Month: July 2018

Why Africa’s GDP is Understated

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This article first appeared in my weekly column with the Business Daily on July 29, 2018

Last week Ghana announced that it is recalculating its Gross Domestic Product (GDP) based on measurements from 2013 instead of 2006 to more accurately reflect recent activity in the petroleum, communication technology and construction sectors. The rebasing will likely add 30 to 40  percent to the size of Ghana’s economy. The rebasing of Ghana’s GDP is a reflection of how the size of African economies are often understated. This understatement is informed by three factors.

Firstly, the actual number and size of businesses actively operating in Africa and contributing to GDP is unknown. Most African governments do not have the operational muscle to conduct research and analysis on the number of functioning business in the economy, their size, profits, or turnover. This is partly informed by the fact that the private sector in Africa is dominated by informal businesses, most of whom are Micro and Small Enterprise (MSE) primarily engaging in subsistence business activity. The combination of millions of MSEs operating in informality coupled with the lack of data gathering and statistical capacity in African governments to collect business activity data translates to notable inaccuracies in terms of the actual number and size of operational businesses on the continent.

A trader serves customers at the Makola Market in Accra, Ghana.

(source: https://www.businessdailyafrica.com/analysis/ideas/Why-most-African-countries-understate-the-size-of-GDPs/4259414-4687360-apix2iz/index.html)

Secondly, private sector in African tends to understate business size and profit earnings in order to minimise tax liabilities.  Again, African government capacity is limited as African taxmen do not have the ability to ensure all companies are posting accurate tax returns. Most companies on the continent have two books of accounts they keep: the official audited reports that are submitted to investors, tax authorities and government bodies, and the internal books that reflect what is actually going on in the business. Given limited tax surveillance muscle, it relatively easy to dodge tax penalties and, most African taxmen are happy taxes are being voluntarily submitted and thus often do not bother to ensure if profits and tax liabilities are being accurately reported. The effect is again, an understating of how much money businesses are making on the continent.

Finally, there are incentives for African governments themselves to understate GDP size. Dimitri Sanga, ECA Director for West Africa echoes my view that some African countries purposefully avoid rebasing GDP upwards to reflect current realities in order to avoid graduating from low income to middle income countries. Low income status comes with certain perks such as cheap loans, generous aid packages and charitable trade agreements.

Image result for GDP

(source: http://cpparesearch.org/nu-en-pl/domestic-gross-domestic-product/)

In short, evidence seems to indicate that there is more money being made in Africa than is being reported and thus GDPs in Africa are probably higher than what is officially captured. And while some countries will rebase GDP upwards in order to access larger loans and shift debt-to-GDP ratios into favourable terrain, it is up to African governments to determine whether rebasing or deliberately understating GDP is in their national interest.

Anzetse Were is a development economist; anzetsew@gmail.com

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US-China Tariff Fallout Sets Stage for Shift in Africa’s International Trade

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This article first appeared in my weekly column with the Business Daily on July 22, 2018

Trade tensions between the two largest economies in the world have made global headlines as the trade war will have implications not only for China and the United States (US), but other countries well.

In terms of the background of the trade war, on June 15, Trump declared that the US would impose a 25 percent tariff on USD 50 billion of Chinese exports; USD 34 billion would start July 6, with a further USD 16 billion to begin at a later date. China imposed retaliatory tariffs for the same amount. A few days later, the US stated it would impose additional 10 percent tariffs on another USD 200 billion worth of Chinese imports if China retaliated against the U.S. tariffs. China retaliated almost immediately with its own tariffs on USD 50 billion of US goods. Keeping track of the back and forth of tariff imposition between the US and China is a task on its own, but what is more important is unpacking how these trade tensions will affect Africa. There are three implications of the USA-China trade war of which Africa should be cognisant.

Workers at the Export Processing Zone in Athi River.

