What’s with all these international sovereign bonds being issued by African governments?
Kenya's Transport and Infrastructure Cabinet Secretary Michael Kamau and the economic and commercial consul of the Chinese embassy Han Chunlin at the Standard Gauge Railway Symposium at Railway Training Institute, Nairobi, on June 16, 2014. Infrastructure projects have usually seen a key element of the activities to be funded by Eurobonds due to their multiplier effects on the economy and the fact that African infrastructure needs are dire. Photo/SALATON NJAU
What you need to know:
It seems as though African government are courting this new-found attention and perhaps entering into more agreements than advisable. Eurobonding seems to be trendy in Africa.
Africa risks becoming overleveraged.
Despite immense optimism about Africa, it is still a poorly understood market, considered a high-risk venture and, therefore, vulnerable to negative hype. That can push it back to being the investment pariah.
When Kenya launched its debut Eurobond, it secured bids worth $8 billion but announced it would accept $2 billion.
The Kenyan Eurobond is a big deal because it is the largest ever debut for an African country as international sovereign bonds continue gaining popularity in African countries.
Sub-Saharan Africa issued a record $4.6 billion in 2013 in sovereign bonds (five per cent of developing country sovereign-bond issues), from zero in 2010.
Thirteen other countries besides Kenya have issued Eurobonds so far: South Africa, the Seychelles, Republic of Congo, Côte d’Ivoire, Ghana, Gabon, Senegal, Nigeria, Namibia, Zambia, Tanzania, Rwanda and Mozambique.
But there are four core questions to ask here: Why are international sovereign bonds becoming so attractive for African governments? Why are the African bonds so well received in global markets? What are the risks and challenges? Can they change the way African governments manage public funds?
A key reason for the attractiveness is that countries need the money. Africa’s development needs such as electricity generation and distribution, roads, airports, ports and railroads require money.
Funds raised through Eurobonds are an effective means of financing such infrastructure projects, which often require resources in excess of aid flows and domestic savings.
In addition, sovereign bonds give governments more autonomy. Foreign aid and funding from multilateral institutions as well as development financing institutions come with conditions, as do funds from unilateral agreements with other governments. They give governments more choice and negotiation power to define how the funds will be used.
African governments are also using the bonds to restructure their debt. Kenya seems to be among those employing this strategy: Part of the Eurobond will be used to “retire a $600 million [Sh52.2 billion] syndicated loan.” Four other African countries — Seychelles, Gabon, Republic of Congo and Côte d’Ivoire — issued similar bonds in the context of debt restructuring.
Another key reason is that they help to reduce pressure on credit in domestic markets. In Kenya, a failure with the issue would not have augured well for domestic borrowers as the government would have crowded out individual and corporate consumers.
In issuing Eurobonds, therefore, African governments leave the credit space more open, allowing more businesses and individuals to access credit and, in doing so, support domestic investment and growth.
Countries also issue the bonds to diversify their sources of capital and reduce reliance on bank financing from abroad and official financing. Bonds also allow governments to reduce budgetary deficits in an environment in which donors are not willing to increase their overseas development assistance.
Ability to repay
Another reason is reduced debt. The Highly Indebted Poor Countries (HIPC) Initiative and Multilateral Debt Relief Initiative (MDRI) significantly reduced the debt of African countries.
In fact, multilateral creditors, bilateral aid organisations, export credit agencies and private creditors have delivered about $100 billion of debt relief to African economies since 2000, allowing them to “borrow in international markets without straining their ability to repay.”
Africa is operating in a context of easy global financial conditions due to “record low interest rates in developed markets and ample liquidity.” As a result, Sub-Saharan African countries have been able to borrow at “historically low yields.”
The bonds also give African states the opportunity to develop a benchmark for pricing other government and corporate bond markets in the international arena. They can use insights gained in international bond issues to develop subnational (for instance, parastatal) and corporate bonds, thereby enhancing African access to international capital markets.
Finally, a successful bond issue signals approval of a country’s current and planned economic policies and would provide grounds on which governments can rationalise economic and development plans to local and international parties.
But while African governments have valid reasons for issuing sovereign bonds, a nagging question is why these bonds are being so well received in global markets.
Investors looking for high bond yields are increasingly buying African sovereign debt because it offers exposure to growing economies with a better return than they would receive in more developed markets.
The world is looking at Africa and becoming increasingly interested in investing in the continent partly because of its robust GDP growth rates and considerable resilience to financial shocks.
