The implications of the end of US QE for Africa

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This article first appeared in The East African on January 25, 2015

The US economy is in recovery, having recorded an annualised GDP growth rate of 4.6 per cent in Q2 and 3.5 per cent in Q3 of 2014.

In addition, the period of quantitative easing (QE), which flooded the global markets with dollars, has come to an end. This effectively withdraws $85 billion of net stimulus each month.

Further, the Federal Reserve looks set to increase interest rates in 2015 after a prolonged period of near zero interest rates. In addition to this, the dollar is strengthening. What does this all mean for Africa?

One effect may be that the aggressiveness with which investments in Africa were sought will wane noticeably. Due to the near zero interest rates in the US and other developed markets as well as the US Fed’s QE, excess liquidity had to look for points of absorption.

As a result, investors were more willing to look farther afield for investments, thereby providing speculative capital flows to countries in emerging markets in particular. In fact, this phenomenon may be a factor behind Kenya’s Eurobond oversubscription.

With the end of QE, global dollar liquidity will lessen and this will mean money flowing into Africa and other emerging markets will taper off.

(source: http://nccadp.org/wp-content/uploads/2013/07/photo_6764_20080814.jpg)

Couple this with the expectation of a rise in US interest rates and you have a phenomenon where dollars will run back to the US making them much harder to attract for countries in Africa.

Indeed, now that the US is recovering and the expectation is that an interest rate hike will soon happen, the value of assets in which speculative investments were made in emerging markets may decline in value.

Why? The IMF states that US policy led to a “global search for yield with investors flocking into emerging markets contributing to a broader mispricing of domestic assets.” Now with the end of QE in sight and a recovering US, the value of the assets in which dollars were invested will lower in value. In short there may be deflationary pressure on many asset classes in developing country markets.

Further, far fewer speculative investments may occur because of rising global risk aversion, thereby restricting cheap dollar access for African economies.

The IMF makes the point that the mere announcement of an end to QE led to “rapid currency depreciations, increases in external financing premiums, declines in equity prices, and reversal in capital flows” in some emerging markets.

Another point to consider is made by DK Matai of Quantum Innovation Labs who states that there is a near $8+ trillion in US dollar carry trade.

Carry trade refers to strategy in which an investor borrows money at a low interest rate in order to invest in an asset that is likely to provide a higher return.

(source: http://gbcenter.net/wp-content/uploads/2013/02/shutterstock_127492433.jpg)

Matai makes the point that, “Of that $8+ trillion, $5.7 trillion is emerging market dollar debt… split between $3.1 trillion in bank loans and $2.6 trillion in corporate bonds.”

So there is a global dynamic going on in which “$8 trillion in borrowed US dollars is now being reversed-back into US dollars to repay debts around the world and thereby reduce the dollar-denominated interest payments.”

In short, those who made investments in continents like Africa at low US interest rates will be racing to pay back that debt before the anticipated interest rate hike is made by the US Fed. Given the scale of debt given to emerging markets, this repayment of debt will make dollars less available, strengthening the dollar and reducing liquidity even further.

So, Africa needs to brace for tougher times in the short to medium term as an end of QE and an anticipated hike in US interest rates means “risky” African investments will not be as attractive as they used to be.

Complicating this melange of factors are tumbling oil prices. Low oil prices are associated with a strong US dollar. The current account and government expenditure of African countries for which oil exports compose a significant portion of revenue will be negatively affected.

Further, due to the strong dollar, African currencies will be losing ground, particularly those of countries such as those in East Africa whose currencies are actually weakening anyway as well.

Thus, although African import economies will benefit from low oil prices, which should have a positive effect on current account deficits, a strengthening dollar and weakening local currency will mean that imports are more expensive, thereby countering the lowering of inflation that low oil prices may have encouraged.

Therefore Africa, at least in the medium term, may increasingly turn to China to sustain capital flows strengthening the Look East creed of many African governments.

(source: http://economictimes.indiatimes.com/photo/39666293.cms)

On the other hand, on Thursday the European Central Bank announced a QE programme that will pump out up to Euro 60 billion a month. There is a chance that Africa can benefit from this, especially in light of the end of QE by the USA.

Let’s see how African governments and markets respond to what is an interesting blend of dynamics.

Political factors key in market performance

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This article was first published in the Business Daily on January 18, 2015

In his book The End of the Free Market, Ian Bremmer makes the point that “in emerging markets, political factors still matter— at least as much as economic fundamentals for the performance of markets.”Certain retrogressive practices if left unchanged can harm economic growth by dampening development prospects.The first political factor is tribalism. As a result of divisive ethnic-based politics, the economy continues to suffer consequences of negative ethnicity.The costs of tribalism are numerous.

