Sunday, March 17, 2013

The African Bond Bubble?

The FT reports of a number of sub-Saharan African countries rushing to raise foreign currency denominated debt. In September 2012, in a heavily overs-subscribed offering, Zambia raised $750 million as 10 year dollar denominated debt at an yield of 5.625%, lower than Spain sovereign bond yield at that time. Rwanda and Angola have announced plans to raise $350 m and $1 billion respectively, and Nigeria and Ghana too are expected to enter the market.

Unlike Latin America and Asia, Africa has had very few foreign currency denominated bond offerings. Currently, only 13 out of 54 African countries have issued foreign currency denominated debt. Multi-lateral and bilateral financing have formed more than three-quarters of external debts in Africa.

The current interest in emerging market debt has to be seen in light of the global liquidity glut engendered by the ultra-low interest rates in developed economies. With debt market yields hugging the bottom, investors have been looking at exotic markets in search of yields. Even the emerging market bond yields have been falling. Zambia was able to raise debt at such low rates despite its offering being rated "junk" (B+) by S&P.

Predictably, the number of African countries trying to raise foreign currency denominated sovereign debt has led to concerns about its repayment and the "original sin" of a Latin American style potential future debt crisis. The low rates does not tell anything about the risks posed by exchange rate volatility and the country's balance of payments (BoP) position. A depreciating currency would increase the effective repayment rates, while a weak BoP position would strain the repayment capacity.

Zambia, for example, is heavily reliant on Copper, which forms 80% of its export basket. Any volatility in exchange rates will therefore have dramatic effects on its real debt burden. Its currency has depreciated by over 40% against the US dollar since January 2008. Others are similarly exposed, with small variations, to commodity prices and therefore forex market volatility could potentially affect debt sustainability.
Historical Data Chart
Given the widespread governance problems in all these countries, it is important that these debts are for clearly defined objectives. For example, debt raised to finance critical infrastructure investments are more likely to be effectively utilized and compensate the debt cost. In this context, multilateral loans for infrastructure projects can be dovetailed with foreign currency debt. The presence of the multi-lateral lender would not only increase expenditure side discipline, but also serve as a credit enhancement and contribute to lowering of the cost of debt.

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