Could the rise of ‘original sin’ condemn African governments once more?
The case against African sovereign bond issuance – from a moral and debt-servicing perspective – is too bearish but local FX depreciation represents a risk.
Emerging-market (EM) fixed-income investing in the 1970s and 80s centred on the old-school punt on political risk: buy sovereign debt for yield in countries where the ruler, more often than not, has a large statue of himself erected in the central square of the capital.
The result: a foreign-credit boom across Sub-Saharan Africa (SSA), followed by a synchronized bust between the 90s and early-00s. As many as 30 SSA governments saddled with large-scale foreign debts, incurred by former kleptocratic rulers, received multilateral-backed debt relief for as much as $100 billion in total, eventually paving the way for the continent’s much-touted economic resurgence.
By and large, this torturous debt history meant the mere mention of Eurobond issuance aroused political controversy. Though Ghana broke ranks in 2007, issuing a well-received $750 million 10-year deal, followed by Gabon that year, sovereign bond issuance was the exception rather than the norm.
In October 2007, for example, Nigeria’s former finance minister Shamsuddeen Usman told this reporter the country would snub Eurobond issuance due to the stigma, despite pressure from the debt-management office for offshore issuance to diversify sources of financing. “Whenever a government talks about issuing debt, Nigerians get scared,” Usman explained.
Fast-forward to 2014: Nigeria, Senegal, Zambia, Rwanda, Gabon and Namibia, sovereigns with mostly weak debt histories, have thrown caution to the wind, joining the ranks of international issuers, driven by a bid to access long-term dollar financing for infrastructure investments, diversify sovereign borrowing sources and establish benchmarks for corporates at a time of record global interest rates.
According to Dealogic, 2013 was a record year for SSA ex-South Africa dollar bond issuance with six deals totalling $4.3 billion, compared with $1.7 billion the year before and $1.5 billion in 2011. This scale is significant, according to the Overseas Development Institute (ODI), using its calculation of sovereign bond inflows at $5 billion in 2013, this is equivalent to 20% of aid to SSA and 12% of foreign direct investment inflows.
The aggressive pricing of Eurobonds even with a turn in the global commodities cycle and jitters over China confirm foreign-investor confidence in the continent’s domestic growth engines. Technicals are at play too. Specialist funds have had no choice but to pick up African credits given the dearth of relatively high-yielding dollar-denominated EM sovereign paper. However, this flurry of issuance has sparked a backlash, with warnings over the moral hazard in financing governments, prone to corruption and economic mismanagement, and fears over debt-service capacity given rising aggregate sovereign debt burdens, the prospect tapering will trigger capital outflows from frontier economies and the risk local FX depreciation will increase foreign-debt servicing costs, dubbed the “original sin” risk.
For bookruners, both the moral-hazard and debt-servicing fears represent a reputational risk for their businesses, given the recent history of protests against both investors – seen to be demanding high rates of interests on developing-country bonds – and bookrunners in their capacity as facilitators of debt issuance for sovereigns for which there are question marks over repayment-capacity.
Michael Holman, the FT’s former Africa editor, is unequivocal about the risks. He writes: “...when investors buy bonds sold by sleaze-ridden governments, it is surely as dubious as giving a bottle of whisky to a known alcoholic. It is not against the law. But at best it is unethical and immoral, and the giver is complicit in the consequences.” Holman goes even further by arguing sovereign bond deals are a means of side-stepping the scrutiny and conditionality of multilateral lenders.
The recent history of African debt issuance is littered with bad omens: with war-torn Cote d’Ivoire restructuring its debt in 2011 after defaulting on its $2.3 billion 2032 bonds; in 2012, Gabon delayed a coupon payment, for the second time, on its 2017 paper; while in 2011, the Seychelles defaulted on its $230 million bond launched in October 2008, which represented a hefty 40% of GDP at the time.
Holman’s opinion-piece elicited a critical response from some quarters, citing the didactic and "Afro-pessimistic" tone.
@raziakkhan was a bit of an outdated, unsophisticated paternalistic sounding rant to have come from an ex-FT editor. Hasn't he read dambisa? — Andrew Alli (@afalli) April 9, 2014
Is this a moralizing tale from a westerner with undue credit given to the positive changes in debt metrics and public-financial management? After all, bookrunners for African sovereign bonds are keen to stress sovereign issuance in recent years has taken place in countries with relatively transparent and sustainable borrowing programmes, and subject to credit-rating agency oversight to assess the institutional capacity to absorb and allocate capital.
