Sub-Saharan Africa: Brexit & SSA: Economic effects will be felt in the region
July 19, 2016
The decision of the United Kingdom to leave the European Union represents a big political and economic shock for the UK with spillover effects spread across the European Union and in the rest of the world. The Sub-Saharan Africa (SSA) region is expected to feel the consequences of Brexit, although the economic effects in the region will be contained. SSA is exposed to the UK through trade and investment, which will be the main channels affected by Brexit in the region. The outcome of the referendum has caused high volatility in global financial markets and the uncertainty regarding the consequences of the unprecedented vote will continue to be present in the short to medium term, at least until new agreements between the UK and the EU are approved.
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The immediate effect of the Brexit vote was mainly observed in South Africa—the region’s most industrialized economy—and the fragile rand plunged sharply against the U.S dollar in the days following the vote. While the currency has returned to pre-Brexit levels, South Africa’s wide current account deficit leaves the country vulnerable to capital outflows amid heightened risk aversion. According to the Office of National Statistics (ONS), South Africa was the largest recipient of British foreign direct investment in 2014, accounting for nearly 30.0% of total UK FDI in the African continent. Thus, the extent to which Brexit-related uncertainly could postpone investment activity represents a downside risk to FDI flows going forward, particularly in the countries that rely on capital inflows to finance their current account deficits. The banking sector could also suffer spillover effects of Brexit, especially if the ability of parent banks in the UK to provide liquidity is reduced amid a challenging operating environment. Analysts at JMP comment:
“While we do not see an imminent threat of a credit crunch, we expect capital flows to the region to be affected as the uncertainty presented by Brexit weighs on the credit appetite of UK banks, with no immediate signs of increase in lending from banks in other financial centres. In fact, results from an IIF survey already showed a marked deterioration in lending conditions in the SSA region prior to Brexit, which was in sharp contrast with EM Asia where other financial centres increased their lending. The deterioration in the score for SSA was largely driven by a tightening of credit standards and deterioration in funding conditions in both local and international markets.”
The strengthening of the U.S dollar in the aftermath of the Brexit vote coupled with macroeconomic uncertainty put pressure on commodities prices, which added to the economic troubles of the SSA’s oil-exporting countries such as Nigeria and Angola. Conversely, gold recorded its biggest surge in years as investors rushed to safe-haven assets, thus helping the economies of Tanzania and Ghana—the region’s biggest gold exporters.
Once the separation process officially begins, the United Kingdom will need to negotiate new trade deals with the remaining 27 members of the European Union and the rest of the world. As a result, the political and economic impact of Brexit, and its spillover effects, will broadly depend on the new UK-EU relationship. Deteriorating domestic conditions and substantial changes in immigration laws could affect the ability of foreigners to work in the UK, which will in turn impact the flow of remittances from the UK to the SSA region. SSA countries such as Nigeria and Kenya depend the most on remittances from the UK. In fact, according to the World Bank, in 2015, Nigeria topped the list with nearly USD 3.7 billion in remittances received.
In the short to medium term, the effect of Brexit through trade will be contained since only 3.0% of the overall exports from the SSA region go to the UK. Moreover, only 2.9% of the region’s imports come from the UK. However, if the European Union’s economy decelerates, this could pose more risks to the region’s economic outlook since SSA’s trade share with the other 27 countries of the region is much bigger than with the UK alone. Today nearly 23% of the region’s exports go to the European Union, while imports from the EU account for approximately 21% of the SSA’s total imports. In the long term, the UK might try to enhance its trade links with the Commonwealth of Nations countries in the SSA. While the Brexit vote will likely have an impact in the region, economic developments will be mainly driven by domestic factors. In this sense, this month, our panel cut the GDP growth forecast by 0.6 percentage points to 2.4%. For next year, the panel expects the SSA region to grow 4.0%.
Growth in SSA decelerates substantially in Q1
A more complete set of data show that the Sub-Saharan Africa region decelerated significantly in the first quarter of this year. GDP expanded 1.8% on an annual basis, which marked a noticeable deceleration over the 3.0% increase observed in the final quarter of last year.
The sharp deceleration in the first quarter came on the back of a slowdown in Nigeria—the biggest economy in the region. Nigeria’s GDP contracted 0.4% in Q1, thus raising concerns that the economy will fall into recession this year. The removal of the currency peg earlier this year caused the naira to plunge, and this weighed on the economy. Moreover, the government has been reluctant to pass reforms that aim at diversifying the economy and disruptions in the all-important oil industry have had a negative effect on the economy. Elsewhere in the region, adverse weather conditions in South Africa took a toll on production in the mining and quarrying sector, thus causing the economy to contract in Q1. In the political arena, the upcoming local elections in South Africa will likely result in support for the ruling ANC party to weaken. The popularity of the party has been impacted by a series of corruption scandals involving its members and discontent with the country’s poor economic performance.
2016 outlook deteriorates for the second consecutive month
The SSA’s economy is set to grow at a slower pace this year as subdued commodity prices, uncertainty regarding the Brexit and its effects on financial markets, and numerous domestic headwinds will weigh on growth. Due to deteriorating domestic conditions in Nigeria and South Africa, the outlook for the region’s biggest economies was downgraded sharply this month, thus weighing on the region’s growth outlook for 2016. Our panel of analysts cut the outlook for the Sub-Saharan Africa region and now expect the economy to expand 2.4% this year, which is down 0.5 percentage points from last month’s projection. This month’s outlook reflects downward revisions for 5 of the 13 countries surveyed while growth projections were left unchanged for five economies, including Ethiopia and Kenya. Angola, Cote d’Ivoire and Tanzania were the only countries for which the GDP outlook improved this month. For 2017, the panel foresees the SSA economy expanding 4.0%.
