses requiring parts from abroad need to use foreign currency to purchase them.

Unfortunately for them, rising competition, falling terms of trade, stagnating tourism spending, and rising foreign debt obligations mean that Ethiopia’s scarce foreign currency reserves are just not enough to go around.

It’s a vicious cycle for Nobel Laureate Ethiopian Prime Minister Abiy Ahmed: foreign currency loans are needed to build infrastructure that opens up routes for trade and encourages development, but paying back those loans can then constrain the very use of that infrastructure by depriving the market of foreign currency.

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Circumstances in Ethiopia today are extraordinary on a number of fronts. The country’s foreign exchange constraint, however, is less so. Thanks to economists Hollis Chenery and Alan Strout, for half a century policymakers have understood the limits placed on development by lack of savings, first domestic savings, but also foreign currency, as industrial growth takes off.

But even developing countries with relatively high savings and foreign currency, including some of Africa’s oil exporters, still face domestic currency uncertainty and foreign currency-related policy constraints.

Enter the recent announcement of a multi-billion dollar, foreign currency-free ‘bauxite for development’ deal between China and Ghana.

The deal is a multi-billion dollar equivalent exchange of refined Ghanaian bauxite, a mineral crucial to aluminium production, in return for Chinese construction of infrastructure in the country.

This represents a step away from mega foreign currency loans and towards direct bartering. In China’s case, it offers a crucial mineral and a step around accusations of China’s debt-trap diplomacy. For Ghana, it offers a loan and foreign currency-free means of securing development investment.

The devil, of course, lies in the detail. The quality and quantity of the infrastructure that will be constructed, what share of local labour and firms will be engaged in the process, and whether there are fiscal reserves to maintain the infrastructure over its intended lifespan, are all unclear at this point in time.

This new style of China-Africa barter arrangement is a step away from the recent and widely used ‘Angola model’. When the war in Angola ended in 2002, traditional Western donors refused approaches by the government of Angola for loans to fund post-conflict reconstruction. Hungry for oil sources and keen to support the post-war state, China was happy to step in.

China’s Export-Import Bank offered a then enormous sum of $2 billion as a line of credit to Angola to finance the reconstruction of the country’s shattered infrastructure – in exchange for oil. This set a useful precedent for China in contemporary Africa, and thereafter the exchange of oil or other commodities for Chinese infrastructure lending became known as the ‘Angola model’.

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The model, however, was not without its problems, in terms of transparency, reliance on Chinese labour and firms, and governance issues. Problems arose around how related revenues and repayments were managed, and because of the fact that at times the oil price has fallen below initial projections.

Almost a decade ago Ghana itself borrowed extensively on the back of an oil find, only to find itself in trouble when oil revenues failed to meet the repayment requirements. In contrast, this new model offers upfront finance for Ghana’s development – at an implicitly fixed price for the agreed supply of Ghana’s bauxite.

In effect, this is something of a fixed interest rate deal – the gamble being on whether the agreed price of bauxite rises or falls against that benchmark.

The deal takes away this uncertainty for Ghana’s planners and offers a step around foreign currency supply and price volatility risks in the process. It is perhaps a kind of new fixed interest rate development loan – one where payment is in the form of a fixed-price commodity, in this case, bauxite.

Determined to regain its longer-term status as a frontier of African development and given its poor experience with resource-backed foreign currency lending, the new bauxite deal suggests that Ghana is instead setting a new, currency-free lending course. The impacts of this may yet be felt across the continent and beyond.

Speaking at the African Union in 2013, Chinese Premier Li Keqiang promised African heads of state ‘innovative and pragmatic’ cooperation. For Ghana, this new bauxite for development deal is surely a new frontier of that innovative and pragmatic cooperation.

Back in Ethiopia, however, and for other countries that may one day consider a Ghana model for financing their own development, a barterable endowment of bauxite may not be as readily available. Outstanding infrastructure problems and a young population do, however, necessitate a change of some kind. In such circumstances, the new Ghana model may or may not be immediately applicable.

Sitting in Addis, Lifan’s Ma Qun is probably sipping another cup of coffee as he considers how to access the foreign currency he needs to be able to buy needed automotive components from abroad for his locally-staffed assembly lines. Perhaps he’s even hoping that China’s demand for Ethiopia’s coffee beans – one of the country’s main foreign currency earners – picks up.

At least in the case of Ethiopia, alongside a need for innovative financing, a more traditional export-driven route to national development and foreign exchange accumulation may also remain helpful. This could also offer Ma Qun’s local job-creating vehicle assembly plants their best hope for profits and for creating more jobs for Ethiopia’s youth.

Jack Ma, the billionaire founder of e-commerce giant Alibaba and its group companies including e-payment giant Ant Financial, and Jack Dorsey, the billionaire founder of Twitter, were both in Ethiopia last week, and change may be on the horizon.

Whether the new Ghana model will come to Ethiopia too, or the rest of Africa, remains to be seen. What is certain is the region will be watching, waiting, and weighing up the implications of its outcome for Ghana’s and their own development.

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