It is almost a decade since a global civil society campaign convinced international financial institutions to drop tens of billions of dollars of debt owed by African nations. The World Bank, International Monetary Fund and other official creditors have swallowed more than $75bn in write-downs under the Multilateral Debt Relief Initiative and its predecessor, the Highly Indebted Poor Countries programme, freeing countries from the high cost of servicing loans taken out over years of political and economic instability during the Cold War.
The fiscal space allowed by debt relief was one contributing factor to a new African growth story that took off in the latter half of the 2000s, a narrative that drew huge direct investment and portfolio flows into the continent. That financial interest has evolved into a private debt boom, demonstrating African countries’ emergence as investable frontier markets. At the same time, however, the boom has prompted warnings that governments running fiscal and current account deficits may struggle to service large foreign debt portfolios, and that capital markets investors are unlikely to be as forgiving as the international public sector in difficult periods.
This year, sub-Saharan African Eurobond issuance is on course to surpass the record set in 2013. Sub-Saharan governments issued nearly $10bn worth of Eurobonds last year and the region’s sovereigns had already almost matched that target in the first seven months of 2014.
In the past two years, a dozen sub-Saharan African countries have taken advantage of the region’s new economic narrative of growth to raise money in international capital markets. With foreign aid declining and enormous financing gaps remaining across the continent, both for capital expenditure on infrastructure and to plug short term fiscal deficits, these countries are graduating from concessional lending to the capital markets. Yield-hungry investors have snapped up the bonds but analysts are concerned about the longer term implications of rising government debt, slow structural reform and worsening macroeconomic indicators in some of the region’s most important economies.
“A lot of people would call them junk bonds,” says Angus Downie, head of research at Ecobank Capital in London. “That’s slightly derogatory. But they’re high yield because there is potential risk embedded in them. It seems to me there’s a little bit of recklessness from the investors by jumping into bonds being issued by the sovereigns and the demand is so strong it allows the sovereign to push the yield right down.”
In May, the IMF warned African countries about the dangers of building up debt in foreign currency that they could struggle to service if international capital inflows reverse.
“It’s an interesting asset class and Ecobank is keen to support the Africa growth story, but I think investors need to know what they’re buying into,” Downie says.
BOND RUSH
The rush began in September 2012 when Zambia brought a long awaited $750m 10 year Eurobond to market. The bond was hugely oversubscribed and attracted a yield of 5.625%. Over the course of the following year, Angola, Rwanda and Mozambique also issued debut Eurobonds and Nigeria, Gabon and Ghana came back to market.
By the time Ghana had issued its $750m Eurobond in late July 2013, it seemed that the heat was coming off. The US Federal Reserve had indicated that it would begin to taper its programme of quantitative easing, leading investors to pull back from emerging markets.
Even though Ghana’s 2013 bond was oversubscribed, investors pushed the yield up to 8%, more than 100bp higher than the yield on a bond Rwanda issued two months earlier. In April, the yield on Ghana’s earlier 2017 bond had traded at 4.25%.
“The expectations around tapering were that possibly appetite would be reduced for these kinds of Eurobond transactions coming out of sub-Saharan Africa, but it appears that the opposite is true,” says Megan McDonald, global head of debt capital markets at Standard Bank in London.
She believes that the relative rarity of sub-Saharan African hard currency debt means that investors seek out issues even during uncertain market conditions. Africa still only accounts for 5% of total emerging market Eurobond volumes, despite the recent growth.
“That scarcity factor is also adding to the interest that we’ve seen on international capital markets for Africa,” she says.
Kenya’s long awaited Eurobond in June was, at $2bn, the largest issued by a sub-Saharan African sovereign to date. Cote d’Ivoire, a country recovering from decades of civil war, brought a $750m issue to market in July, surprising analysts by achieving lower yields than Kenya, despite defaulting on $2.3bn worth of Eurobonds during a political crisis in 2011.
“That was quite surprising but I do think there are some fundamentals underpinning it,” says McDonald. With Cote d’Ivoire’s GDP predicted to expand 8% this year, investors may be buying into the growth story as well as a commodity play — the country is the world’s largest producer of cocoa.
STARS LOSE THEIR LUSTRE
More surprising is that investor interest has continued despite the enormous difficulties faced by two of the earliest sovereign issuers, which were previously believed to be among the best-managed economies on the continent.
The Ghanaian cedi is the worst-performing currency in the world, having fallen by 30% in the first half of the year. The Zambian kwacha is not far behind, dropping more than 20% over the same period. Both countries have suffered from a combination of external market factors and rising domestic spending that have undermined their macroeconomic indicators and prompted investors to take flight.
For two decades, Ghana outperformed its regional peers in development indicators and poverty reduction. Its stable democracy and solid business environment brought in international investment, driving further economic growth. In 2011 it was the fastest growing economy on the continent, buoyed in part by the discovery of large reserves of oil and gas offshore.
However, the wheels had already begun to wobble in 2010, when the government introduced a new salary structure for civil servants, increasing the wage bill by 47% over the following two years until salaries consumed more than 70% of tax revenues. Public spending also spiked ahead of a closely fought election in 2012, leaving a deep hole in the budget.
By 2013 the wheels had come off entirely, with a fiscal deficit of 11% of GDP compounded by a current account deficit of nearly 14%. IMF data shows that debt levels in Ghana, which were 26% of GDP in 2006, after the country was granted debt relief by international lenders, will rise to more than 60% of GDP by the end of 2014. The central bank printed money to plug the government’s budget gap in the first quarter of the year and inflation has risen to 15%.
Zambia’s macroeconomic problems have been marginally less damaging but stem from the same root. An election promise to increase salaries and spending, without any appreciable rise in revenue collection, pushed the country’s fiscal deficit to more than 6.5% of GDP in 2013. The country’s current account slipped into a 2% deficit as foreign currency earnings from the mining sector fell.
The Zambian government went back to the capital markets in April 2014, selling $1bn in Eurobonds in an issue that was oversubscribed. The coupon on 10 year bonds rose to 8.5% as investors punished the country for its macroeconomic indicators. In June, Zambia announced that it would seek IMF assistance, prompting an immediate bounce in the kwacha.
Ghana should do the same to convince investors that it is serious about going through with the structural reforms that are needed to fix its stricken economy, according to Kaan Nazli, senior economist in Neuberger Berman’s emerging markets debt team in the Hague. Even so, he is not hopeful that the country will genuinely seek aid, despite talks scheduled to begin later in the year.
“I think this government has been very slow in reforms; they are facing elections in 2016,” he says. “The government thinks it can manage, it can grow out of the problem and keep the financial markets happy with the prospect of an IMF programme, but we haven’t seen anything that suggests they are willing to do anything that the IMF wants them to do. I think they would require a strong, front-loaded fiscal adjustment before engaging in a programme.”
TRANSPARENCY FEARS
Transparency and a lack of experience in dealing with the capital markets have added to investor concerns about Ghana, Zambia and other sub-Saharan African sovereigns.
“There are very few countries that have an investor relations type of culture,” says Nazli. Meetings with finance ministry officials can turn into discussions of construction projects and development indicators rather than metrics that excite capital market investors.
Nazli believes that to a large extent the return of the IMF is supporting the current interest in African debt, as investors believe that international financiers will backstop their borrowing and continue to move reforms forwards.
“There has been so much international support and involvement in the region, which I think has provided some encouragement to investors that even if things go wrong there will be international assistance available,” he says. “Kenya is in a successful IMF programme, Cote d’Ivoire as well and Senegal. I think it has given confidence to people that even the tail risks are low.”