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The Role of Debt Management for Financial Stability and Growth in Africa

Sep 03, 2010
Development literature has extensively discussed the nexus between finance and growth. Cross-country research shows that both financial development and stability play a critical role for growth. Less discussed has been what the building blocks for financial stability are, especially in developing economies.

I will highlight how debt management can contribute, directly, to financial stability and development and, by implication, to growth in Africa. The recent global financial crises have underscored how sovereign risks against the backdrop of growing public debt can pose a threat to financial stability in advanced economies. These lessons are instructive even for the emerging and low-income economies in Africa.

Generating sustainable and pro-poor growth in Africa will require investment in both developmental software (financial stability and development, rule of law) and hardware (e.g., infrastructure, investment in strong manufacturing base). The quality and development of the former are critically linked to those of the latter.

How does debt management promote the developmental software – financial stability in particular?

Prudent debt management can help minimize sovereign risks through improving debt structures (e.g., maturity, currency composition)
and financial stability. It can also enhance the shock absorbing capacity of public finances (and therefore of the economy) by minimizing the risks to the public debt stock from, inter alia, interest rate and exchange rate risks. As evidenced during previous global crises, developing economies are particularly vulnerable to financial and commodity price shocks through multiple channels – trade, aid, remittance, and cross-border capital flows (both FDI and portfolio). Hence managing market access and growth volatility partly through reducing the sensitivity of public finances to interest and exchange rate shock is of paramount importance.

Financial intermediation in Africa is primarily bank-based and the depth of financial markets is often limited. Given that banks generally are the single largest holder of domestic public debt against the backdrop of limited institutional (both domestic and foreign) investors, prudent debt management becomes a necessary condition for financial stability. This lesson on the link between financial stability and debt management is instructive not only for the advanced economies, as seen in the recent crisis, but also for emerging and developing countries in Africa and elsewhere. ###MORE###

In developing countries, debt management and financial development are closely interlinked. One of the key objectives of a medium-term debt strategy is market development. A growing domestic debt market can serve as the much needed sources for financing in times of global crises, especially as low-income countries are often hit with a set of correlated shocks: declining international market access, capital inflows (both FDI and portfolios), and remittances.

There is a growing appreciation among policy makers in Africa that debt management can play a very supportive role to other macroeconomic policies and widen policy spaces. A few countries are already reaping benefits from the improvement in their debt management and the deepening of their debt capital markets. For example, Kenya has continued its progress in debt management and, in the aftermath of the recent crisis, effectively relied on its domestic debt market as external financial declined.

As many African economies strive towards achieving financial stability and development, policy makers in the region will need to extract the policy and institutional benefits of prudent debt management in conjunction with sound monetary, exchange rate and fiscal policies.

Udaibir Das is an Assistant Director in the Monetary and Capital Markets Department of the IMF. The views expressed herein are those of the author and should not be attributed to the IMF, its Executive Board, or its management.

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