Thursday, March 19, 2009

Global Economic Downturn - Part 1: Implications for Africans

In the last edition of the publication I wrote on the importance of corporate social responsibility and how this may improve performance and sustain economic growth in Nigeria. I hope you have enjoyed reading it. In this edition I have outlined briefly some of the impact of current global economic downturn on sub-Saharan African countries economy especially in Nigeria.

Background to current economic crisis: The current economic slowdown, triggered by the sub-prime mortgage collapse in the United States (US) is likely to have far-reaching implications for African countries. People may be wondering what a sub-prime mortgage is. That will not be a surprise as mortgage of any type is still alien to many of us on this part of the world (Africa). In Africa, we took pride in buying own land and build a house to our taste and size. This is contrary to that in the Western society, we property developer buys land from the government build houses of the same shape and sizes and then sell them to the public. So to buy one of these properties, you will need a loan from the bank. A mortgage is the pledging of a property to a lender as a security for a loan. A sub-prime mortgage is a type of loan granted to individuals with poor credit histories, who, as a result of their deficient credit ratings, would not be able to qualify for conventional mortgages. Government policies and competitive pressure among banks in the last decade had led to high risk lending. Some estimated the value of sub-prime mortgage in the US was to be around $1.3 trillion. So you can imagine the impact this will have on the US economy if there were defaults.

So what led to the crisis? There mortgage defaults were increases at alarming rate. This was caused by rise in interest rate which makes borrowing to become expensive. As a result, refinance of mortgages became difficult leading to decline in demand for US properties. Rise in interest rate also increases loan repayment, the main catalyst for default in loan repayment. The above two consequences lead to the fall in value of properties in the US.

So how do all these affect global economies? During the property boom in the US, financial product called mortgage-backed securities (MBS) which derive its value from mortgage payments and housing prices were “essential” securities to purchase for institutional investors around the world. Major Banks and financial institutions around the world had borrowed too heavily to invest the US housing market. As property prices starts to fall, so was the value of mortgage-backed securities. The effect of this on major household names in banking was critical, as balance sheet starts to shrink. Banks and institutions holding MBS saw their value receded. This resulted in banks not lending to each other (credit-freeze), which later triggered a liquidity crisis that has negative effects for global economy. The impact of credit crisis on other economies is so viral due to globalization.

So how will the crisis affect Nigeria and other sub-Saharan countries? So often I have heard people said, “That the current crisis is American and European problem” and should not be brought to our shore. I think this assertion is coined with naivety and it underestimated the effect of globalization. The current crisis is an impediment that comes at a time when sub-Saharan African countries are beginning to experience steady economic growth. Below are some ways in which some African countries can be affected:

The last few years Nigeria as well as other sub-Saharan countries’ economy has attracted private and institutional investors’ money from abroad. The current crisis means those investors will now struggle to raise funds in their countries to invest in African projects and subsequently pull back the supply of money.
There will be reduction in demand for African exports which will push the prices of commodity down, and place restrictions on inflow of capital from foreign investors. This will lead to fall in value of local currency.
For countries that import more goods/services to sustain economic growth, these imported goods and services will now become expensive to purchase.
As local currencies depreciated due to lack of demand for export goods, fall in local currencies means fewer holidays abroad. For those parents with children in foreign countries, this means they have to work harder to finance college and universities fees.
Some African banks and financial institutions will be badly affected as most have deposits with troubled foreign correspondent banks. Therefore, for those who have invested with banks who have reserves in foreign banks this is a worrying times.
Another way this may impact is through capital repatriations by troubled parent banks/companies. Foreign banks/companies operating in sub-Saharan countries may start to pull back investments which may lead to close-down and subsequently job losses.
Slowdown in trade and fall in Oil prices will reduce government revenues especially in Nigeria where government fiscal policy is largely dependent on Oil revenue. What this translate into are; there will be lack of money to complete projects. The growing expectations among populations that infrastructure will improve will be dampened.
In Nigeria States governments and their affiliates should expect a challenging times ahead as plenitude allocation of funds from the Federal governments will eventually decline.

In the last few years African continent has seen economic growth and this created lot of job opportunities and return of middle class. This growth has now been challenged and governments in this region need to rise above the global economic downturn. In the next edition of this magazine, I will write about ways to raise finance for a start-up or and existing business.

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