(source: https://www.businessdailyafrica.com/analysis/ideas/US-China-tariff-fallout-Africa/4259414-4675670-pdvicjz/index.html)

Firstly, the imposition of tariffs between two lucrative markets in the world may well encourage both countries to diversify their export markets away from each other. Africa is one of the fastest growing markets in the world, and the potential loss of income from both new tariffs as well as ‘new’ non-tariff barriers that will likely appear, will provide impetus for both China and the USA to push deeper into African markets.

Secondly, the trade feud will deepen the resolve of the Chinese government to diversify away from export to consumption-driven growth. While the export-driven economic development model has reaped dividends for China, it has also left it vulnerable to this precise scenario. Thus, expect added commitment from the Chinese government to shift to primarily consumption-driven growth with greater urgency. This will affect Africa in that China will likely continue to offshore its manufacturing capacity to other countries, including those on the continent.

Image result for china us trade war

(source: https://www.newsmax.com/finance/economy/china-trade-war-confidence/2018/07/18/id/872331/)

Thus, the third implication of the US-China trade spat is that it may provide added impetus for increasing manufacturing investment and activity into Africa, particularly by the Chinese private sector which is already on this trajectory. A 2017 McKinsey report indicated that about 10,000 Chinese-owned firms operate in Africa, of which about 90 percent are privately owned. 31 percent of these firms are in manufacturing and already handle about 12 percent of industrial production in Africa with annual revenues of about USD 60 billion. Further, expect Chinese private sector to leverage AGOA and tariff hop into the US markets through Africa. In doing so, they will secure access to the US, access which would be much more difficult if were they domiciled in China.

Anzetse Were is a development economist; anzetsew@gmail.com

TV Interview: Value Addition in Africa

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I was part of a panel on Talk Africa of CGTN, discussing how Africa can build manufacturing capacity and scale value addition.

 

The Financial System That Keeps The World Cup Going

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This article first appeared in my weekly column in the Business Daily on July 15, 2018

The last few weeks have been dominated by the FIFA World Cup with fans all over the world tuning in to support their teams and catch all the action. What many may not know is the size of the World Cup economy and the financial ecosystem that keeps it running.

The first element of cost of the World Cup is paid by the host nation. Russian media reports indicate that the total cost of hosting the event is over USD 10 billion. Interestingly, this is USD 5 billion less than the cost of the 2014 World Cup in Brazil. There are differing views as to whether investment in hosting the World Cup generates financial returns for the host economy. A study on FIFA World Cups indicated it has varied impacts on host country stock markets. In the case of South Africa, the tournament announcement date was linked to a largely positive trend on stock returns. However, in Japan there was a decline in daily stock returns a day after the announcement of the tournament.

Gianni Infantino

(source: https://www.businessdailyafrica.com/analysis/ideas/Financial-system-that-keeps-the-World-Cup-tournament-running/4259414-4664084-121ir1pz/index.html)

Further, some economists assert that no observable short-term economic growth linked to the World Cup exists within the tourism, retailing, accommodation, and employment sectors of host countries. Others insist that the World Cup can boost tourism, retailing, accommodation, and employment because of the novelty effect of new stadiums, the feel-good effect, and the Cup’s effect on the international perception of a host country. While not all factors affect every host nation to equal degrees, the World Cup as a whole, can turn out to be positive.

In the case of Russia in particular, Moody’s is of the view that the World Cup will have limited impact on rated Russian companies, including banks, regional governments, and the sovereign itself. They argue the economic benefit will be short-lived because much of the economic gain has already been attained through infrastructure spending, and even that impact is limited because World Cup-related investments in the 2013-17 period have accounted for only 1 percent of total investments in Russia. They argue that the games will last just one month and the associated economic stimulus will pale in comparison to the size of Russia’s USD 1.3 trillion economy.