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For example, it leads to sub-optimal allocation in public sector appointments. Because the President is now expected to factor in tribes during decision-making, he does not have the luxury of choosing the best person for the job. Instead he appoints individuals who would be accepted with the least acrimony.This is not to suggest the appointees are incompetent but rather to illustrate how tribal lens affect capacity to ensure the best always manage agencies.Recently it was revealed three tribes hold at least half of all public sector jobs, with some overrepresented compared to their total population.Whether this over representation was deliberate is an issue that disturbs many Kenyans. So strong is tribalism that the Public Service Commission chair said ethnicity is an appointment criterion to ensure all tribes need to be represented fairly.Political and public sectors are at a point where tribe trumps demonstrable skills, professionalism or competence.How can a government run efficiently if tribe rather than aptitude is a key qualification to manage the ministries, Central Bank, parastatals and other agencies that inform growth?

(source:https://mahustlerszone.files.wordpress.com/2014/05/kenya-ethnic-groups.jpg)

Another issue closely linked to ethnicity can be seen in how individuals decide whether to invest in certain regions while shunning others.During the post-election violence in 2008, many flourishing businesses were shut down as owners fled hostile regions.The losses are still being felt by the economy because some entrepreneurs are yet to return. Such tensions have economic costs because ethnicity rather than economic viability informs location.

The second political factor is corruption. The public sector is rife with corruption, brunting the capacity of capital to be employed efficiently to spur growth and development.Transparency International ranks Kenya 136 out of 175 in public sector corruption. Graft is costly as it affects resource allocation in two ways.Firstly, it can change private investors’ assessment of the relative merits of various investments as graft informs changes in comparable prices of goods and services, resources and factors of production.The International Monetary Fund believes if bribery comes into play in enterprise, this lowers investment and retards growth. Ernst and Young reported a third of companies it surveyed paid bribes to win contracts and half of Kenyan CEOs justified the practice.How can resources be allocated efficiently with such shadowy activity?

(source: http://i.bnet.com/blogs/mayers_corruption.jpg)

Secondly, an economic journal shows corruption misallocates resources through decisions on how public funds are invested, or choice of private investments allowed by corrupt agencies.Misallocation comes from possibility of a corrupt decision-maker considering rent-seeking as a key decider.Corruption leads to reduced domestic and foreign direct investment, overblown government expenditure as well as diverting state expenditure away from education, health, and infrastructure towards white elephants.

The third political factor is the public wage bill reportedly now at 53 per cent of the budget, using up 55 per cent of public revenue.This is likely to remain for decades as there is no political will to effect change. Thus, instead of allocating resources to investment or development, we will be busy funding a public sector yet to shun corruption or embrace a culture of efficiency.These political factors cost the economy dearly and their impact must be addressed.

What the latest economic growth data in Kenya really mean

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This article was first published in the Business Daily on January 11, 2015

Last year’s Q3 gross domestic product (GDP) figures show the economy expanded by 5.5 per cent compared to a revised 6.2 per cent in the same period in 2013. The growth was mainly supported by strong activity in construction, finance and insurance, trade, information and communication, and agriculture and forestry.All sectors recorded positive growth except accommodation and food services (hotels and restaurants) that have consistently been on a decline since last year.

GDP KENYA

But what do these growth figures really mean? Underlying the GDP growth snapshots are some long-term structures that should be analysed and of which Kenyans must be cognisant.The first question is the extent to which all Kenyans are benefiting from growth. The latest UN Human Development Report ranks Kenya 147 out of 187 countries and although there has been a rise in human development since the 1990s, only a small section of the population has gained.To illustrate, the incomes of the richest 20 per cent have risen steadily and now stand at 11 times more than those of the poorest 20 per cent.In fact, a country report by the Africa Development Bank states that the biggest challenge is not raising GDP but ensuring inclusion.There is a widening gap between the rich and poor with the creation of a dual economy where the rich prosper and the poor continue to struggle.This can be attributed to an underdeveloped social security net that does not provide consistent and sufficient income support to the poorest.The core concern with inequitable growth is not just the ideological issues around fairness and justice but the reality that while the poor have a high propensity to consume, they lack the disposable income to engage in many of the spending and profit-making activities that spur investment and growth.