Cote d’Ivoire, Tanzania and Ethiopia, in that order, are expected to grow the fastest this year with GDP growth rates above 6.0%. Conversely, South Africa is likely to be the worst performer with a projected GDP expansion of 0.3% this year. Among the other major economies in the region, Kenya and Nigeria will expand 5.9% and 1.0%, respectively.
NIGERIA | Weak currency restrains short-term growth prospects
The Nigerian naira has weakened sharply since the Central Bank allowed the currency to freely float in the exchange rate markets on 20 June. The value of the naira has plummeted from the over-a-year-long currency peg of 199 NGN per USD to around 282 NGN per USD in the last few days. Despite the sharp depreciation of the currency, there is still room for a further weakening as it is trading at around 365 NGN per USD in the parallel market. Moreover, activity in the all-important oil industry remains under severe distress. Although Oil Minister Emmanuel Ibe Kachikwu stated that oil production had recovered to 1.9 million barrels per day (mbpd) at the beginning of July from a multi-year low of 1.4 mbpd in May, the Niger Delta Avengers militant group continues to attack oil facilities, which is reducing output volumes and squeezing oil revenues.
The adoption of a more market-determined foreign exchange will be beneficial for the country in the long-run as it will reduce macroeconomic imbalances. However, in the short-term, the depreciation will cause inflation to shoot up and likely trigger a tighter monetary policy. Moreover, attacks on oil infrastructure and spillovers from the Brexit will weigh on growth. FocusEconomics Consensus Forecast panelists see GDP rising 1.0% this year, which is down 1.2 percentage points from last month's projection. Next year, the panel sees GDP growing 3.5%.
SOUTH AFRICA | Economic weaknesses carry over into Q2
Following the contraction in Q1, the economy of South Africa continued to show weaknesses in Q2. In June, the PMI dropped into contractionary territory. Moreover, in the aftermath of the UK’s decision to leave the EU, the rand took the deepest plunge among emerging market economies as investors lost appetite for risk assets. The Brexit vote has cast a shadow on South Africa’s economy as the country has close financial and trade ties with both the UK and the EU. South Africa’s economy is already suffering the consequences of slowing demand from China and low commodity prices, and uncertainty regarding the spillover effects of Brexit are creating anxiety about the country’s economic prospects. In the political arena, local elections will be held on 3 August and, according to the latest opinion polls, the ruling ANC party will likely lose considerable support. The popularity of the party has been dented by a series of corruption scandals involving its members and discontent with the poor performance of the economy.
The country’s outlook remains fragile as electricity and water supply constraints coupled with low commodity prices will weigh on growth. Moreover, the government’s failure to push forward fiscal consolidation reforms could provoke a downgrade of the country’s credit rating to junk territory. The FocusEconomics panel expects the economy to expand a weak 0.3% this year, which is down 0.3 percentage points over the previous month’s estimate. For 2017, the panel projects growth of 1.2%.
ANGOLA | Government announces more austerity measures
The slump in commodities prices has put Angola’s oil-dependent economy under severe pressure. In a rare disclosure of data on the current health of the economy, the Ministry of Finance offered a bleak picture of government finances. Government spending will be cut by 20% as tax revenues have plunged by more than 35%. The country has also accrued over USD 11.0 billion in foreign debt since November to cover financing needs. Furthermore, the government revealed that the Angolan state-owned oil company has not made a single fiscal transfer since January. Although funds have dried up, the government decided to end talks with the IMF for financial assistance. Moody’s and Fitch Ratings warned that suspending talks with the IMF will debilitate public finances further and, consequently, result in a credit rating downgrade.
Angola’s growth outlook is bleak as low oil prices pose significant challenges to government finances—oil constitutes approximately 95% of exports and 75% of fiscal revenues. Although oil prices have increased this year, they are not expected to reach the highs required to shore-up public finances. FocusEconomics panelists expect that GDP will grow 2.0% this year. Next year, the panel sees GDP growth picking up to 3.3%.
KENYA | Economy gains steam in Q1
Solid public spending and robust private consumption propelled the Kenyan economy to robust growth in 2015. The positive momentum from last year carried into this year and the economy gained steam in annual terms in Q1 compared to the previous quarter. The acceleration in the first quarter was supported by a broad-based increase in all sectors of the economy, with construction and tourism tallying the largest increases. Meanwhile, the government announced that it is considering tapping into international debt markets this year. The government plans to issue Eurobonds for the second time ever to fund an oil pipeline that will cost USD 2.0 billion to build, plug the swelling budget deficit and finance public spending ahead of the 2017 general elections.
Kenya is set for another solid expansion this year on the back of increased infrastructure spending, a pickup in domestic demand and looser monetary policy. However, macroeconomic imbalances and political instability represent downside risks. FocusEconomics Consensus Forecast panelists forecast that GDP will rise 5.9% this year, which is unchanged from last month's projection. Next year, the panel sees GDP growth accelerating to 6.0%.
INFLATION | Inflation increases in June
According to a preliminary estimate, inflation in the SSA region edged up from 12.4% in May to 12.9% in June. The figure marked the highest reading in nearly eight years. Higher inflation was recorded in some of the biggest countries of the region, including Angola and Kenya. Weak local currencies coupled with electricity and water shortages are keeping inflationary pressures high. This month, the analysts we surveyed expect regional inflation to average 12.2% in 2016, which is up 1.6 percentage points from last month’s estimate. The inflation outlook was revised up for 7 of the 13 countries surveyed. Our panel expects inflation to moderate significantly next year and average 9.3%.
Written by: Dirina Mançellari, Senior Economist