The official debt relief granted to sub-Saharan African countries provides many with scope to increase spending on priority areas, but financing needs across the region remain vast: for infrastructure alone, some estimates put spending requirements at 9–13% of GDP per annum over 10 years, or around $40 billion a year. Meeting this burden, over and above existing spending commitments and budgetary support – for which many countries still rely on donor resources – is a major policy challenge.
Donor flows alone cannot fill the gap. The international financial institutions (IFIs) and donors have publicly said as much, yet they remain fearful about a renewed unsustainable debt build-up. In reality, it is only appropriate that African states should seek to escape decades of aid dependency, which means looking to the private sector.
So governments in the region will need to turn to domestic and international capital markets as they seek alternative sources of capital. This is partly because the scope to raise domestic savings, at least in the near-term, is also limited, although remittance inflows may help.
As a pre-condition, this will require the continued pursuit of sound monetary and fiscal policies, which many African countries are already delivering, but it will also require measures to improve domestic capital markets and encourage private capital flows to Africa, as recognized by IMF and G7 initiatives. From our experience, we can see important steps that would improve both domestic debt and equity markets.
Home grown debt
With access to international capital markets limited, or more accurately restricted by the conditions of HIPC programmes, some African governments have been active in developing their domestic debt markets, and opening them up to international investors. Moderate levels of domestic debt can have a positive effect on economic growth, but this also raises significant policy issues. Donors have expressed anxiety about the high cost of domestic debt compared with concessional financing; local capital markets are generally shallow, so maturities are often short, which raises refinancing risks, while secondary market trading is virtually non-existent. This means that expanding domestic debt markets will require deepening the whole financial system and reviewing local investment regulations.
If domestic debt markets are to develop, it is also vital to improve local debt management, which has generally lagged behind efforts at debt relief. Countries need a clear debt management plan and issuance strategy, which might include publishing a debt management report, lengthening the yield curve, building benchmark issues as conditions permit and widening the investor base. Results of government debt auctions need to be published on a timely basis and, as markets develop, publishing an auction calendar in advance would help improve market transparency. Governments are sometimes reluctant to do this because volatile market conditions can disrupt issuance plans, but a move away from opportunistic debt issuance should bring longer-term benefits.
fears
The IFIs have many concerns about the development of domestic debt markets, accessible by non-residents. Such a development blurs the traditional boundaries for assessments of debt sustainability, which tend to focus on external debt only and must become more sophisticated to include domestic debt. There are also fears about vulnerability to capital outflows. Investors should not try to pressure HIPC countries into rapid capital account liberalization – a gradual process is appropriate, including careful sequencing to ensure the existence of a local secondary market before foreign funds surge in.
In any case, this focus on domestic debt markets should not ignore the role that can be played by prudent use of borrowing on the international market. The limited size of local debt markets means that not all financing needs can be met domestically, and external commercial borrowing may also be cheaper than domestic debt, by removing the inflation and currency risk faced by international investors. Finally, it also fits in with the need to maintain a diversified funding mix. African governments now seem ready to test international investor appetite with sovereign issues, and Ghana’s milestone Eurobond issue in September points the way – the Ghanaian government could not have raised $750 million at a yield of 8.5% in the local market. African companies have also been active in the international market, especially telecoms and banks, and we believe international bond issues will be a significant feature of corporate Africa going forward.
We believe developing Africa’s largely nascent equity markets should also form part of the post-HIPC financing strategy. This will help further develop local sources of capital, raise savings and foster an entrepreneurial private sector.
African equity markets, although in their infancy, are growing rapidly. There are only 15 countries in sub-Saharan Africa (excluding South Africa) with a local stock market. The markets tend to be small, with low levels of turnover and liquidity. With a combined market capitalization of $80 billion, these markets represent only 10% of the market capitalization of South Africa, and turnover averages in a year what South Africa manages in a week. Yet, there are significant opportunities for investors. The Exotix market capitalization weighted index of sub-Saharan African equity markets (excluding South Africa) is up 39% year-to-date (end-September), after a rise of 36% in 2006. Returns on African equities also display lower volatility than other emerging market regions, offering great potential for portfolio diversification.
But there is clearly more to do in developing Africa’s equity markets. Dealing costs in sub-Saharan Africa stock markets for example are on average three to four times more expensive than in other emerging markets. Encouraging greater competition, promoting a more investor-friendly environment and creating a more supportive regulatory structure would all help to develop Africa’s emerging stock markets.
The private sector can – and will – play a much greater role in financing Africa. IFIs and relevant authorities need to create the right enabling environment rather than stifle these opportunities, allowing private finance to complement traditional donor sources, balancing their valid concerns over the possibility of a fresh build-up of unsustainable debt with the importance of letting Africa graduate from aid. After all, is that not the point of debt relief?
Stuart Culverhouse is chief economist at Exotix, a specialist brokerage in emerging market illiquid debt and equity. He was previously an economist for the UK government