(source: http://buzzkenya.com/wp-content/uploads/2013/12/poverty-in-kenya2.jpg)

As a University of Nairobi analyst said, this creates a vicious cycle in which low growth results in high poverty that in turn abets low growth.Today, each of the 42 million Kenyans would earn Sh189,624 ($2,158) yearly if income was distributed equitably. Sadly, the manner in which GDP growth is currently structured only encourages economic dualism.In addition, the growth structure ensures that the youth are at best fringe beneficiaries of the economic largesse, which elicits the feeling that they are in a no-win situation with the older generation.The International Labour Office (ILO) points out that while young women and men account for 37 per cent of the working-age population, their participation in employment is less than 20 per cent.Due to difficulties in securing jobs, the youth feel the best option is to leave the labour market. This leaves them more vulnerable to chronic unemployment or eking out a living in a tough economy.The result of this skewed system is frustration and dissatisfaction, coupled with security concerns as the jobless youth engage in crime to survive. Their exclusion from mainstream economic activity can create discontent and another “Arab Spring”.

(source: http://nextcity.org/images/made/NairobiForefrontPhoto5_600_398_80.jpg)

Linked to the youth issue is the fact that these relatively healthy GDP figures mask the reality of jobless growth. This is where the economy experiences growth amidst decreasing employment.Indeed, the ILO released a report last year stating little progress is being made in reducing working poverty and vulnerable forms of employment such as informal jobs and undeclared work.Unemployment in Kenya stands at more than 13 per cent, masking the enormity of the labour market challenges where a significant proportion of the population is inactive rather than unemployed. Of the employed, many are engaged in informal jobs.So while GDP figures are important, it is crucial we foster equitable and inclusive growth as well as develop job creation strategies to address the burgeoning chronic unemployment and underemployment.

Is impact investment the answer to Kenya’s socio-economic challenges?

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Kenya is being sold the idea that impact investment that goes beyond the profit motive alone and instead seeks to generate triple bottom line returns namely social, environmental and financial, is the smartest way to structure investment into the continent. It is argued that the triple bottom line focus is warranted given Kenya’s socioeconomic issues which range from poor health and education services, to poor infrastructure, environmental issues, inadequate housing, water and sanitation structures and a healthy representation of low income citizens in the general population.

The Rockefeller Foundation states that, ‘Impact investing could unlock substantial for-profit investment capital to complement philanthropy in addressing pressing social challenges’. In terms of market size some argue that the industry could grow from around US$50 billion in assets to US$500 billion in assets within subsequent decades. Clearly this is becoming a big deal globally and already in Kenya there are numerous impact investment activities on the ground funding enterprises that seek to generate triple value. Bear in mind that Corporate Social Investment (CSI) is often not considered impact investing as the core focus of the corporation is profit not mission and CSI is a conduit of funds into social activities that do not inform core business. There is a spectrum along which impact investments lie; on one hand are those that are more mission oriented and on the other end are those that are more profit oriented but both share a commitment to generate economic, social and/or environmental (hereafter ‘social’) returns.

trico-2But is marrying impact and profit realistic? Some argue that Nairobi has already hit an impact investment bubble where, ‘too much money chases too few investment-ready companies, weak performers are propped up when they should really be driven out of business by superior competitors’. From a logical point of view, impact investment makes sense and if such investments do deliver triple returns it is an effective one in all pill for Kenya’s holistic development. Further, given Kenya’s weak regulatory framework and even poorer implementation of policies and law, it is a good idea to welcome investors who seek to work honestly, responsibly and with economic and social development in mind. Some companies pollute the environment, defy labour laws and exploit local communities as they conduct business and the truth is that they can get away with it because even if there are laws in place to prevent such phenomena from occurring, corruption and kickbacks means business can get away with unsavoury behaviour. Thus welcoming ethical investors creates an automatic buffer against such delinquency. In addition, when social financing is done in partnership in communities­­ to build their entrepreneurial capacity to tap into their resources, develop assets and ensure assets benefit and are owned by the community, some dramatic socioeconomic graduation can occur. Impact investors are already active in Kenya are scaling up SMEs and strengthening the positive social and environmental footprint of the business in which they invest. This is an industry that is set to grow in the country and this provides the incentive to better understand how it functions. CSI21One problem with impact investing is that the definition given in this article is one of many. For an industry that wants to scale, there is no consensus on what qualifies as impact investment. For example, some argue that impact investors have to expect a lower than market rate of financial return because those with market rate returns should be easily absorbed by the market. Others, such as the UN, define impact investing as any investment that has the intent to create benefits beyond financial return. The problem with ambiguity with basics such as definitions is that any enterprise can masquerade as an impact focussed investment and give a distorted representation of how big the impact market it. Further, as Stanford Social Innovation Review states, it creates, ‘a lot of confusion about when impact investing works and when it doesn’t’. So how can Kenya be sure we are benefitting from impact investment when no one agrees on what that exactly means? Secondly, categorising certain investments as ‘impact investing’ insinuates that other types of investment do not make any impact beyond financial gain. Yet we know that SMEs all over the country, especially those active in poor communities, do not self-identify as impact enterprises, yet they are creating impact in their communities. They provide employment for thousands, support the development of employees and even provide medical care for them. Yet they do not formally fall under the umbrella of impact investment. It makes one wonder whether impact investment is a just a new trend to mop up excess liquidity. Impact-Investing-Returns-300x236Another concern is that trying to marry people, planet and profit is not always profitable, especially when dealing with genuinely poor communities that have little market power and many needs. Such communities are the ones that need low cost services the most, yet , ‘delivering at a price point the poor can afford almost always translates into very small margins’ meaning that impact businesses often have to be subsidised over long periods of time. Therefore, are they viable market players? Many impact investments need subsidies which, may be prolonging the life of poor business ideas and products. Further, a chronic problem in the impact industry is the difficulty in measuring and demonstrating impact. There are so many models available on how to measure impact and different impact investors use different models thereby generating different, incomparable data sets. So how can one call it impact investment if measuring the impact has not been truly sorted out in a manner where comparisons between projects can be made? Making-Impact-Logo So clearly impact investment is a mixed bag. It is a commendable approach to investment that Kenya should seek to benefit from while cognisant of the pitfalls.

