Africa's debt crisis has 'catastrophic implications' for the world

After a new tax increase incited weeks of deadly riots in Kenya early this summer, President William Ruto announced that he was reversing course. He abandoned the finance law he had proposed, and then he shook up his Cabinet.

Last week, the government reversed itself again. The newly appointed finance minister announced that some of those discarded tax increases would be reintroduced.

The Ruto administration is desperately trying to raise revenue to pay off billions of dollars in public debt and avoid defaulting on its loans, even as critical public assistance and services are being cut.

Governments throughout Africa are facing the same dilemma.

The continent's foreign debt reached more than $1.1 trillion at the end of last year. More than two dozen countries have excessive debt or are at high risk of it, according to the African Development Bank Group. And roughly 900 million people live in countries that spend more on interest payments than on health care or education.

Outsize debt has been a familiar problem in the developing world, but the current crisis is considered the worst yet because of the amounts owed as well as the huge increase in the number and type of foreign creditors.

And in Africa, a continent pulsating with potential and peril, debt overshadows nearly everything that happens.

It leaves less money for investments that could create jobs for what is the youngest, fastest-growing population on the planet; less money to manage potential pandemics like Covid or mpox; less money to feed, house and educate people; less money to combat the devastating effects of climate change, which threaten to make swaths of land uninhabitable and force people to migrate.

If nothing is done to help countries manage the financial crunch, "a wave of destabilising debt defaults will end up severely undermining progress on the green transition, with catastrophic implications for the entire world," warned in a new report from the Finance for Development Lab at the Paris School for Economics and Columbia University's Initiative for Policy Dialogue.

At the same time, economic stagnation in combination with government corruption and mismanagement has left many African countries more vulnerable to brutal wars, military coups and anti-government riots.

In Nigeria, where foreign debt amounts to $40 billion, rising inflation and widespread hunger spurred a string of violent anti-government protests this month. Forty percent of the country's 220 million people live in extreme poverty. Yet more than a third of the revenue collected by the government is used to pay the interest on its public debt.

In Uganda, where foreign creditors are owed $12 billion, demonstrations in July targeted corruption. And in Kenya, which has $35 billion worth of external debt, some protesters have said they are ready to march again after the latest news of impending tax increases.

In many African countries, there has been zero per capita income growth in the past decade. The debt crisis has caused the value of many currencies to depreciate, further sapping purchasing power.

The string of economic shocks produced by the coronavirus pandemic and Russia's invasion of Ukraine helped to supercharge the debt crisis. Food and energy prices soared as government coffers dwindled. The moves by central banks in wealthy countries to fight inflation with higher interest rates caused borrowing costs to rapidly climb.

The issue, though, is not just how much money countries like Kenya and Nigeria have borrowed, but whom they have borrowed from.

In recent decades, the pool of potential lenders has exploded to include thousands of private bondholders and a major new geopolitical player: China.

Seeking to spread its own clout and counter American and European influence, China has transformed itself into the world's biggest national lender, financing roads, ports, bridges, airports, power plants, telecommunications networks and railways in developing countries.

Many nations, bristling at loan conditions dictated by Western lenders or the International Monetary Fund, were eager to find an alternative source of financing. Agreements with China were opaquer, but they often came without environmental, financial or human rights restrictions.

China now accounts for 73% of bilateral borrowing in Kenya, 83% in Nigeria and 72% in Uganda, according to the United Nations Conference on Trade and Development.

Over the past two decades, 1 in 5 infrastructure projects in Africa was financed by China, a report from the National Bureau of Asian Research found, and Chinese firms built 1 in 3 projects.

Some of them -- like Kenya's railway between Nairobi and Mombasa -- have turned into showcases of corruption and blunders. Many of these large-scale infrastructure projects will never produce enough revenue to justify the costs.

Economic conditions and loan repayment prospects have soured, but China has been reluctant to offer debt relief. It has instead been holding out for repayment, extending credit swaps and rollovers that end up putting off the day of reckoning.

It took Zambia nearly four years to reach a loan restructuring agreement after it defaulted in 2020, for example, primarily because of opposition from China, the country's single largest creditor.

The monumental increase in the number of private bondholders and creditors has further complicated efforts to resolve debt crises.

The International Monetary Fund and the World Bank encouraged poor and middle-income countries to embrace Wall Street and seek private loans overseas in the 2010s, said Jayati Ghosh, an economist at the University of Massachusetts Amherst. Interest rates were extremely low, investors were on the hunt for higher returns and development officials hoped countries could tap a big new source of capital.

As a result, governments looking to rally political support or finance development borrowed too much and creditors seeking gains lent too much.

When interest rates suddenly rose, countries were forced to take out new loans, at high costs, to repay the money they had previously borrowed.

Investors were also able to impose costly loan terms like higher rates on struggling nations that were sometimes on the edge of default -- what's known as a risk premium. Kenya's government paid more than 10% on international bonds to pay off a $2 billion debt that was due in June.

Countries that borrow more than they can afford end up experiencing intense economic and social pain as output crashes, employment dries up, and inflation and poverty rise. The systemic problem, said Indermit Gill, chief economist at the World Bank, is that lenders who also made bad decisions by extending too much credit often don't pay a financial penalty.

"You got paid a risk premium for a reason," Gill said of the lenders, adding that if they don't absorb losses, they will make more reckless loans. "That's a major weakness in the way the system works."

The debt overhang leaves countries unable to make the kind of investments that could put their economies on stable footing, which would enable them to repay their loans.

And money that was intended for economic development ends up being siphoned off: Emergency loans from international institutions like the IMF and the World Bank have been used to pay off private foreign creditors or China.

In Kenya, the central bank announced in June that private creditors would get $500 million of a World Bank loan.

As the Finance for Development Lab report concluded, "The global community is currently funding loans to developing countries, which end up 'leaking out' to pay off other creditors."