Africa grew at an estimated four per cent in 2013 and is expected to hit 4.7 per cent this year. This compares well with 2.5 per cent for the United States, Western Europe (1.5 per cent), Brazil (3.0 per cent) and Russia (2.9 per cent).
These figures strengthen investors’ appetites for African offerings. African countries rated by either Moody’s, Fitch or Standard & Poor’s increased to 21 from 10 in 2003. Credit ratings make it easier to sell the country and related offerings.
Africa’s limited exposure to international capital markets provides an opportunity for investors to make deals on the continent through instruments such as international sovereign bonds that carry relatively low risk. Indeed, Moody’s predicts “significant potential in Africa for increasing the use of international capital markets.”
There are possibilities for healthy profits by increasing African exposure to capital markets and foreign investors are aware of this (risks notwithstanding).
But does real danger lurk behind the glitter? What are the risks and challenges for issuing the bonds?
African governments are issuing the bonds in an environment where record low interest rates prevail in the US and more developed markets. Yield hunting has brought investors to Africa’s door but there are fears that when global interest rates increase and concerns about the global financial crisis abate, governments in Sub-Saharan Africa will have to compete with other issuers for funding.
The governments seem to be cognisant of this, which may lead to over-issuing in order to seize the moment. Further, there is an air of optimism around Africa and the world is beginning to look at the continent as a truly viable member of the global economy.
It seems as though African government are courting this new-found attention and perhaps entering into more agreements than advisable. Eurobonding seems to be trendy in Africa with one commentator stating: “Eurobonds have become like stock exchanges, private jets and presidential palaces. Every African leader wants to have one.”
I therefore echo Stiglitz’s concerns about Africa’s Eurobond spree when he asks: “Are shortsighted financial markets, working with shortsighted governments, laying the groundwork for the world’s next debt crisis?”
If so, Africa will be affected far more significantly this time around, not least because of the manner in which Eurobonds are integrating African economies into the global financial system. The current conditions spiral into several other risks.
This environment may make Africa over-borrow for it is relatively easy to get the money. But the IMF is of the opinion that “the rates at which Sub-Saharan African countries are borrowing on the international markets are not sustainable.”
The rates they are getting are probably “unsustainable in the long run unless these countries are able to generate high and sustainable economic growth and further reduce macroeconomic volatility.” Africa risks becoming overleveraged.
Linked to these is debt sustainability, or rather, the lack thereof. Prior to the Eurobond (as of March), Kenya’s debt-to-GDP ratio stood at 52.2 per cent.
Kenya has gone ahead with the issue despite the fact that in the same month the IMF and the World Bank “raised the red flag over Kenya’s debt,” specifically suggesting that “the debt ratio be kept at not more than 50 per cent of GDP.”
The Eurobond exacerbates Kenya’s debt burden and deepens sustainability concerns. The institutions are warning that, after a spate of debt forgiveness, “many countries’ debt levels are creeping up again, which could undermine the region’s growth boom.”
For example, if Ghana, Uganda, Mozambique, Senegal, Niger, Malawi and Benin “continue to borrow at current rates, their debt indicators could be back to pre-[debt] relief levels within a decade.” Eurobonding is risky behaviour.
Another danger is defaulting. The scale of funds that the governments are accessing via Eurobonds — which have more stringent conditions than concessional loans — are actually predicated on robust growth of the borrowing economies in order to raise the capital required to meet maturity deadlines.
No one can guarantee robust growth and, therefore, defaulting is a real risk. In fact, African countries have already defaulted on Eurobonds.
The Seychelles defaulted on a $230 million Eurobond in October 2008. Due to election disputes, Côte d’Ivoire missed a $29 million interest payment, leading to a default in 2011 on a bond issued in 2010.
Ghana and Gabon are struggling to find money for a $750 million and $1 billion bond, respectively, on 10-year Eurobonds that will reach maturity in 2017.
There is also the problem of poor project selection. Infrastructure projects have usually seen a key element of the activities to be funded by Eurobonds due to their multiplier effects on the economy and the fact that African infrastructure needs are dire.
However, there is no guarantee that the specific projects selected are the best candidates for such finances.
Indeed, the IMF argues that due to factors such as limited administrative capacity, low efficiency of public investment expenditure and governance issues, “there is a risk that increased public spending or investment projects financed by bond issuance may be poorly selected or executed and therefore would not render value for money.”
Anyone familiar with the African political scene knows that sometimes flagship projects are selected for political currency rather than economic or developmental return, or the prestige enhancement and legacy effect they will confer on leaders and not their prudence and pragmatism. Are the governments choosing the Eurobond-financed projects wisely?