The risks of foreign denominated debt for Kenya

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Anyone keeping an eye on the economy will have noted the level of public debt being accrued, particularly foreign denominated debt. Total debt stood at KES 2.37 trillion (USD 26.78 billion) after Kenya’s sovereign bond issue in June. The concern with the debt being accrued is that we are getting into larger foreign denominated debt than previously was the case. Kenya is an import economy so by default, in order to service foreign debt, government has to buy dollars. The assumption being made is that the foreign debt will boost the economy primarily through investment in infrastructure which is expected to generate the capital required to service the debt. It is important to note that although there is support for this hypothesis there are also those who question the logic that infrastructure equals growth. In fact, the London School of Economics states that, ‘empirical estimates of the magnitude of infrastructure’s contribution (to growth) display considerable variation across studies. Overall, however, the most recent literature tends to find smaller effects than those reported in the earlier studies’. This article will not debate this point but instead highlight the challenges Kenya will face should this almighty investment in infrastructure not generate the growth expected. How does payment in shillings affect the economy should the foreign denominated debt fail to yield the returns expected of it? How then, will government raise shillings to service this substantial debt?

Debt The first and most obvious option is for government to raise taxes in order to raise shillings that can then be used to service the debt. But Kenya is already a heavily taxed country and one wonders if we have reached a point on the Laffer Curve where raising taxes further will harm profitability and actually lower revenues. Tax rates that are too high effectively penalize people for engaging in economically productive activities; so government risks harming its own revenue if increasing taxation becomes the main strategy used to raise shillings.

The second option is to borrow shillings locally and use this capital to buy dollars and service the debt. The argument has been made that Kenya entered into foreign debt to ease pressure on local credit and interest rates. But if that investment doesn’t yield what is expected then government may have to borrow locally to service the debt anyway. This borrowing obviously crowds out the private sector and reduces private sector access to credit. One consequence of this it that private sector may not be able to implement activity and developments that were to be debt financed. Further, but borrowing locally, government will put pressure on interest rates possibly pushing them up which again, will make credit less available to private sector borrowers. The economic growth of the country may then be muted because private sector and SMEs would not been able to access the credit they needed to become more productive. Further, borrowing locally does not solve the debt problem but merely rolls it over to be dealt with at a later date.

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The third option for government is to implement austerity measures and reduce recurrent expenditure so that more shillings are made available for debt servicing. But in Kenya, this option does not seem feasible. The prevailing climate in the country is one where those being paid by Kenyans always seem to want to increase their salaries not reduce them. This makes it very difficult for government to reduce recurrent expenditure.

The fourth option through which government can ‘raise’ shillings is by printing shillings. Government has done this in the past and this phenomenon is certainly not unique to Kenya. The problem with printing money is that it expands money supply which often drives inflation up. The excess supply of KES can also lead to a further depreciation of the currency making it even more expensive for government to buy dollars and service foreign denominated debt. Therefore if the government prints KES, it will be effectively making the debt more expensive.

Growth

Clearly, none of these four options are attractive and each has consequences that could have economic and perhaps even socio-political implications. These options present the risks Kenya faces as it enters into an era of acquiring and servicing foreign denominated debt on a scale far larger than ever before.

