Key Issues in African Trade
Examining Africa’s relationship with trade, the global financial industry, and the long-term growth of its economies.
Published on August 25, 2021
It can be challenging to summarize a topic as complex and consistently changing as African trade. Myriad factors affect trade between African countries and the rest of the world, from regulatory policies to capital markets, and it can be tempting to over-generalize in a few broad strokes.
There are several main components of African trade, however, that can form a basic understanding of the topic. Analyzing the current challenges, their sources, and potential solutions is perhaps the best way to achieve this—and there is no shortage of challenges and solutions.
Here’s a look at the current state of African trade:
The African Trade Finance Gap
Global trade is made possible by financial products used by banks and companies to facilitate trade and commerce—otherwise known as trade finance. The amount of requested trade finance on the continent that is rejected, the African trade finance gap, is estimated at as much as $100 billion annually.
African banks’ credit ratings are capped by their respective sovereign ratings. Given that many African sovereign nations have non-investment grade credit ratings, due to their significant debt, strong financial institutions on the continent can still be subject to low ratings.
These ratings limits can negatively affect banks’ pricing, thus increasing the difficulty in raising capital and doing business in the international market. As a result, the import and export challenges can be more expensive in Africa than other continents, thus contributing to the ongoing trade finance gap.
The most significant factor in this gap is unmet demand due to the low credit ratings of African financial institutions, which are often viewed as unsatisfactory to the high standards maintained by international (LC) confirming and lending banks. These low credit ratings tend to reduce the inclination of international banks to participate in the market, thus reducing supply.
It is worth noting, however, that that the unmet demand in trade finance has declined significantly in recent years, from $120 billion in 2011 to $81 billion in 2019. This improvement can be largely attributed to increases in direct foreign investments, as well as a global response from key players in the trade finance sector.
While the trade finance gap can be a substantial obstacle to economic growth, the excess capacity also provides a wealth of opportunities for intra-regional trade and African businesses to take for themselves. There is no need for Africa to rely exclusively on the international community for transactions and capacity that can be handled on the continent.
The Withdrawal of International Banks
Since the 2008 financial crisis, the number of international banks operating on the African continent has fallen substantially.
International authorities place increasingly significant regulatory and compliance requirements on banking activity, due in part to the evolving nature of anti-money laundering and counter terrorist financing. In order to operate successfully, financial institutions must comply with these requirements, which make it difficult for banks to do business in locations that don’t meet certain requirements. As many African countries’ AML controls are still evolving, banks are less able to do business in these countries. Between the perceived hazards and high cost of compliance, many international players have decided that the risk and reward don’t match up in Africa.
African banks, however, have a different knowledge of key stakeholders in trade throughout the continent, and are often able to operate and provide banking services in ways that the international institutions cannot. We can safely expect to see a substantial increase in banking activity on the continent in the months and years to come, supported by African-based banks.
Trade between African countries, or intra-African trade, is growing at a substantial rate: from 1995 to 2017, the share of intra-African exports as a percentage of total African exports rose from 10% to 17%, due to regional integration, economic diversification, improvements in infrastructure and new trade agreements. Without question, the most promising driver of intra-African trade is the recent commencement of the African Continental Free Trade Area (AfCFTA) on January 1, 2021, establishing the largest free-trade area in the world by connecting 54 of the 55 African Union nations.
Africa has undergone a significant expansion in cross-border banking activity since the 2008 financial crisis, led by groups spear-heading the expansion of financial services and economic integration. These Pan-African banks are overtaking their Western rivals through their ability to combine the best of both worlds: the global position of foreign banks and the home-grown nature of local banks. They are stronger and more profitable than ever before, with capital to invest abroad.
As intra-African trade continues to grow throughout the continent, due in large part to the commencement of the AfCFTA, Pan-African banks will play an increasingly important role through the introduction of modern banking products to the complex trading environment.
The Key to African Economic Growth
Trade is perhaps the most vital factor in the economic growth and development of sub-Saharan Africa. The continent’s tremendous natural resources, from petroleum to coffee, remain a significant source of revenue for its countries, and the ability of exporters to tap into the global supply chain ultimately determines the livelihoods of Africans across the continent.
Most countries in other continents do not have a fraction of Africa’s natural resources, and so the economic potential in African trade is substantial—and will ultimately play a significant role in the growth of the continent for years to come.