Covid-19 clouds the African horizon

The novel coronavirus Covid-19 is a black swan event: highly unlikely, and with potent potential consequences. Still, its swift initial containment to some extent demonstrates China’s capacity for fit-for-purpose strategic solutions in times of crisis. Near half of China’s cities and districts are currently classified as low-risk, and a return to business as usual is apparently imminent. Nevertheless, the situation in China and globally remains both fluid and uncertain.

We are far less optimistic when it comes to the impact of this outbreak on China’s economy. The current consensus, that growth will slow to just 4.5% in Q1:20, followed by a robust rebound and then stabilization, seems optimistic. The immediate downturn is likely to be far more severe and acute. Consider that vast swathes of GDP has been frozen for an extended period: manufacturing (32%), retail trade (10%), real estate (7%), transport (4%), automobiles (3%), retail hotel (2%), and so on.

Even now, after an incredibly rough few weeks, the Chinese economy is probably running at about 50% capacity. Last week, provincial governments started to publish “resumption rates” for businesses with revenues above CNY20mn. The variation is large: Sichuan 20%, Anhui 40%, Zhejiang 48%, Guangdong 50%, Fujian 60%, Jiangsu 65%, Shanghai 68%, Shandong 71%. Of course, plausibly gains could be clawed back in Q2:20, but the policy impact is likely to be smaller than in the past.

We also doubt that the impact here and globally will be transitory. The comparisons to the V-shaped recovery trajectory in the aftermath of severe acute respiratory syndrome (SARS-CoV) is fraught terrain. SARS-CoV infected far fewer people; Covid-19 has infected 10 times more people already, directly or indirectly, affecting millions of families. SARS-CoV infections were concentrated to Guangdong Province and Beijing. Infections of Covid-19 have affected every district and city across the Mainland, surpassing 500 cases in eleven provinces, and severely disrupting business operations throughout the country in every sector.

Most notable, unlike in 2003, China does not have a favourable cyclical and structure outlook. Then, nominal GDP growth was a juggernaut, surging by near 20% each year in the subsequent five years up to the global financial crisis. Today, COVID-19 coincides with an economic transition toward higher-quality growth. Consumption is under pressure, the manufacturing sector is struggling, the various components of investment seem in no position to rebound, and local governments are grappling with falling tax revenues and rising outlays. The financial system, which saw several episodes of liquidity stress last year and is currently being used as a critical buffer to prevent greater corporate disruption, will experience blowback. We expect restructuring, mergers and acquisitions, takeovers and bankruptcies. 

For Africa, the gradual adjustment of growth expectations in China will hit sentiment and narrow anticipated interest rate differentials with advanced economies, challenging the path of African currencies, equities and assets. Already, after much hope for a global recovery in 2020 in the wake of the US-China Phase One trade deal, things have changed dramatically, and sentiment towards emerging markets has soured. Financial markets are now adjusting and re-pricing assets. Even before survey data and macro data can confirm the hit to the global manufacturing recovery, central banks in key emerging markets (Brazil, Russia, India, Mexico) have started easing interest rates. Central banks in Africa, like Namibia, Botswana and South Africa, have also acknowledged the COVID-19 headwinds.

Worse still, African sovereign borrowing rates may move against them. Indeed, since the global financial crisis of 2008/9 and during times of low rates, African governments have now accumulated record levels of debt. Gross government debt across SSA has surged by an average of 20 percentage points (pps) of gross domestic product (GDP) since 2010, nearing an average of 60% of GDP in 2019. Countries like Zambia (+72pps), Mozambique (+65pps) and Angola (+57pps) have led the way, but several regionally important economies like Ghana and South Africa have also seen sizeable gains. Whilst financial deepening and building out the yield curve obviously has benefits – especially if the debt raised is used in ways that lay the foundation for future economic activity and boosts productivity – the speed of growth is worthy of pause. Also, the debt is increasingly from commercial sources and, increasingly, denominated in foreign currencies. African Eurobond issuance alone has increased by near USD60bn in the past two years.

Should the Chinese economy expand by 4.5% in 2020 – down from 6.1% in 2019 and far lower than currently expected – the entire global economy will struggle, expanding by just 2.5% in 2020. The less favourable external environment could end up shaving-off at least 1.2pps from SSA growth. Indeed, the IMF has responded by lowering its GDP forecast for Nigeria – SSA’s largest economy – from 2.5% to 2.0% due to fall in oil prices, which has already placed the currency under pressure.

Much like in 2015, African countries are likely to see downward revisions in coming weeks, as expectations around China are downgraded. As recently as 2015-16, adjusted expectations for China’s medium- to long-term economic growth rate, demand for resources and volatility in its financial market were felt across Africa. Recall then, China first experienced a stock market boom and bust, then a currency devaluation, which triggered capital outflows, panic and the burning of USD1tr in FX reserves. Also, entrenched factory gate deflation had undermined profitability and debt sustainability of many Chinese corporates. Nominal GDP growth slumped to just 6.5% – a 17 year low – equaling the cyclical trough experienced at the height of the GFC in June 2009. Fastened to longstanding historical trends, a stumble by a major commercial partner echoed into Africa. SSA GDP slumped from 5.1% in 2014 to 3.1% in 2015, and then to just 1.3% in 2016 – slower than advanced economies for the first time since the aftermath of the Asian financial crisis. 

Even before Covid-19, we argued that Africa should take heed of changes in China. Since 2016, Beijing has shown foresight and fortitude, allowing the slowdown to play out without reverting to traditional levers to support near-term growth, giving air to rebalancing, emphasizing Belt and Road ahead of all other outward initiatives. Most tangibly though, the landscape has been altered by the de-risking of the financial system, which has been the over-arching domestic policy framework since 2016, focusing the domestic policy tilt on ensuring that resources – land, labour and capital – are allocated towards productivity-enhancing ends.