This is why interest rates will remain high for Kenyan borrowers

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There are myths told to Kenyan consumers on a regular basis. One myth is that if government does not borrow locally, it should lead to lower interest rates because of the ease of pressure on demand for domestic credit. The second myth is that the Kenya Banks Reference Rate (KBRR) will let consumers know how much credit should cost and thus foster competition in the banking industry which will lead to lower rates. Yet since the introduction of the KBRR only one bank has lowered its interest rates. Further, even after announcements by government clearly signalling that it will borrow from outside Kenya, interest rates have not dipped. Why? Why aren’t banks lowering interest rates in any noticeable manner? There are several factors at play that will not only ensure interest rates do not lower but in fact may push interest rates up. The focus here will be on external factors that inform rate setting rather than internal dynamics of banks (such as riskiness of client, required rate of return on funds/capital etc) as these are harder to influence and ascertain.

Growth

The first factor is the cost of borrowing; according to the CBK, during the month of November the interbank lending rate seesawed between 6.39 and 7.6 % but often more long term rates are used and insiders say the real rate can be double this figure. Banks have to on-lend at a rate higher than that at which they borrowed so this borrowing rate is the first rate- hike that hits consumers.

Inflation is another factor that informs rate setting since high inflation devalues the shilling and therefore pushes rates up in order for banks to recover the equivalent value of capital. Calculations on long term inflation demonstrate that the Inflation Rate in Kenya averaged 11.13 % from 2005 until November 2014, well above CBK’s target rate of 2.5-7.5%. Given how unstable Kenya’s inflation rate is year on year, banks would rather err on the side of caution and keep rates up to make sure they get the value of their money back.

Another factor banks have to consider is tax. The Corporate Tax Tate since this obviously eats into profits. Corporate Tax Rates in Kenya currently stand at 30% for residents and 37.5% for non-residents. However, a 2013 report by PriceWaterhouseCoopers found that a company in Kenya on average pays a total tax rate of 44.2%, higher than the global average of 43.1%. Further, it takes a firm operating locally 308 hours to comply with taxes; the global average is 268 hours. These factors lead to a high cost of doing business in Kenya which leads to a higher financial burden in terms of man hours. So it can be understood why some of this financial burden is passed on to consumers in the form of higher interest rates. Additionally, for banks (and any other company) listed on the Nairobi Securities Exchange Withholding Tax on Dividends stands at a rate of 5% for dividends paid to residents of Kenya and on listed shares for citizens of the East African Community; the rate is 10% for other non-residents. To top it all off, the government recently announced the re-introduction of the Capital Gains Tax at 5%. Banks are facing millions of shillings in tax charges on transactions starting January 2015. Such tax burdens increase the cost of funds and puts pressure on banks to find ways to secure profit margins and hiking interest rates is a viable option.

Kenyan-Shillings

There are also non-financial reasons why banks feel no pressure to reduce interest rates: Kenyans do not necessarily choose banks due to their interest rates and Kenyans do not necessarily leave banks if the interest rate goes up. There are other factors that inform how Kenyans choose banking partners or stay with them. A study by Ernst and Young earlier this year indicated that Kenyans, like millions of others across the world, open and close their accounts due to customer experience and this factor is more important than fees, rates, locations, press coverage or convenience. Add to this the reality that Kenya recorded a higher than average increase in confidence in their banks. In fact, while 44% of customers around the world express complete trust in their banks, this figure is 59% in Kenya; the highest level in Africa.

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Given all these factors, why would banks seek to drive down interest rates? It appears as though banks would prefer to reward depositors with higher interest rates and general customers with better services than bring lending rates down. Sadly, no reprieve is in sight for you, Kenyan borrower.

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A version of this article was featured in the Business Daily on December 1, 2014. You can read it here.

The Pros and Cons of Free Trade Areas

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Many Africans are of the opinion that greater economic integration of the continent through Free Trade Areas will be of benefit to the continent’s growth. But is this truly the case?

