Africa bond issuers are selling more of their debt on international markets. While the issuers’ intentions, such as mitigating the economic effects of the Covid-19 pandemic, are understandable, this debt could become a serious problem. We examine why this is the case.
Capital News Africa: From the Trading Floor – Week 16-2022
African issuers are increasingly relying on international bond markets for funding. According to the accounting firm PwC, the number of bonds from African issuers in non-local currency rose to 94 in 2021 from 81 in 2020. The volume of those bonds totalled USD 47.5 billion, up 66% from the previous year.
Between 2007 and 2020, 21 of the 55 countries on the African continent tapped international debt markets at least once. The preferred instrument for the bond sales was eurobonds, which, at the end of 2021, totalled USD 140 billion. Moreover, several African countries have borrowed money either from China or from multilateral institutions like the World Bank or the International Monetary Fund (IMF).
In an article for the IMF regarding the African issuers’ success on international markets, the economist Gregory Smith says: “Investors are attracted by expanding economies, low debt levels after debt relief, much improved macroeconomic policies, and the opportunity to diversify their portfolios.” Smith adds: “Other factors also helped, such as historically low interest rates that triggered a global search for yield.”
We do not share the investors’ enthusiasm for African bonds in non-local currency. It is already clear to us that most of the African countries selling the debt will never be able to pay it back. Let us explain: When African issuers sell their bonds in USD or EUR, it is naturally very convenient for international investors. They get payments of interest and principal from the issuers in two currencies that are easy to exchange. For the issuers, however, these bonds can pose a problem as they must find the necessary cash to honour payments of interest and principal. And unfortunately, the projects financed by these bonds are normally not those that provide that cash.
As a result, many African issuers are violating the principle of currency match. This stipulates that the proceeds for and the revenues from a certain project must be in the same currency. International bond investors are aware of this violation. They remember well that the US government used this kind of leverage in the past to make some foreign governments more amenable to its wishes. Today, China is accused of luring some African governments into a debt trap, as Bloomberg reported recently. We can’t speak directly to the veracity of the charge, but we also feel that the IMF and the World Bank are not above reproach in this regard.
Of course, the currency mismatch will push up borrowing costs for African issuers. Says Smith: “Eurobonds and other forms of market borrowing do not come cheap. The cost of eurobond borrowing reflects market participants’ judgments on the quality of the bonds being issued.”
Another problem is the fact that by selling their bonds on international markets, African issuers are subject to the whims of their investors. On this point, Smith writes: “While markets can be a useful source of financing, loyalty is not guaranteed. Sentiment can shift quickly.” Indeed, such a shift may not even be the fault of the issuers themselves. The markets can just decide to be less risk-averse and dump African bonds. Adds Smith: “This volatility, combined with the foreign currency risk and high cost of borrowing, can make eurobond borrowing hazardous.”
As we see it, the debate about African debt has largely been about its size. But such size is not a problem. The average debt load of African countries is less than that of Italy or Spain. But the capability of European countries to serve their debt is much higher – and their local currency is already the euro. Therefore, some African countries may run into trouble paying off their debts even if their debt level is relatively low.
In any event, Africa needs fresh capital to finance its infrastructure. Its railroads, power stations, electricity networks, airports, hospitals, schools and sea ports are either too small or in very bad shape. The need for more infrastructure finance also has to do with a growing population that, increasingly, is moving to urban areas.
African governments cannot find the funds for more infrastructure finance in part because it raises too little in taxes. There are three reasons for this: Incomes are generally too low to tax; the system itself is crumbling; and finally, too much public money simply disappears.
One solution for African governments could be the development of local bond markets. This won’t be easy, given the poor status of the tax system. Moreover, domestic investors will only be swayed by well-developed markets, including those that provide the necessary liquidity.
Even then, however, Africa will not be able to end its dependency on foreign capital but merely reduce it. Still, we think that should not be a reason to continue this dependency. As we have stated, loans are a very effective way of keeping borrowers submissive. A first step European development finance could do is to lend more local currency.