Poor implementation of the projects is a serious risk because “there are carry costs for not using proceeds and these are greatest when there are delays in projects.” This thought makes one shudder given the ongoing debacle in the Kenyan government’s management of the standard gauge railway (SGR) project that, if well handled, could provide proof of competent management of funds for infrastructure development. It seems to be proving the opposite.
Rollover risk
Sadly, in response to the Kenya 2014/15 budget — in which the Eurobond was incorporated — PricewaterhouseCoopers stated that the projects planned by the government have inherent risks that “relate to time and cost overruns. These will require significant upgrades in technical, legal and institutional frameworks to manage and control the delivery of the investments.”
If governments do not address such concerns, projects will be implemented poorly, which may cause the bonds to mature before the projects are completed, in which case governments may have to roll over the debt.
Given the implementation risk and the possibility that planned projects may develop significant delays, rollover risk is very real.
Rollover risk is “a risk associated with the refinancing of debt commonly faced by countries [and companies] when their debt is about to mature and needs to be rolled over into new debt. If interest rates rise adversely, they would have to refinance their debt at a higher rate and incur more interest charges in the future.”
Bear in mind that, in case of Kenya’s Eurobond, the five-year tranche matures in 2019 and the 10-year one in 2024. These are tight deadlines given the delays infrastructure projects are experiencing. Kenya’s SGR project was due to start in November last year, yet no work has begun. That is an eight-month delay with no resolution in sight. Rollover risk is real.
Rollovers happen if investors are of the opinion that the borrower is capable of meeting the new terms and deadlines. Africa doesn’t have this luxury.
Despite immense optimism about Africa, it is still a poorly understood market, considered a high-risk venture and, therefore, vulnerable to negative hype. That can push it back to being the investment pariah.
Africa’s perception risk is of particular concern given that “negative or inaccurate international market perceptions about a sovereign issuer’s economy may develop due to a lack of comprehensive and timely information on the pursuit of appropriate policies, fears of instability stemming from political developments and unfavourable interpretations of economic or political pronouncements.”
When African economies suffer from internal political instability or terrorist attacks, these are prominently covered and sensationalised in local and global media and create negative global perceptions of Africa. This then undermines its “ability to secure access to international capital markets on a sustained basis, thus significantly increasing refinancing risk.”
Also, if Africa’s economies begin to weaken significantly as more developed markets recover, international markets may not be inclined to refinance, thereby forcing Africa to service the debt by cutting government spending in areas such as health, education and agriculture.
With a debt on the scale of the Eurobond, how much spending will have to be cut? It makes one shudder.
Another obvious risk is currency depreciation: Debt in foreign denominations may have to be paid when the borrower’s currency is weaker.
Interestingly, the opposite scenario is also a risk because like “other forms of capital flows, international bond financing has potential repercussions for exchange rate policy” since a shift to larger foreign financing “potentially implies appreciation pressure for the domestic currency [depending on the import content of the associated spending].” This may harm export competitiveness, a concern for African countries that need healthy exports to service foreign currency debt.
Kenyan media reported that in one of the Eurobond pitch documents: “The Treasury stated, as a key risk, that the informal economy is not recorded and is only partially taxed, resulting in a lack of revenue for the government, ineffective regulation, unreliability of statistical information and inability to monitor or otherwise regulate a large portion of the economy.”
So the government has handicapped revenue generation capacity linked to widespread economic informalisation (a long-term problem) yet the bond will mature well before the issue is resolved.
This is a simple illustration of how even acknowledged weaknesses in the economic infrastructure of African governments still carry real risks.
Willingness to accept debt at higher rates than in other financing packages may reduce access to low-interest vehicles like concessional deals, particularly if Eurobonds “generate new macrofinancial and debt vulnerabilities.”
All the above risks exist even if the funds raised are used responsibly. There may be delays in projects and low levels of competence but the assumption is that no one is trying to steal and engage in corruption.
Yet the monstrosity called corruption is a trademark of African governments and competent public debt management is not in place in many countries.
So there are real and present dangers in Africa’s love affair with Eurobonds. The natural question then becomes how the governments can manage all these risks, and opinions will vary on how to mitigate each of them.
Some may argue that many of the risks are unavoidable and part and parcel of getting into Eurobond deals. However, I posit that the risk that is most needless is corruption.
Interestingly, although corruption is the risk that could most seriously sabotage the positive power of Eurobonds, it is also the risk most readily addressed via Eurobonding itself! How? Well...
The writer is a lecturer at the Aga Khan Graduate Media School.