China had signaled these changes for some time. Recall, after ballooning every three years, China’s financing commitments to Africa stayed flat at FOCAC in 2018, and a smaller share of the commitment was comprised of pledges of aid, interest-free and preferential loans, and export credit lines. This shift in emphasis is correct. The heavy lifting by diplomats, policy banks and Chinese SOEs has been completed, ushering in thousands of entrepreneurs and private business. Given the objective of FOCAC was always to strengthen China-African commercial and economic cooperation, trade and investment, handing the reigns over to business to focus on bidirectional commercial opportunities is desirable and more sustainable.

Evidence of China’s adjustment is also evident in Chinese imports of Africa, which contracted by 4% and remain below 2013 peaks. Recall that a one percentage point decrease in China’s domestic investment growth is associated with an average 0.6 percentage point decrease in Africa’s exports. Indeed, China’s rebalancing translates into investment doing less heavy lifting and expanding much more sluggishly. Back in 2010, domestic investment was growing at 30% y/y but has slowed steadily in each of the past 10 years, slipping to just 4% in 2019. And 2020 is likely to be closer to zero. Meanwhile, African countries have fallen in relative importance to China: South Africa, for instance, slipped from China’s 12^th-largest source of goods in 2013 to outside the top 20 last year.

This year, a demand shock and price decline would be very difficult for Africa. Even though tallying the impact of this coronavirus is not yet possible, already expectations for oil consumption have been reduced by 1.5mn barrels per day in Q1:20 and demand for copper is forecast to fall by 300,000 metric tons in 2020. Already, prices of key commodities, like copper, oil and thermal coal have already fallen by 20% since mid-January, and a few reports are emerging that Chinese buyers have postponed overseas orders, some declaring force majeure.

Unfortunately, resource sales (and prices) play an oversized role in fiscal revenue collection to help fund public expenditure. Consider that resource exports account for 40% of total exports in nearly half of SSA, and for eight the ratio is about 70% of exports. Furthermore, the path of commodity prices has one other significance. Making matters worse, around a quarter of China’s loans have been backed by resource concessions. On this score, the more indebted – often to China, backed by resources – are Angola and Zambia.

It is also plausible that the China-related deal pipeline will be smaller than it otherwise would have been. Disruptions in China will crimp revenues for companies in sectors affected by this coronavirus and divert attention of policy banks and commercial banks – the scaffolding for China-Africa deals. That said, much of the rationale for China’s endeavors in Africa (or Belt and Road, for that matter) are to leverage China’s competitive advantage in infrastructure, offshore some overcapacity sectors and heavier industry, and tap into fast-growing consumer markets. All of this remains.

Meanwhile, China’s infrastructure projects in Africa will face disruptions as people flow is restricted. Granted, most Chinese workers in Africa seem to have remained in Africa over the Chinese New Year – an estimated 70% of the Chinese workforce for Standard Bank clients – and more and more firms have hired locally. However, the biggest issue is that supply chains for key inputs are very much broken down, making key inputs, components, equipment and machinery harder to source, whilst transport hubs and ports in China may be operational, but only at depressed levels, may create costly delays.

China’s sales to Africa are likely to rise just a fraction in 2020 while China’s purchases will depend on commodity prices. Chinese goods have penetrated markets deeply, increasing from 3% of Africa’s total imports in 2001 to 19% in 2019. Around two-thirds African countries list China as their largest source of goods. In contrast to China’s growing penetration, Africa’s traditionally large trading partners have seen their market share decline. Last year, China’s exports to Africa expanded by 7.2% y/y, to USD113bn in 2019. And now, COVID-19 has disrupted the path ahead. Consider Yiwu in Zhejiang: as much as 7% of all of China’s exports to Africa originate from Yiwu. But today, Yiwu is far from business as usual. In terms of sourcing from China for domestic demand, South Africa and Nigeria purchase the most from China, but the risk of disruptions affecting cities in Africa is more a function of the relative share of China’s production in overall supply. In addition, overlaying loan data, it seems that Kenya, Tanzania, Mozambique and Ghana are likely sourcing considerable quantities of equipment and machinery from China.

For many, reducing reliance on the Mainland as a supplier seems even more relevant to some now, supporting the rationale for industrial hubs in South Africa, Ethiopia, Egypt and elsewhere. Africa must therefore more forcefully and single-mindedly prioritize tactics for further industrialization, job creation, and technology transfer through Chinese investment in manufacturing, creating hubs in Africa to serve as an engine for intra-Africa trade.

China’s economy is likely to slow more than originally anticipated in 2020, and this matters a great deal. In 2015, when China’s nominal GDP growth slumped to just 6.5% – a 17-year low – equaling the cyclical trough experienced at the height of the GFC in June 2009, SSA GDP slumped from 5.1% in 2014 to 3.1% in 2015, and then to just 1.3% in 2016 – slower than advanced economies for the first time since the aftermath of the Asian financial crisis. Once again, SSA growth will feel the impact in a variety of direct and indirect ways, halting three consecutive years of acceleration. That said, eventually, structural forces will reassert themselves. China will likely see an ongoing shift towards slower, but higher-quality, economic growth, one less factor- and investment-driven, and buoyed by innovations from globally minded, competitive and ambitious corporates. Africa is likely to see robust economic growth, favourable demographics, rapid urbanization and industrialization, and rising incomes as well as a growing middle class. This novel coronavirus is therefore unlikely to alter the formidable underpinnings of the structural, deep-rooted China-Africa commercial ties.

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