The International Finance Corporation has been instrumental in helping to develop capital markets across the emerging markets, and nowhere more so than in Africa, where the infrastructure investment requirement is so great. Philip Moore analyses the organisation’s three-pronged approach to local currency issuance.
It is doubtful that any organisation has done more to underpin the growth of local currency bond markets than the International Finance Corporation (IFC). That should not come as a big surprise. Its mandate, after all, is to promote the development of the private sector in its 184 member countries — the majority of which, by definition, are emerging or frontier markets.
That has called for a substantial commitment to lending in local currencies, although its total portfolio is “overwhelmingly” concentrated in dollars (71%) and euros (15%), according to a recent Moody’s analysis.
“The proportion of our local currency-denominated lending is still relatively low,” says Jingdong Hua, who joined IFC as vice president and treasurer after an eight year stint at the Asian Development Bank (ADB) in Manila, latterly as head of funding. “This is partly because in many countries where we lend, capital markets are still non-existent. But it is also because in frontier markets, nominal interest rates in local currencies are much too high because of inflationary pressures. From an internal rate of return (IRR) perspective, it makes no sense for borrowers to pay double-digit rates plus a spread.
“This means that in many countries, borrowers still have no choice but to borrow in dollars,” says Hua. “The problem with this is that although nominal rates may be much lower in hard currencies, it exposes borrowers to huge foreign exchange risk.” This has been in very clear evidence in recent months, with currencies in a number of high current account deficit countries nose-diving against the dollar since May, when global markets began to fret about the possibility of a reduction in US quantitative easing later this year.
This FX risk is what drives the IFC’s ambition of nurturing the expansion of local capital markets. “The vast majority of our clients are successful entrepreneurs whose objective is to grow their businesses, add value and create jobs without incurring currency risk,” Hua adds. “It is very clear to us that these private sector clients want bespoke solutions that match their own cashflows.”
At a broader macroeconomic level, Hua says, there are other compelling reasons for supporting the growth of local capital markets. He points to a recent IMF study on African capital markets that found there was increasingly strong evidence that well functioning corporate bond markets make an important contribution to economic prosperity.
The result, says Hua, is that over the last 10 years the IFC has provided more than $10bn in local currency funds in almost 60 currencies. “By a big margin we’ve provided more local currency funding than any of our peers.”
Much of that lending has been raised locally, in a series of ground-breaking issues with appropriately colourful names, ranging from El Dorado and Inca bonds in Colombia and Peru, to Atlas bonds in Morocco and Panda bonds in China.
Three point approach
The IFC’s total local currency issuance needs to be seen in perspective. Its funding strategy is based on what it describes as a “three point approach”. The most important of the three, by volume, is issuance in core markets such as US and Australian dollars. In 2012, for example, 60% of its $10bn funding for the year was accounted for by three global US dollar bonds. This year, the IFC expects its total funding to rise to $14bn, with dollar benchmarks playing a larger role than in previous years.
The second prong of IFC’s funding strategy is ensuring it retains access to a wide range of markets “to benefit from opportunistic and competitively priced transactions”. The Uridashi market is one example: in the first half of 2013, the IFC raised $900m in 19 bonds targeted at Japanese retail investors.
This leaves the promotion of emerging capital markets by issuing bonds in local currencies as the third component of IFC’s funding strategy.
The absolute volumes issued by IFC locally are less important for the evolution of individual capital markets than the contribution they make to the development of the essential infrastructure needed to support their growth.
“Even a triple-A borrower like the IFC needs to ensure that in order to have unimpeded access to local currency capital markets the necessary regulatory framework needs to be established,” says Hua. “This means that we need to work with local regulators, stock exchanges, banks and investors to put the essential building blocks in place, currency by currency, market by market.
“It also means that issuance in an individual currency is not our only objective,” he adds. “As well as issuing local currency bonds, we are also committed to supporting the development of the full gamut of complementary capital market products, such as credit guarantees and swaps.”
Issuance by the IFC in local currency markets is of limited benefit if it is done on a one-off basis. As Hua acknowledges, an initial transaction by the IFC will only do its job of supporting the development of local capital markets if it is able to issue on a follow-on basis, and — over the longer term — if this issuance acts as a benchmark or reference point for other borrowers.