In October 2014, delegates from 26 countries of three main trading blocs in Africa agreed to launch the continent’s largest free trade area in December 2014. ‘The Tripartite Free Trade Area (FTA), comprising the East African Community (EAC); the Common Market for Eastern and Southern Africa (COMESA) and the Southern African Development Community (SADC), aims to boost intra–regional trade, increase foreign investment and promote the development of cross-regional infrastructure’.[1] This Free Trade Area (FTA), ‘will have a combined population of 625 million people, a Gross Domestic Product (GDP) of USD 1.2 trillion’ and ‘will account for half of the membership of the African Union and 58% of the continent’s GDP’.[2] This trend towards regional integration is well underway as this FTA will be, ‘the launching pad for the establishment of the Continental Free Trade Area (CFTA) in 2017’. The decision to develop a Tripartite FTA occurred in October 2008 where it was agreed that FTA would be guided by the following overarching principles[3]:

  • Duty-Free and Quota-Free Market Access and no quantitative restrictions on goods that meet the Tripartite Rules of Origin.
  • Standstill Provisions and Incremental Liberalisation: Tripartite countries to present national tariffs and declare customs duty rates for all tariff lines at the start of the negotiations and should undertake not to raise customs duties on imports from other Tripartite countries before, during or after the negotiations, and to continuously reduce non-zero customs duties so that they are completely eliminated as part of the Tripartite FTA.
  • Most Favoured National Treatment where Tripartite countries should accord each other Most Favoured Nation (MFN) treatment where there is no prevention by country members from maintaining or concluding preferential or free trade agreements, either separately or together, with third countries provided such agreements do not go against the letter or spirit of the Tripartite Free Trade Agreement.
  • National Treatment: Member countries to accord the same treatment to products manufactured in other Tripartite countries once imported into their territory as that accorded to similar locally manufactured products.

 Public Private Partnerships_4

Further cooperation between member countries will include the harmonisation and coordination of industrial and health standards; combating of unfair trade practices and import surges, relaxation of restrictions on movement of business persons; development of cultural industries in the region and the development of sector strategies to increase productive capacity and link producers to buyers and consumers.[4]

UNECA indicates that there may be a 3 phase process towards the creation of a continental FTA. The on-going COMESA-EAC-SADC FTA is FTA1; The Economic Community of West African States (ECOWAS), Community of Sahel-Saharan States (CEN-SAD) and the Arab Maghreb Union (UMA) would be FTA 2 and finally the Economic Community of Central African States (ECCAS), The Central African Economic and Monetary Community (CEMAC) and possibly the Economic Community of the Great Lakes Countries (CEPGL) as FTA 3.[5] These 3 FTAs would then combine to form a Continental FTA.

This all sounds fine but what one often doesn’t see in Africa is the questioning of the principle of FTAs. Given that we’re hurtling towards FTAs with great momentum, it would be prudent to ask: how good an idea are they?

PROS OF FTAs

1. Enhances intra-regional trade and investment

FTAs encourage member countries to increase trade with each other. Further, it allows projects, particularly in infrastructure, to be designed from a regional perspective allowing for greater efficiencies and cost-sharing between governments. Private sector can also design the development of plants, factories and large industrial facilities more strategically.

2. Increased price competitiveness

The introduction of new players in home markets means expensive goods are replaced with cheaper goods due to competition.[6] This applies to goods made by countries within the FTA as well goods from outside the FTA which may have to cut prices to maintain exports to the region.[7] In a continent where poverty is a reality for many, cheap is better for most.

3. Every country is bound to benefit due to different areas of specialisation

Ideally, each country has a comparative advantage in different areas of production and this allows partner countries to gain as a result of specialisation.[8]

4. Increased performance

Because FTAs engender specialisation in goods and services in which the nation has comparative advantage, ‘countries are able to take advantage of efficiencies generated from economies of scale and increased output’.[9] Further when, ‘firms face increased competition from rivals producing similar goods and services they usually lift their performance to the benefit of consumers in all participating countries’.[10]

5. Variety and Innovation

The FTAs will give African consumers access to a wider variety of goods and increased competition will spur, ‘companies to innovate and develop better products and to bring more of their goods and services to market, keeping prices low and quality high in order to retain or increase their market share’.[11]

development

6. Investment efficiency

Fragmented African markets may have engendered the inefficient duplication of plants/ factories/ in different countries. [12] Integration allows for investment, particularly capital intensive investments, to be made in a manner that is most strategic at a continental level.

