An increase in sovereign bond issuance across Africa over the last two years has been driven by both the demand side in its search for yield and the supply side on the need for infrastructure funding and the financing of deficits.
These factors have in turn been further driven by lower rates in the global markets than in local domestic markets, which have enabled African nations with (relatively) lower levels of debt to access dollar funding.
The need to fund budget deficits has arguably been one of the main drivers of debt issuance from SSA. The deficits of Ghana and Zambia ballooned over the last few years due to not only infrastructure spending, but also public sector wage increases and subsidies.
Zambia’s budget deficit in 2015 was recorded at 8.10% of GDP, whilst Ghana’s was at 10.40% in 2014, although since agreeing to an IMF programme in 2015, the latter country has seen its deficit come down sharply, which was recorded at 6.70% of GDP last year.
A senior Africa-focussed economist noted that external financing has factored into the servicing of such deficits across SSA, which has led to a build-up of debt. Although leverage across SSA in general remains relatively low, the region does still face debt-related difficulties.
Currency depreciation, widespread across the region, has increased the debt-to-GDP ratio of many SSA sovereigns. “This starts to look bad from a pure credit metrics standpoint,” said Regis Chatellier, senior EM credit strategist at Societe Generale.
The economist agreed, adding that currency depreciation – which was partly caused by slumping commodity prices and the size of some deficits – was driving up the external portion of outstanding dollar debt.
Although currency depreciation is increasingly a concern – the situation does have the potential to deteriorate rapidly – Chatellier noted that “we are not there yet.”
“In general, no SSA nation’s debt is unsustainable at this stage. They could still run into renewed problems, but the exchange rates have been more stable this year than last year – so large currency depreciations should be behind them, meaning there will not be large increases in public debt as a result of further devaluation,” the economist said.
On top of weak currencies, low FX reserves present a concern, particularly because these tend to be used to make repayments on outstanding liabilities. Chatellier stated that SSA sovereigns do not have ample reserves to ‘cushion’ them from repayments, unlike North African countries such as Algeria, whose reserves are substantial.
Algeria’s FX reserves stood at US$152.7bn in Q3 2015 according to Trading Economics. In comparison, even Nigeria’s and Kenya’s FX reserves combined do not amount to Algeria’s level, coming in at US$23.950bn as of September and US$98.09bn as of February 2016 respectively.
“This means that many SSA countries are dependent on risk appetite. The only way for them to repay their outstanding liabilities is to rollover their existing debt.”
The good news for SSA in general is that as their debt-to-GDP ratios remain relatively low – Nigeria’s debt-to-GDP ratio, for example, stood at 11.50% in 2015 – and their FX reserves, although small, are not yet perceived to be at critical levels.
However, the resilience of a country’s currency can impact its reserves. For example, following the (partial) removal of a currency peg against the dollar earlier this year, causing the naira to fall from 199 to around 284.50 to the dollar in June according to Bloomberg, Nigeria’s debt-to-GDP will have risen sharply – making it harder for the nation to repay its external liabilities. The currency has further depreciated and is now trading at 315.52 to the dollar.
Still, it appears that SSA sovereigns do seem to have some breathing room in this regard too. “Although weakening currencies versus the dollar will cause debt matrixes to deteriorate, again, this is not yet of concern,” Chatellier said.
In addition, relative political stability – meaning no Mozambique-style debt revelations – ensures that on the whole SSA sovereigns are able to continue to issue debt. “It is important for these countries to maintain some credibility to this end,” he continued.
Both concessional and Eurobond financing will factor into the future funding plans of SSA nations. Although concessional borrowing will be taken where possible, simply because it is cheaper, this would need to be ‘topped up’ with Eurobond or domestic issuances.
However, of the latter two options, Eurobond issuances are likely to be preferred. The economist noted that although Nigeria and South Africa have large domestic markets, other countries such as Ghana do not.
Despite currency depreciation, there is still appetite for African paper and the cost of international borrowing has fallen since a peak at the end of last year – meaning countries without a large local market can turn to the international markets.
“Ghana is one of the most heavily indebted SSA sovereigns, and even it was able to achieve cheaper pricing on its US$750mn 5-year Eurobond issued in September compared to last year’s issuance,” said the economist. Ghana’s September Eurobond was 4x oversubscribed, and carried a yield of 9.25% at the time of issuance. The country’s debt-to GDP ratio stood at 67.60% in 2014.
The economist added that Kenya and Nigeria were also likely to issue soon, although in the latter’s case, only pending approval from the Senate, which just sunk President Buhari’s plans to borrow US$30bn abroad to fund infrastructure projects and budget needs until 2018.
Although the hunt for yield is driving interest in higher yielding debt, the relatively strong fundamentals of SSA sovereigns assist in gaining investor interest.
These counties are also in a somewhat stable position at present because many have issued quite recently, and the majority of their repayments are relatively far from now. This gives them some room for manoeuvre.
Credibility however remains one of the overriding factors, and without it SSA nations would not be able to attract international interest. For example, although Kenya’s budget deficit is high, recorded at 8.10% of GDP in 2015, the country can only legally borrow for capital spending – meaning projects such as rail, road, power and infrastructure.
“If funds are spent on wages and subsidies, or are misused through corruption, for example, then borrowers will likely to struggle to get funds (Mozambique being a prime example). But so long as the borrowing is for capital spending to further develop the economy, this is not a problem,” the economist stated.
As an example, although Ghana’s debt-to-GDP ratio is now around 70%, it is falling, according to the economist, who expects it will continue to fall. GDP is also expected to accelerate on increased oil production – and hence investment.
Zambia on the other hand, will likely see its debt-to-GDP ratio rise as the country has not got rid of government subsidies. As a result, it will likely need to rely on IMF assistance because private lenders will not see any funds they provide being put to good use, the economist continued.
Although sovereigns will need to retain credibility to issue debt in the future to refinance these maturities when they come, rate hiking cycles across DMs could impact investor sentiment on the region through no fault of its own.
Chatellier noted that although a one off hike from the Fed would not change the bigger picture, a widespread hiking cycle would have an impact, and not just on SSA but on EMs as a whole, but he added that the Fed would be unable to hike at a sustained pace at present.
Besides, the economist noted that African exchange rates tend to react more to domestic developments than global developments.
“Although a Fed hike would have an impact, if a country makes a policy misstep, there will be a much bigger reaction in the currency markets than on external monetary policy,” he concluded.