Hua says there can be no better example of a country where the IFC has accomplished much of what it set out to achieve in the local currency market than China, where it issued its first Panda bond in October 2005. Some five years in the making, this Rmb1.13bn ($140m) 10 year bond led by CICC and Citic, and issued at the same time as a debut ADB offering, may not have led to the explosion of issuance from foreign borrowers in the onshore RMB market that some were predicting at the time.
But Hua says that the Panda initiative was an important step in the development of the local currency market. “I’m not implying that there was any causality, but when we went to China for the first time in 2005, the corporate bond market there was nascent, representing about 5% of GDP,” says Hua.
“Now it’s worth about a quarter of the economy. Since we went in and created a dialogue about the importance of the local capital market as a means of financing infrastructure, a regulatory framework has taken shape and a vibrant capital market has developed. The same has happened in a number of other Asian markets, triggered partly by international borrowers such as IFC, and partly by regulators determined not to allow a repeat of the Asian crisis to happen.”
Where possible, this means issuing in liquid format, which has informed IFC’s strategy in a key market such as Nigeria, which with a population of 158m is Africa’s largest country. It is the continent’s largest oil exporter. And although growth slowed to 6.6% in 2012, compared with 7.3% in 2011, the economy continues to expand at a healthy clip, with Standard Bank forecasting growth for 2013 of 6.7%.
At the same time, however, Nigeria remains blighted by widespread poverty, high unemployment and GDP per capita of $1,500, well below comparably rated countries. Nigeria is also hampered by the low level of diversity in its economy, with 65%-70% of government revenues generated by oil. It is also handicapped by its hopelessly inefficient infrastructure. As Moody’s comments in its most recent review, “despite elevated levels of investment, the country continues to face a chronic infrastructure deficit that weighs on productivity and competitiveness”.
That all adds up to a fairly long list of reasons why Nigeria is crying out for a deeper, more liquid and more transparent capital market. The good news is that both internationally and domestically, Nigeria’s capital market continues to expand. In 2011, it launched its debut internationally-targeted bond, a $500m 10 year transaction led by Citi and Deutsche that generated total demand of $1.25bn and was intended as a benchmark for other borrowers to follow.
Domestically, meanwhile, according to the IFC, debt markets have become “crucial sources of capital funds”. It notes that between the end of 2008 and December 2012, Nigeria’s total outstanding debt stock rose from N2.3tr to N6.tr, which is an increase from 9% of GDP to 15% in the four year period. The growth of the market has also paved the way for important initiatives such as the recent launch by Lagos State of N167.5bn debt issuance programme to finance in-state infrastructural development.
The bad news is that even after this impressive growth, Nigeria’s capital market still punches below its weight, and the absence of local currency issuance by IFC looked increasingly irrational given the importance of its lending programme in the country. Hua says that this year, IFC has made about $1.5bn of new loan commitments to Nigeria, which represents about 30% of its entire sub-Saharan African portfolio, which has itself expanded from about $200m nine years ago to a little more than $5bn this year. “Just imagine how beneficial it would be to the Nigerian capital market if half of that had been in local currency,” says Hua.
IFC kicked off its issuance in the naira market in February with a transaction that started life as an N8bn ($50m) five year bond and met with sufficient demand to warrant an increase to N12bn ($76m). Standard Chartered Bank Nigeria and the Nigerian investment bank, Chapel Hill Denham, led the IFC’s curtain-raiser in the Naira market, which was offered at a coupon of 10.2%.
Andrew Cross, manager of treasury client solutions for Africa, Latin America and the Caribbean at IFC’s Washington headquarters, says that the naira bond, which was placed entirely with domestic investors, was priced through the local government curve. Cross says that IFC adopts a pragmatic approach to pricing local currency bonds in markets which have credit ratings well below its own triple-A rating, but which also have at least two key privileges that neither IFC nor any other supranational has. Given that national governments determine tax laws and print money, there is an argument that their bonds should be regarded as the local risk-free asset, irrespective of their rating.
