West Africa’s Non-Benign Benin Signal
In March even hard core frontier market investors raised eyebrows when tiny Benin, part of the West Africa CFA Franc Economic and Monetary Zone (WAEMU) dominated by Cote d’Ivoire and Senegal which previously issued abroad, floated a 500 million euro 8-year bond at an initial near 6% yield. It followed another debut deal from Uzbekistan, where the new President has embarked on far-reaching currency and trade reforms and the stock exchange opened to foreign funds with capital control modification.
Benin’s inaugural sovereign ratings were in the speculative “B” category, with Fitch pointing out that over 6% gross domestic product growth from cotton and cashew exports was offset by poor development indicators and weak diversification and external accounts. For two decades the country of 11 million with $11 billion in output has been under International Monetary Fund programs, and relied on agriculture and port activity often directed cross-border to Nigeria. That large neighbor is just emerging from recession, and Benin’s government infrastructure spending as a backstop will likely breach the regional 3% of GDP fiscal deficit target.
The IMF’s March report on WAEMU common policies pointed out that budget and current account gaps were increasingly funded through Eurobonds rather than regional central bank loan facilities and the Abidjan-based government bond market. Public debt approached 55% of GDP and servicing one-third of revenue in 2018, and the “structural impediments” of the local bond market include the lack of primary dealers and a single supervisor and depository stifling placement and secondary trading. External borrowing diverts from core stock exchange challenges such as increasing non-bank investor participation, and also dilutes the zone’s tighter monetary stance to preserve low 2% inflation and the CFA Franc-euro peg, the review suggested.
The global banks which led Benin’s offering may have wished to extend longstanding Francophone Africa relationships and tap favorable temporary high-yield appetite, but could attain dual long-term commercial and development returns through a model shift as technical advisers. They can compete with traditional development institutions like the African Development Bank, with its own dedicated data collection and market building initiative.
Cote d’Ivoire and Senegal Eurobonds in 2018 did not lift international reserves to the recommended five months imports range for the zone, although they covered almost 90% of the combined fiscal deficit. The current account gap rose to almost 7% of GDP on negative terms of trade with oil import demand, and the Fund found “shrinking room for maneuver” to avert debt distress. The average tax revenue/output ratio for the eight member group, which includes conflict and terror-prone Burkina Faso, Mali and Niger, was up only 1% the past decade to 15%. The original public debt ceiling was set at 70% in the aftermath of the 2000s HIPC official relief program when concessional financing dominated, but a 10% lower sustainability threshold is now in order in multilateral agencies’ view.
Banks are phasing in Basel III prudential standards over five years, as annual credit growth remains in high-single digits and concentrated on the public sector. Three large banks could not meet the new capital minimum, and bad loans were almost 15% of the total in mid-2018. A repo market does not yet exist to support broader bond transactions, with banks at rollover risk especially if existing sovereign instruments are of limited collateral use.
Cote d’Ivoire is projected to grow 7% annually over the medium-term aided by state enterprise restructuring, and its debt strategy envisions a two-thirds/one-third regional-external split. However, over the past two years the latter has been the main channel and foreign debt increased to 30% of GDP, and in net present value terms the debt distress trigger is close with the repayment profile, the IMF warns. Maturities range from 8-30 years, and officials are considering hedges with international counterparties for dollar exposure.
Senegal has only a policy support program with the Fund, but it too was admonished about vulnerabilities following “breaches” in debt-to-export measures and missing information on total liabilities, including to Chinese creditors under showcase road and stadium projects. President Macky Sall easily won reelection in February after opponents were disqualified, as critics raised questions about off-budget financing also reflected in asset manager research.
Countries have long promised simple improvements to the regional bond market such as aligning auction and syndication approaches, eliminating multiple regulators, and creating a private insurance and pension fund institutional base, but progress stalled amid recent access to global fixed-income investors. The Benin deal was a breakthrough as well as a wake-up call that the zone may have leverage and functional cracks. International issue underwriters could work to fix them for a more durable franchise, at the same time they seek immediate fees and returns, and the next Francophone exercise can commercially seize this frontier.