 7. Countries with similar economic structure stand to gain from each other

Integration can facilitate intra-industry trade between economies that produce similar products. In Europe it allowed firms in the same industry (in this case motor industry) to, ‘specialise in parts of a production process that they previously undertook in its entirety, or to concentrate on particular market segments’.[13]

 8. Economic and political reform

FTAs can lock member countries into economic and political reforms particularly if those policies or rules are stipulated within the agreement.[14] This is particularly the case for African countries that want to reassert their commitment to policy reforms and improving the underlying conditions of the economy in order to attract investment.[15]

9. Security

FTAs will enable Africa to not only enhance trade between countries on the content, they may well create a, ‘web of positive interactions and interdependency’ which is, ‘likely to build trust, raise the opportunity cost of war, and hence reduce the risk of conflicts between countries’. FTAs can help countries develop a ‘culture of cooperation’ on common issues in intra-regional security that can be addressed through common defense strategies and mutual military assistance.[16]

 10. Makes Africa economically stronger and more attractive

Africa is currently fragmented into 47 small economies each with its own regulatory structure and each of which present small potential markets. Integration will make Africa a larger more integrated and larger market making it more attractive to investors both within and outside the FTA. Further, FTAs create a platform that increases Africa’s visibility and bargaining power when negotiating agreements giving the continent space to make more lucrative deals.

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CONS OF FTAs

1. Facilitates the flow of illicit trade

It is not a stretch to surmise that as borders come down and the flow of goods, services and people is facilitated across nations, illicit goods can more easily get through the porous borders as well.

2. Increased security threats

While FTAs may allow better coordination between security arms of member governments, the relaxation on borders and free movement of people may allow individuals from terrorist organisations as well as criminals to more easily expand their activity beyond the borders of one country into another.

3. Increase in structural unemployment

Structural unemployment may arise in industries in some member countries that are in, ‘direct competition with other lower-cost trading partners due to a loss of comparative advantage’. [17]

 4. Risk of Trade Diversion

If African countries move to free trade between themselves but, ‘maintain significant tariffs vis-à-vis the rest of the world it may well result in trade diversion and welfare loss’.[18] This is additionally detrimental because FTAs can prevent innovation and creativity from non-member countries entering the FTA zone if tariffs are prohibitive.

diversion5. Can Magnify Inequalities

Africa is varied with regard to the stage at which each country stands in terms of economic development, size and strength. FTAs risk creating a scenario where, ‘more developed countries within the regional integration scheme dominate the market because they may have a head start’.[19] The playing field is not level and this may create momentum that magnifies the discrepancies in economic development on the continent.

 6. Creates difficulties for new industries and sectors

‘Developing or new industries may find it difficult to become established in a competitive environment with no short-term protection policies by government’[20]. Therefore, nascent industries may fail given the access to local markets by economies in which such industries are more developed.

7. Diplomatic tensions

Africa’s FTAs may benefit some member countries more than others and even though these benefits may only accrue in the short term, it risks the development of tension between governments and citizens of countries that are benefitting and those that are not yet seeing benefits. This dynamic will have to be carefully managed.

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 8. Increase in transaction costs

FTAs increase the complexity of the trading system and can raise transaction costs for business; ‘for example, complicated rules of origin are required to prevent third country products entering via the other party’.[21] Thus business may have to spend more time and money ensuring compliance to the introduction of new rules and regulations.

 9. Increased vulnerability to external shocks

A Continental FTA fosters, ‘closer trade links among member countries, and as a result increases the interdependence of their economies. This means that a recession in one country may quickly spread to other countries, which are its trading partners’.[22] Further, as African more intimately links itself to the global economy while also increasing intra-African economic integration, there is a risk that economic downturns in the global economy will spread over Africa more rapidly than would have been the case without regional and continental FTAs.

 10. The interface between Corruption and FTAs

Corruption may well find a new lease of life through FTAs in Africa. Because member countries get preferred access, unscrupulous traders may seek to gain entry into markets by repackaging external goods as those for member countries. This may present a new avenue of collecting illegal dues, particularly by government officials. Corruption remains a monster on the continent and FTAs may present a new and lucrative avenue through which this beast is fed.

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Therefore, it is clear that Africa can both gain and lose from FTAs. It is important that Africans enter this era of economic integration cognizant of these dynamics in order to ensure the process goes as smoothly as possible, that losses are minimised and benefits are maximised.

Endnotes

[1] Samuel Njihia (2014), ‘Africa’s largest free trade area to launch in December’, Business Daily http://www.businessdailyafrica.com/Africa-largest-free-trade-area-launch-December-/-/539546/2500008/-/wd82nr/-/index.html

[2] Samuel Njihia (2014), ‘Africa’s largest free trade area to launch in December’, Business Daily http://www.businessdailyafrica.com/Africa-largest-free-trade-area-launch-December-/-/539546/2500008/-/wd82nr/-/index.html

[3] COMESA-EAC-SADC Tripartite (2009), ‘Focal area 1: The Tripartite Free Trade Area (FTA)’, http://www.comesa-eac-sadc-tripartite.org/intervention/focal_areas/tripartite_fta