This would therefore imply that all other credits issuing in the local currency should price at a spread to the local government curve. That, however, would make the pricing of local currency bonds hopelessly uneconomic for a zero risk-weighted issuer like IFC, and would in turn hamper its efforts to support the development of local currency markets.
“We’re very conscious of the role we play in helping to develop local capital market, part of which is helping domestic investors to analyse and price credits,” says Cross. “But the pragmatic part is that you do a market no justice if you misprice credit, and there are often compelling reasons why our pricing should be below the government benchmark.”
Besides, Cross says that pricing below the government curve can be beneficial for local currency markets. “In some markets where we’ve been able to price through the sovereign, the domestic market has rallied quite aggressively, thus helping to reduce the government’s financing costs,” he says. “We’re careful not to claim direct credit for that, but we have been told that one of the reasons for this is that the presence of an IFC bond in the local currency market provides greater clarity about pricing risk.”
Some investors say that to invest in a triple-A issuer such as IFC in local currency in an emerging or frontier market defeats the purpose of taking exposure to the market in the first place. Cross says, however, that an IFC issue can act as a helpful introduction to a new market for investors. “IFC local currency bonds appeal to investors looking to familiarise themselves with settlement systems and credit mechanisms in new markets,” he says. “So they can be helpful for investors who want to take a gradual and methodical approach to putting new risks on their books.”
The naira initiative is one of several being undertaken by IFC across sub-Saharan African local currency markets. This has included setting up a pan-African domestic medium term note (MTN) programme allowing it to issue debt instruments with maturities of three months or longer in Bostwana, Ghana, Kenya, Namibia, Rwanda, South Africa, Uganda and Zambia.
In July, Zambia’s Securities and Exchange Commission granted approval for the issuance of up to 2.5bn Zambian kwachas ($460m) under the MTN programme. The following month, IFC announced that it had been granted permission by the Ghanaian regulator to issue regular cedi denominated bonds for up to a total of $1bn under the same pan-African initiative.
Not just Africa
While much of IFC’s recent focus has been on quite under-developed markets in Africa, it has also chalked up a number of other firsts in local currency bond markets over recent months. In Russia, for example, it launched its inaugural Volga bond in November 2012, raising Rb13bn (around $410m), soon after being granted approval by the Russian Federal Service for Financial Markets to issue rouble denominated bonds in the domestic market up to Rb23bn ($730m).
Keshav Gaur, manager of treasury client solutions for Asia, Europe, Middle East and North Africa (EMEA) at the IFC in Washington, says this five year bond was significant not just because it was its first rouble denominated bond. It was also a breakthrough for the Russian capital market as it was the first issue of its kind with a coupon linked to an index that broadly approximates the performance of the Russian Consumer Price Index.
“The idea was to create a bespoke inflation basket catering to the demands of Russian investors who need protection against the adverse impact of inflation on real returns,” says Gaur.
“The transaction was warmly welcomed by the Russian government which believes it could play a key role in widening the range of instruments available in the local capital market,” he adds. “We hope to issue several repeat transactions with the same structure.”
While local currency issuance by IFC in populous countries such as Nigeria and Russia has the obvious benefit of helping to grease the wheels of capital markets with very substantial potential long term growth potential, with a population below 10m the Dominican Republic is at the opposite end of the spectrum.
At the end of last year, IFC launched a so-called Taino bond for 390m Dominican Republic pesos, led by Citi. This was the equivalent of about $10m — which is microscopic, in comparison with most supranational public bonds, but as Cross says, enormous in the context of the local capital market. As well as being the first domestic placement by a triple-A rated issuer in the Dominican Republic, this was also the first IFC bond in the Latin American-Caribbean region which raised proceeds for on-lending to the local private sector. As the IFC announced at the time: “This creates access to local currency finance for the private sector while providing a viable channel for domestic savings to be directed into productive long term investments.”
Hua says that the significance of the Taino bond stretches well beyond the $10m it raised, because it will support expansion and innovation in the Dominican Republic’s financial services industry. “The proceeds were on-lent to commercial banks that in turn used the funds to create fixed mortgages in the country for the first time,” says Hua. “That has helped to stimulate competition in local market for affordable housing lending.”