De-risking, renminbi, internationalization, and regional integration

This paper takes a close look at sub-Saharan Africa’s (SSA) trade and payment integration with the rest of the world as well as its regional integration. Using a unique dataset of cross-border payments (MT 103 messages from the Society for Worldwide Interbank Financial Telecommunication, SWIFT) as well as bilateral trade data from the International Monetary Fund (IMF) (Direction of Trade Statistics-DOTS) from 2003 to 2014, we find a number of stylized facts:

• Euro-SSA corridor: The 2008 global financial crisis has led to significantly lower payments from the eurozone area, suggesting that in addition to spillover effects from reduced economic activity and banks’ compliance with new financial regulations, European banks may have engaged in de-risking activities with respect to their African counterparts. Global financial regulation and the associated adjustment of global banks can, therefore, have important unintended consequences on African economies.

• U.S.-SSA corridor: The U.S. is SSA’s largest counterpart when it comes to payments transactions, and U.S. dollar-denominated transactions dominate payments with SSA. While many goods such as commodities are traded in the U.S. dollar, having the U.S. as the “middle man” between African countries and the rest of the world can be costly in terms of transaction costs and exposes African countries to de-risking from global banks and to the consequences of U.S. sanctions on third-party countries.

• China-SSA corridor: Although China has become SSA’s largest trading partner, China accounts for a negligible share of cross-border payments. Whereas China accounts for 15.8 percent of SSA’s trade with the rest of the world, 70.9 percent of this trade is denominated in U.S. dollars while the renminbi accounts for only 1.2 percent of Sino-African transactions. However, in its payment flows with SSA, China relies more than other countries on trade finance tools such as letters of credit and documentary collections (MT400 and MT700). Although such tools help mitigate risks for exporters, they are costly compared to other types of payments (MT104). The internationalization of the renminbi will reduce the dominance of the U.S. dollar, and efforts are underway to gradually promote the use of the renminbi by African countries. However, it is likely that the U.S. dollar will remain used for the payments of commodity trade transactions.

• Intra-SSA corridor: Regional integration within SSA is increasing and has proved resilient to the 2008 financial crisis. The resilience of intra-African flows point to increased intra-regional transactions that helped buffer the fall of transactions from the eurozone. As discussed above, de-risking by European banks seems to have contributed to the reduced payment flows from Europe to SSA.

A number of policy recommendations follow from the above stylized facts:

1. Global financial regulation is important for SSA, and its unintended consequences on the region such as the extent of de-risking by global banks should be assessed and managed. Stricter international financial regulation in the aftermath of the crisis was aimed at strengthening global financial stability. Increased global security concerns have also led to a tightening of anti-money laundering (AML), know your customer (KYC), and combating the financing of terrorism (CFT) regulations. However, regulatory compliance by global banks can have unintended consequences on African countries if payment flows are negatively impacted. This seems to have been the case for payments flows between the eurozone and SSA. The enforcement of U.S. economic and trade sanctions (by the Office of Foreign Assets Control-OFAC) can have a negative effect on payments with Africa as payments to third-party countries mostly transit through U.S. banks. African policymakers should be fully aware of current developments in the global financial architecture and assess their consequences on domestic and regional economies. African policymakers, regulators, and supervisors, as well as financial institutions should clearly articulate the costs to their domestic economies of the unintended consequences of global financial regulation and have a voice in international standards setting bodies. Exercises such as the joint World Bank-IMF Financial Sector Assessment Programs (FSAPs) could be used to provide detailed information on the impact of global financial regulation such as de-risking by global banks on African economies.

2. As China is SSA’s largest bilateral trading partner, the use of the renminbi as a currency of payment between the two regions should be increased. The region’s payment flows with China—its largest bilateral trade partner—are routed through correspondent or clearing U.S. banks with associated costs and risks. Although a large share of Sino-African trade includes commodities whose international prices are denominated in U.S. dollars, the renminbi accounts for less than 2 percent of payments between China and SSA. This is in part due to the limited internationalization of the Chinese renminbi, which increases transaction costs and exposes Sino-African payments to global spillover financial risks (outside the two regions), exchange risks, and the risks from economic and trade sanctions. A number of initiatives are under way to increase the use of the renminbi in Sino-African trade, including the clearing of renminbi business and the opening of individual renminbi accounts in South Africa, as well as the establishment of currency swap agreements with six African countries. Going forward, African countries should have a clear strategy on how the internationalization of the renminbi will affect their economies and how best to take advantage of this trend. For instance, as China reduces its imports of commodities from the region, there is an opportunity for the region to attract Chinese direct investment in sectors such as manufacturing. Efficient payments between China and Africa can help facilitate such an adjustment.

3. Regional financial integration should be encouraged as it helps support trade and investment integration and increase the region’s resilience to external shocks. Regional trade integration in sub-Saharan Africa is the lowest globally and countries in the region trade more with the rest of the world than with themselves. Regional integration has become a policy priority on the continent and as African countries reduce non-tariff trade barriers and improve regional infrastructure, it will be important to also strengthen regional financial integration. At the moment apart from the Southern African Development Community (SADC) and the West African Economic and Monetary Union (WAEMU), payments between African countries have to be mostly channeled through banks in the U.S. and eurozone. By harmonizing legal and regulatory frameworks and building regional payment systems and other financial market infrastructure, African countries can help facilitate regional trade integration. Facilitating intra-regional payments can also help support the operations of pan-African banks and corporations, and support the development of regional money and capital markets. For instance, central banks in the five East African Community (EAC) member states have recently agreed on direct convertibility of their national currencies. The data suggest that Nigeria can play a much more important role in terms of payment integration in the WAMZ and that there is a potential to increase integration in the Economic Community of Central African States (ECCAS).