[4] COMESA-EAC-SADC Tripartite (2009), ‘Focal area 1: The Tripartite Free Trade Area (FTA)’, http://www.comesa-eac-sadc-tripartite.org/intervention/focal_areas/tripartite_fta

[5] UNECA (2011), ‘Study On The Establishment Of Inter-Recs’ Free Trade Areas In Africa Drawing On Lessons From The COMESA-SADC-EAC FTA experience’, http://www.uneca.org/sites/default/files/uploaded-documents/CTRCI-VII/tripartite_comesa_eac_sadc_fta-study-final-report.pdf

[6] Monash University (2001)‘An Australia-United States Free Trade Agreement – Issues and Implications:FTAs– advantages and disadvantages’, http://www.dfat.gov.au/publications/aus_us_fta_mon/Chapter3.pdf

[7] Lolette Kritzinger-van Niekerk (2005), ‘Regional Integration: Concepts, Advantages, Disadvantages and Lessons of Experience’, http://www.sarpn.org/documents/d0001249/P1416-RI-concepts_May2005.pdf

[8] Monash University (2001)‘An Australia-United States Free Trade Agreement – Issues and Implications:FTAs– advantages and disadvantages’, http://www.dfat.gov.au/publications/aus_us_fta_mon/Chapter3.pdf

[9] Edge, Ken (1999) Free trade and protection: advantages and disadvantages of free trade (), Charles Sturt University, http://www.hsc.csu.edu.au/economics/global_economy/tut7/Tutorial7.html

[10] Monash University (2001)‘An Australia-United States Free Trade Agreement – Issues and Implications:FTAs– advantages and disadvantages’, http://www.dfat.gov.au/publications/aus_us_fta_mon/Chapter3.pdf

[11] Denise H. Froning (2000), ‘The Benefits of Free Trade: A Guide For Policymakers’, Heritage Foundation, http://www.heritage.org/research/reports/2000/08/the-benefits-of-free-trade-a-guide-for-policymakers

[12] Lolette Kritzinger-van Niekerk (2005), ‘Regional Integration: Concepts, Advantages, Disadvantages and Lessons of Experience’, http://www.sarpn.org/documents/d0001249/P1416-RI-concepts_May2005.pdf

[13] Monash University (2001)‘An Australia-United States Free Trade Agreement – Issues and Implications:FTAs– advantages and disadvantages’, http://www.dfat.gov.au/publications/aus_us_fta_mon/Chapter3.pdf

[14] Lolette Kritzinger-van Niekerk (2005), ‘Regional Integration: Concepts, Advantages, Disadvantages and Lessons of Experience’, http://www.sarpn.org/documents/d0001249/P1416-RI-concepts_May2005.pdf

[15] Lolette Kritzinger-van Niekerk (2005), ‘Regional Integration: Concepts, Advantages, Disadvantages and Lessons of Experience’, http://www.sarpn.org/documents/d0001249/P1416-RI-concepts_May2005.pdf

[16] Lolette Kritzinger-van Niekerk (2005), ‘Regional Integration: Concepts, Advantages, Disadvantages and Lessons of Experience’, http://www.sarpn.org/documents/d0001249/P1416-RI-concepts_May2005.pdf

[17] JC Economics, ‘Analyse the impact of FTAs on the Singapore economy and assess the extent to which the impact of FTAs has been positive’, jc-economics-essays.blogspot.com/2012/08/analyse-impact-of-ftas-on-singapore.html

[18] Lolette Kritzinger-van Niekerk (2005), ‘Regional Integration: Concepts, Advantages, Disadvantages and Lessons of Experience’, http://www.sarpn.org/documents/d0001249/P1416-RI-concepts_May2005.pdf

[19] Lolette Kritzinger-van Niekerk (2005), ‘Regional Integration: Concepts, Advantages, Disadvantages and Lessons of Experience’, http://www.sarpn.org/documents/d0001249/P1416-RI-concepts_May2005.pdf

[20] Edge, Ken (1999) Free trade and protection: advantages and disadvantages of free trade (), Charles Sturt University, http://www.hsc.csu.edu.au/economics/global_economy/tut7/Tutorial7.html

[21] Monash University (2001)‘An Australia-United States Free Trade Agreement – Issues and Implications:FTAs– advantages and disadvantages’, http://www.dfat.gov.au/publications/aus_us_fta_mon/Chapter3.pdf

[22] JC Economics, ‘Analyse the impact of FTAs on the Singapore economy and assess the extent to which the impact of FTAs has been positive’, jc-economics-essays.blogspot.com/2012/08/analyse-impact-of-ftas-on-singapore.html