What’s more, Zambia's $750 million issuance in 2012, for example, was accompanied by reassurance the funds would be used to fund infrastructure projects, rather than for recurrent expenditure, meaning foreign markets, by and large, have not directly financed state largesse.
What’s more, public debt has only increased moderately, and African governments remain under-levered relative to the more developed EMs, with stronger capital markets and institutional capacity to absorb funds. According to an April report by the World Bank, debt-to-GDP ratio for the region has risen moderately from 29% in 2008 to 34% in 2013.
However, Dirk Willem te Velde, head of the international-economic development group at the ODI, urges caution, citing, in the main, currency risk. “The scale of the currency-rate risk is considerable," he says. "Ghana issued a bond in 2013 and its coupon rate was 7.875%. Interest rates on local debt can be 19% to 23%.
"Debt service on the Eurobond looks much lower at first glance, but would actually be very similar (7.875 plus 14.35 is around 22%) on domestic and sovereign bonds if we take into account annual exchange-rate devaluation [around 14% per year since 2007]. Ghana is also much more dependent on global conditions. This simple comparison suggests that it would be wise to pay more attention to the development of domestic bonds, as the currency risk is taken on by the bond issuer.”
In addition, the pace of growth of external debt payments in the form of sovereign debt, as a proportion of total debt, is a concern combined with bond issuance as a proportion of gross national income, says Willem te Velde, adding: “Given that tax-to-GDP ratios are normally around 10% to 15% of SSA, the debt payments can be between 2% and 5% of total tax revenues.”
(Willem te Velde says data on tax revenue are too patchy to assess and compare annual debt-service capacity between African economies.)
On the upside, however, the tide of capital has not been indiscriminate. African sovereigns, such as Ghana and Nigeria, have had to pay a premium for their fiscal laxity and current-account deterioration for the second Eurobond deals, while weaker countries underperformed during the May taper tantrum.
|Claver Gatete, Rwanda’s minister of finance|
There are some worrying precedents, however. Rwanda’s 6.875% yield for $400 million deal seems aggressively low for a single-B issue, its sub-benchmark size, and the fact it represents a hefty 6% of GDP and a third of government spending. Meanwhile, its principal source of FX revenues comprises international aid, suggesting a lack of credit differentiation and aggressive hunt for yield, decoupled from fundamentals, might also be at play in pricing terms, though Rwanda's finance minister Claver Gatete is upbeat about the country's growth prospects. What’s more, tapering represents a real challenge for SSA governments as dedicated real-money investors and specialist funds, the core foreign-investor base for SSA sovereign deals in dollars, are still modest in size.
In reality, however, Africa’s problem is not too much capital-market access for public-sector issuers but too little long-term funding in dollars for the private sector. While sovereign Eurobond paper is not always a pre-requisite for private-sector issuance – Nigeria’s Guaranty Trust Bank preceded the sovereign with a $350 million deal in January 2007 – it typically helps to establish price benchmarks for corporates and market the country’s economic model to foreign investors.
For all the recent negative headlines about African debt issuance – a notable break from the fashionable trend to wax lyrical about Africa’s promise – the irony is that the scrutiny of public accounts through rating credit-rating agencies and foreign-investor discrimination could help to reduce governments’ rent-seeking behaviour, while investing in infrastructure would nurture private-sector growth and, in theory, reduce the role of the state as a provider of marketable goods and services.
What’s more, starving countries of international capital is itself a form of sanction. After all, domestic pension funds have modest firepower – Nigeria’s fiscal savings-to-GDP at 1.7% contrasts with the oil-producer average of 65% – a blow to African government’s long-term infrastructure-financing needs, without foreign borrowing.
With rising foreign debt from private, rather than official, sources, the stakes for African governments for governance mis-steps are higher than in the past and foreign investors could face losses once global rates normalize. A decade - the most popular tenor for African sovereign issuance -, after all, is a lifetime in the region's economic and political cycles. However, judging by aggregate debt statistics and rising GDP, African sovereign bond issuance, by and large, does not feel like a credit bubble yet.