Image result for russia world cup stadiums

(source: https://www.footyheadlines.com/2018/04/all-russia-2018-world-cup-stadiums.html)

The second component is the cost of a ticket to attend the games. Here records have been broken because for the first time at a FIFA World Cup, some tickets will cost more than USD 1,000. CNN reports that fans will have to pay at least USD 1,100 for the most expensive ticket at the final, an increase from the USD 990 charged at the last World Cup final held in Brazil. The cheapest tickets for non-Russian fans will cost USD 105, a USD 15 increase on the equivalent ticket in 2014.

The third element is payments made to participating teams. FIFA announced they have allocated USD 791 million for prize money, payments to clubs and player insurance fees as part of the World Cup. USD 400 million will be awarded to 32 national federations depending to how they finish in the tournament and the FIFA World Cup 2018 winners will pocket USD 38 million.

In short, either way you look at it, the World Cup speaks money, and this is likely to only amplify over time.

Anzetse Were is a development economist, anzetsew@gmail.com

TV Panel: The Interest Rate Debate

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On the June 18, 2018 Fanaka TV held a debate in collaboration with the Kenya Bankers Association, The institute of Economic Affairs and Strathmore Business School. The debate engaged both sides of the capping divide with an intention of deeply analysing the impact of capping of interest rates and came up with possible solutions and way forward. I was among the panelists for the debate.

Kenya’s Development Expenditure Problem

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This article first appeared in my weekly column with the Business Daily on July 8, 2018

The budget for FY 2018/19 revealed the divide in expenditure as follows: recurrent expenditure will amount to KES 1.55 trillion, development expenditure is projected at KES 625 billion, and transfers to County Governments will amount to KES 376.4 billion. Development expenditure will only be 24 percent of total expenditure (below the 30 percent threshold), recurrent about 60 percent and transfers to county 15 percent. To be clear, public spending in itself is useful in principle because it increases the level of aggregate demand in an economy and can compensate for failings in other components of aggregate demand, such as a fall in household and private sector spending.

Image result for government budget

(source: https://www.vskills.in/certification/blog/meaning-of-government-budget-and-its-objectives/)

That said, government has a development expenditure problem where the development-recurrent ratio always favours recurrent, both at national and county government level not only in terms of allocation but also in terms of actual spending. The first supplementary budget for financial year 2017/18 was submitted to Parliament in September 2017 in which development expenditure was reduced by KES 30.6 billion. As the Parliamentary Budget office points out, this reduction translates to slower implementation of some projects leading to higher project costs and accumulation of pending bills as well as delayed returns on investment. At the same time, net recurrent expenditure increased mostly to cater for the repeat presidential election, enhancement of Free Day Secondary Education, drought mitigation measures as well as the implementation of Collective Bargaining Agreements in the education sector. Thus, the first problem is that the original development-recurrent ratio is not respected or followed.

The second problem is that a reduction in development expenditure juxtaposed with a rise in recurrent expenditure is deeply worrying. Government’s narrow fiscal space has led to a large bulk development expenditure being debt-financed. Thus, it is fair to ask whether if through supplementary budgets, where development spending is reduced and recurrent increased, Kenya is using debt to finance recurrent expenditure. If so, this is going against both basic common sense and fiscal prudence.

Image result for Kenya budget

(source: https://www.capitalfm.co.ke/business/2013/11/cabinet-approves-sh116bn-supplementary-budget/)

Finally, the supplementary budget above is not the first time development spending has lost out to recurrent; the question is why? Given deep development needs in Kenya, where the infrastructure deficit alone stands at USD 2.1bn annually, and significant development spending required, why does recurrent remain the winner? The first factor is the bloated wage bill, a reality that is well known and very difficult to change. Another factor is how spending is classified, which can be confusing because it makes the tracking of types of spending difficult. Public debt accrued in the development docket one year is shifted into the recurrent the next year. Development expenditure covers expenses incurred for the purchase or production of new or existing durable goods, while recurrent expenditure, includes wages and salaries, other goods and services, interest payments, and subsidies. Thus, the broadening yearly financial needs of recurrent spending are informed by debt binges of previous years.

