Credit | EEMEA | Fiscal Policy
– African Sovereign Eurobonds have lagged the broader EM rally
– Debt sustainability must be assessed on a country-by-country basis
– Transparency and financial innovation are key for creditors and debtors
– New instruments are needed to respond to the crisis
A recent article argued that debt forgiveness for many African governments is inevitable. Investors remain reluctant, too. Since the height of the Covid-induced sell-off in March, most financial assets have experienced a remarkable recovery. The spread of JP Morgan’s Emerging Markets Bond Index Global Diversified has narrowed by more than 300 bp to about 420 bp.
Africa stands out as an underperformer. The spread over the broad index remains at an elevated level relative to the past ten years – a period in which the African complex has more than doubled its index weight. Many African governments seized the opportunity of low global interest rates by issuing Eurobonds. The current crisis now turns out as the first litmus test for the ‘new kids on the block’. Covid-19 is putting pressure on comparatively weak healthcare systems and exhausts the oftentimes already limited fiscal space. But some countries are better prepared than others to withstand the storm. While debt metrics in the region have generally deteriorated, there are significant differences across countries. A clear-cut answer to the question on whether debt is sustainable does not exist. Consequentially, haircuts on Eurobonds to potentially restore debt sustainability or create urgently needed fiscal space are, in the majority of cases, not the appropriate means.
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- African Sovereign Eurobonds have lagged the broader EM rally
- Debt sustainability must be assessed on a country-by-country basis
- Transparency and financial innovation are key for creditors and debtors
- New instruments are needed to respond to the crisis
A recent article argued that debt forgiveness for many African governments is inevitable. Investors remain reluctant, too. Since the height of the Covid-induced sell-off in March, most financial assets have experienced a remarkable recovery. The spread of JP Morgan’s Emerging Markets Bond Index Global Diversified has narrowed by more than 300 bp to about 420 bp.
Africa stands out as an underperformer. The spread over the broad index remains at an elevated level relative to the past ten years – a period in which the African complex has more than doubled its index weight. Many African governments seized the opportunity of low global interest rates by issuing Eurobonds. The current crisis now turns out as the first litmus test for the ‘new kids on the block’. Covid-19 is putting pressure on comparatively weak healthcare systems and exhausts the oftentimes already limited fiscal space. But some countries are better prepared than others to withstand the storm. While debt metrics in the region have generally deteriorated, there are significant differences across countries. A clear-cut answer to the question on whether debt is sustainable does not exist. Consequentially, haircuts on Eurobonds to potentially restore debt sustainability or create urgently needed fiscal space are, in the majority of cases, not the appropriate means.
Note: Chart shows amount outstanding of respective issuances, i.e. takes into account liability management of Ivory Coast, Gabon and Ghana and does not consider matured bonds
The Magnitude of Fiscal Challenges Greatly Varies Across Countries
Disregarding the unfortunate case of Mozambique,[1] debt levels in the region have risen by almost 30%-points from about 29% of GDP in 2010 to 59% by the end of 2019 – a trend that applies for oil-exporting as well as oil-importing countries. In most cases, the increase in external debt has been the predominant driver (Chart 2). Eurobond issuances are one factor in this equation. Cheap credit from China is another. Borrowing on commercial terms has become increasingly popular.
Higher interest payments also reflect the rising debt burden. In 2010, the average of interest payments over revenues amounted to about 6%. Now governments use 15% of their income to afford their debt. Importantly, for many countries such as Ivory Coast, Senegal or Gabon, the number, albeit higher than in 2010, is still within a manageable range (Chart 3). These countries have been engaged with the IMF in the past and also intend to do so in the future. Broadening the revenue basis is never an easy task. Ethiopia along with the oil exporters witnessed a decline in revenues as a share of GDP over the last decade.
Some countries did, however, achieve notable progress. Ghana generated revenues as a share of GDP of almost 16% in 2019. In 2010, this number was only at 12.5%. Yet, Ghana also stands out as one of the countries where interest payments account for a large share of revenues of 38%. Similar to Kenya, it can obtain financing on a local market. However, the yield the governments pay on a 7-year local bond versus a Eurobond with the same maturity are about 300 bp higher in the case of Kenya and a whopping 1000 bp higher in Ghana. The weakest links are Angola and Zambia. But again, their fundamentals differ and with them their capacity and willingness for reforms. In 2018, Angola went on a boat with the IMF and delivered primary fiscal surpluses of an impressive 6% for two years on the run. In contrast, Zambia rather appears as an expert in not engaging with the IMF, posting budget deficits that can amount to 10% of GDP even in non-Covid times.
Note: Many countries in African have rebased / re-estimated GDP data over recent years lowering debt ratios. Ivory coast data refer to the old GDP number.
Longer-term Outlook For African Eurobonds Still Promising if Crisis Managed Correctly
Sub-Saharan Africa has an age dependency ratio of 83%.[2] The region’s median age is 20. Some countries achieve growth rates of 7% or above in normal times – a growth story most other regions in the world lack. But few people can set aside savings. Poorly developed financial markets are ill-suited to finance the investment needed to ensure long-term growth. The region on aggregate ranks 138th out of 190 countries/regions in the IMF’s financial development index.
Over the past ten years, the region’s net international investment position has grown from -9% to -24% of GDP. Capital imports total on average 7.5% of GDP per year, with portfolio inflows contributing substantially. A broader wave of (disordered) sovereign defaults would risk this access to capital markets – maybe not forever, but for a time long enough to weigh on economic growth. Fears of more defaults could cause nervousness among investors, thereby leading to higher interest rates for all borrowers in the region. Given the complexity of African debt, with China being the key actor in many cases, negotiations could be time-consuming.
A coordinated and transparent way is needed to create fiscal room where needed. Various ideas have been brought up including Special Purpose Vehicles or Social Development Goal Bonds where an independent entity is to monitor the use of proceeds. These ideas are headed in the right direction. In addition, the finance industry has not kept up with the changing environment. Supporting the lower income economies by providing capital fulfils an integral role for inclusive and sustainable growth. However, the classic Eurobond format offers no room to manoeuvre in the case of unforeseen external shocks. Special (natural/health/climate) disaster clauses that allow for a greater flexibility in coupon payments could become a new norm for poorer countries when issuing a bond. Such mechanisms would enable investors to remain engaged in testing times.
- Mozambique experienced a scandal on hidden debt. After the government had failed to declare USD 2bn of additional loans, donors stopped lending to the country. ↑
- Source: https://data.worldbank.org/indicator/SP.POP.DPND,
Worldbank Definition dependency ratio: Age dependency ratio (% of working-age population): Age dependency ratio is the ratio of dependents (people younger than 15 or older than 64) to the working-age population (those aged 15-64). ↑
Alina Eidt focuses on Emerging and Frontier Markets both from a research as well as an investment perspective which also includes ESG aspects. She has started her career as an Investment Strategist for Emerging Markets at Deutsche Bank and holds a MSc in International Economics and Public Policy.
(The commentary contained in the above article does not constitute an offer or a solicitation, or a recommendation to implement or liquidate an investment or to carry out any other transaction. It should not be used as a basis for any investment decision or other decision. Any investment decision should be based on appropriate professional advice specific to your needs.)