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Cracks emerge in local bond fund plan

By Sid Verma
26 May 2010

The African Development Bank’s bid to mobilize domestic savings by creating a regional bond fund will hit a wall unless it stumps up cash and provides a credit guarantee, monetary policy officials warned this week

The AfDB’s bid to mobilize domestic savings by creating a regional bond fund will hit a wall unless it stumps up cash and provides a credit guarantee, monetary policy officials warned this week.

The AfDB is considering forming an African Domestic Bond Fund, through which it, together with African central banks, would invest in long-dated local currency government bonds in the region in order to jumpstart local capital markets.

But key potential stakeholders said thin liquidity and credit quality concerns would hamper the effort.

Konrad Reuss, director of sovereign ratings at Standard & Poor’s, said: “Barring countries in North Africa, South Africa and Botswana, the majority of [local currency government] bonds are rated BB or single-B.”

He said the lowest rated country would the primary driver in determining the credit quality of a fund “unless the AfDB provided a credit guarantee.”

As a result, Lamido Yuguda, acting director of the reserves management department at the Central Bank of Nigeria, suggested Nigeria would be cool on the local bond fund in its prospective form.

“We will not throw away our reserves. The AfDB must address the fact that we can only invest in high quality assets that have strong liquidity”, he said.

Yuguda – who argued that Nigeria’s $39.8 billion foreign exchange reserves were “excessive” – said the AfDB should work on developing a collateralized debt obligation, an investment-grade bond backed by a pool of junk bonds.

The AfDB, which is AAA rated, is not planning to guarantee the fund and would be constrained in its financial backing, Stefan Nalletamby, coordinator of the bank’s Making Finance Work for Africa project, said.

Nalletamby, who is spearheading the bond initiative, said: “We need to make sure our Treasury book itself is high-quality and that new investments don’t comprise our credit quality.”

He declined to give a figure on how much the AfDB could provide. AfDB financial specialists will pitch the initiative to board members next year, he said.

As well as aiding financial market development, Nalletamby said the fund would enhance monetary policy by helping African central banks to diversify their reserves, which across the continent are concentrated in low-yielding US-dollar holdings.

But former AfDB president Babacar Ndiaye shot down this rationale. “African central banks are all talking about diversifying their assets but won’t be able to do it because no asset in Africa is AAA or liquid enough.”

The non-convertibility of most currencies in the region is “the biggest constraint”, Benno Ndullu, central Bank governor of Tanzania, said. The AfDB should work on providing African central banks with currency swaps to incentivize the reserve managers to invest in local currency government bonds of neighbouring states, he said.

The AfDB initiative received strong backing from Emmanuel Assilamehoo, deputy director of market operations at Central Bank of West African States (BCEAO). He said: “this initiative will help us add liquidity to long-dated government paper and so aid the creation of sources of long-term finance.”

Nalletamby said the local bond fund did not have to be “big to make an impact as it would establish a precedent.”

By Sid Verma
26 May 2010