As Kenya continues to accrue debt, interest payments on all the debt will be tabled under recurrent leading to a further bloating of this component of spending. This shift in allocations can make it difficult to determine whether development spending is ever used efficiently through its entire project lifetime.

Anzetse Were is a development economist; anzetsew@gmail.com

Don’t hold your breath for Kenya’s Fiscal Consolidation

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This article first appeared in my weekly column with the Business Daily on July 1, 2018

The budget speech for FY 2018/19 is of interest because desires of government seem to be in opposition. On one hand is the previously articulated intent from government for fiscal consolidation and on the other, the need to finance the Big Four. This article will focus on fiscal consolidation and assess the budget using this lens with a focus on planned expenditure, revenue generation and borrowing. Under fiscal consolidation, expenditure should reduce, revenue generation increase and borrowing reduce.

Budget: Treasury Cabinet Secretary Henry Rotich

(source: https://www.businessdailyafrica.com/analysis/ideas/-Kenya-fiscal-consolidation/4259414-4640846-wga0eu/index.html)

Already we can see that appetite for increased expenditure continues unabated. Planned total expenditure for the FY 2018/19 is Ksh 2.56 trillion (equivalent to 26.3 percent of GDP). Under the current administration, projected spending has gone up from Ksh 1.6 trillion in 2013/14 to Ksh 2.29 trillion in 2017/18 and now to 2.56 for 2018/19. Clearly, expenditure continues to grow indicating an inability to effect fiscal consolidation measures which are exacerbated by weaknesses in the composition of expenditure. Of planned spending, recurrent expenditure will amount to KES 1.55 trillion, development expenditure is projected at KES 625 billion, and transfers to County Governments will amount to KES 376.4 billion. It seems the element of expenditure that has been cut is the most economically productive, namely development expenditure. Indeed, development expenditure will only be 24 percent of total expenditure (below the 30 percent threshold), recurrent about 60 percent and transfers to county 15 percent. So government seems to be cutting development expenditure while allowing the excesses of recurrent spending to continue. Thus, the government is not leveraging the budget to drive public spending in an economically productive manner.

In terms of revenue generation, the government argues that revenues will rise by 17.5 percent to about KES 1.95 trillion (equivalent to 20 percent of GDP) in the FY 2018/19 from the estimated KES 1.66 trillion collected in the FY 2017/18. Part of the ‘revenue enhancement’ steps include higher corporate tax as well as a tax on the informal economy. What may materialise is not more revenue, but less. Kenya already struggles with high costs of production attributed to high power, transport and labour costs, as well as endemic corruption and rent seeking. These are dynamics that affect both big and small private sector players. Increasing tax on the private sector may well push them to a level where the combined effect of high production costs and higher taxes cut into profits substantially reducing the total government can claim as tax revenue.

Finally, government announced that in the fiscal year ending in June 2018, they estimate a fiscal deficit of 7.2 percent of GDP, down from 9.1 percent of GDP in the previous year. Indeed under, their fiscal consolidation plan, government project the fiscal deficit to narrow to 5.7 percent of GDP in the FY 2018/19 and further to around 3 percent of GDP by FY 2021/22. While this is a step in the right direction, government seems to have a problem in keeping on a disciplined path of fiscal deficit reduction. Last year government’s target for the 2018/19 fiscal deficit was 6 percent, yet here we are at 7.2 percent.

Image result for fiscal policy

(source: http://www.theedvantage.org/economics/fiscal-policy)

The fiscal deficit of KES 558.9 billion will be financed by external financing amounting to KES 287.0 billion, while domestic financing will amount to KES 271.9 billion. This clearly indicates that domestic borrowing will be substantial. In the context of an interest rate cap, government knows that continued heavy borrowing in the domestic market squeezes out private sector and places upward pressure on interest rates.

Anzetse Were is a development economist; anzetsew@gmail.com