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It was supposedly good news when leaders of 44 African countries signed up to a continental free trade area last week. But a Moody’s report points to the lack of trade finance and other non-tariff barriers as limits to the deal’s potential.

Advocates undoubtedly have big hopes for what is officially known as the African Continental Free Trade Area (AfCFTA). If fully implemented, it will create a single African market for goods and services, covering 1.2 billion people and a GDP of US$2.5tn across 55 member states of the African Union.

According to the African Union, such a free trade area has the potential to boost intra-African trade by 53% by eliminating import duties, and to double trade in the region if non-tariff barriers are also reduced.

Such a boost is much needed on the continent: although intra-African trade has increased from 11% in 2008 to 15% of the continent’s total trade, the levels remain remarkably lower than those in other developing regions.

No wonder, then, it was described by African Union leaders as “a historic moment in the life of the continent” when 44 nations signed a number of legal instruments to move towards greater economic integration.

The good news is that by driving African trade the deal could improve the region’s credit profiles “given the greater stability and sophistication that intra-regional trade can offer” says Moody’s in its report.

Growth in intra-regional trade could also boost diversification of Africa’s revenues, which in turn would help develop the region’s local economies. The report notes that while African exports to the world remain largely undiversified and heavily oriented towards raw materials, intra-regional trade contains more value-added goods. Manufactured goods, for example, accounted for 43% of intra-African exports between 2010 and 2016, whereas this number was only 20% for exports to the rest of the world.

The credit ratings agency points to countries with larger manufacturing bases and better infrastructure as the real winners of further regional integration. This includes South Africa, Kenya, Morocco, Namibia, Tunisia, Côte d’Ivoire, Senegal, Cameroon and Ethiopia, which in Moody’s view all stand to gain from increased intra-African trade.

For other nations, however, the benefits could be harder to spot.

“Poor infrastructure and non-tariff barriers will continue to restrict the trade sector’s development and long-term growth potential,” says Colin Ellis, Moody’s managing director of credit strategy and the report’s co-author.

These barriers include corruption, ineffective customs documentation and broader procedural approaches. According to World Bank estimates, the cost of intra-African trade is around 50% higher than in East Asia. Meanwhile, the number of days it takes to clear exports and imports are on average double that of high-income OECD countries.

The report also emphasises the lack of trade finance as limiting the full trade potential of the region and thus the hoped-for benefits of a continental free trade agreement.

According to Moody’s calculations, Central African firms are the biggest losers when it comes to accessing trade finance for regional trade. In fact, less than 5% of trade finance in that specific region relate to intra-Africa trade, compared to Southern Africa, where almost 25% of trade finance is issued in support of intra-African trade.

The African Development Bank has estimated that Africa has an unmet demand for trade finance of more than US$90bn annually.

All of this together “will continue to restrict the trade sector’s development and long-term growth potential”, with or without a free trade area, the report concludes.

 

Feedback from financiers

This challenge has been acknowledged by institutions in the region. For one, the president of the African Import-Export Bank (Afreximbank), Benedict Oramah, says the signing of the deal will “build a solid foundation for prosperity for all Africans”, but he recognises that the bank has an important role to play “to make sure that opportunities created by the history-making step taken by African leaders are fully realised”.

Therefore, the bank has opened credit lines amounting to US$800mn to 55 banks across Africa to facilitate the confirmation of letters of credit in support of intra-African trade. According to Oramah, the goal is to extend such lines to at least 500 banks in all African countries by 2021, with the goal of significantly reducing the cost of intra-African trade finance and to counter the constraints posed by country risks.

Afreximbank has also introduced a guarantee programme to enhance the ability of African businesses to obtain trade financing, and it will soon launch an intra-African trade platform to facilitate the clearing and settlement of regional trade transactions in African currencies. The hope is that this will significantly reduce the use of hard currencies in trade settlements.

As for the AfCFTA, the deal will now have to be approved and sanctioned through national parliaments. For it to come into force, it must be ratified by 22 countries.