African Sovereign Bonds’ Devious Development

As Sub-Saharan sovereign issuers again line up after commodity and Ebola scares for initial and repeat market taps, the UK’s Overseas Development Institute pointed out in a critical report that funds have been diverted for “political spending” and that a debt surge to almost $20 billion could follow the pattern of previous Asian and Latin American crises. It noted “excessively high” interest rates and unfavorable terms relative to concessional official agency lines. Exchange risk has spiked with hard currency denomination and although the international investor base has widened it remains “fickle” and retail participation in the US may be dampened by regulator warnings. In both 2013 and 2014 over $5 billion was placed and 15 countries have been active with the average maturity at 10 years and yield 7 percent. In the primary market the latter has diverged between sovereigns with identical credit ratings, and global investment bank underwriters have not always achieved fair pricing, ODI believes.  On the demand side buyers have been lured by double-digit MSCI frontier stock index gains, the raw materials boom, and 5 percent annual GDP growth and better economic management until setbacks last year. Traditional donor darling Ghana raised policy questions with fiscal overshooting and currency depreciation, and the IMF lowered medium-term expansion projections. The Ebola epidemic caused jitters, and Nigeria’s and Zambia’s outlooks were downgraded. Foreign bonds mostly come under UK law but the New York court decision on Argentina entitling hedge funds to seize payment streams bred fiduciary caution. From a local financial market standpoint the absence of derivatives to hedge exposure is a gap which compels dollar and euro structures. However interest rate risk is low with fixed-coupons and liquidity concern is moderate with two-thirds of instruments with bullet repayments. An FX stress test in turn applying worst case 20 percent devaluation scenarios as in Ghana and Nigeria in 2014 would generate over $10 billion in losses across all regional sponsors with Cote d’Ivoire most devastated with a 12 percent of GDP hit. Debt sustainability is currently mixed as the ratio to GDP is 40 percent but fiscal deficits have again started to jump with export slowdown. Bank balance sheets in Kenya, Mozambique and Senegal are already under pressure from rapid credit growth and capital flow reversal would be an additional blow, according to the paper.

 Borrowers’ debt management capacity is limited, and parliamentary checks and independent audits can help verify proper proceeds use. Development agencies can provide technical assistance with system establishment and deal review and building domestic government and corporate fixed-income support. Risk-mitigation instruments can bridge the public-private sector divide especially in long-term infrastructure allocation, but default “bailouts” should be avoided, the organization recommends. That proposition may soon be tested in Nigeria after the postponed ballot is held as power projects are hostage to naira weakness and changing rules eroding guarantee and flotation foundations.

Posted in