Africa’s Eurobond Risk More Nuanced Than ODI’s $11 Billion
Eurobonds, which are simply bonds issued in dollars rather than the local currency, have only been a fixture in African financial markets for the past eight years or so, with South Africa as the notable exception.
The financial crisis spurred rapid growth in the space; as interest rates dropped in the developed world, investors began hunting for higher bond returns further afield. For their part, African sovereigns were looking to finance their own growth and development, and a market was born.
“I don’t think it’s unexpected or inappropriate for these countries to be going into international markets simply because that’s where they’re going to find the most deep capital pools that are willing to participate,” Mohammed Yaseen Nalla, head of strategic research with Nedbank Capital, told AFKInsider.
That issuance doesn’t come without risk for investors. The Overseas Development Institute recently released a report which claims that these Eurobonds present a looming threat of $11 billion in potential losses due to currency risk.
The number is based on a 30 percent currency depreciation scenario across the issuing nations. Typically, a country that borrows in dollars has to pay back in dollars, so a sudden decline in the local currency could make those payments relatively more expensive.
But while the numbers are impressive, these claims don’t quite capture the nuanced ways that currency risk threatens African Eurobond issuers.
Simple view of Africa
The report itself points out that people often take an overly simplistic view of Africa and her myriad economies. The varying risks facing each nation — and the varying interest rates on their respective bonds — are testament to that. “You can’t assume there’s a one-size-fits-all approach,” Nalla said.
He said that investors need to do a “deep-dive analysis” into each investment opportunity. For example, as Tyson herself wrote, for commodity exporting countries that earn revenue primarily in dollars, the practical threat of her calculated currency risk is almost negligible. Nalla noted that the majority of issuers fall into this profile.
Nalla identifies the cyclicality of commodity markets as a major pressure point. “It is very hard to escape in any respect,” he said. “In the event of an exogenous shock [to commodity prices], the currency risk that you had thought you mitigated [as an investor] is translated directly into a credit risk, mainly because it severely curtails the ability of that country to make the repayment.”
In other words, for a dollar-earning nation, it’s not the currency movement that investors should be worrying about. Rather, it’s the commodity price volatility that often underlies those movements.
For some issuers, an inflexible monetary policy could make matters worse — not necessarily for investors, but for residents, who buy and sell in the local currency.
“I think all policymakers worry about the relative value of their respective currencies,” Angus Downie, head of economic research with Ecobank, told AFKInsider in an email interview.
“In many of Africa’s undiversified economies that are reliant on one or two key exports (such as Nigeria and oil), when global prices crash, policymakers running fixed/floating regimes are left with few options to reduce currency pressure.
Therefore, the move to more flexible, market-determined rates is more sustainable from a [foreign exchange] perspective.”
Another risk, which faces issuers and investors alike, is the burden of unproductive debt.
Tyson notes that some nations are more transparent than others in their use of funds, and that the use of debt for questionable purposes is not uncommon.
Two notable examples of less-than-stellar decision-making are Mozambique, which reportedly used funds raised for the fishing industry for military vehicles instead, and Ghana, which has financed public sector wage growth with debt.
Investors must thus scrutinize bond issues a bit more carefully, Nalla said. “I certainly agree with the statement they put forth in the ODI report that investors start paying more attention to what is happening with the money being raised,” said Nalla.
Now that African nations face the real issue of depreciation, low oil and other commodity prices, and the phasing out of quantitative easing, which spurred demand for high-yielding Eurobonds, is Africa being thrown into a tumult?
Not exactly. Rather, domestic bond markets are becoming more attractive. Ghana, for example, just issued a cedi-denominated bond. Downie said that it “was well subscribed, which underlines the strength of demand for [local currency] bonds.”
He said that more local issues would support greater local bond market deepening and enhance liquidity. The result could be a lower-priced and more attractive marketplace for sovereign bond issuers.
And perhaps this could solve another problem facing African issuers. A country like Ghana must choose between a relatively small and illiquid (not to mention expensive) local market and its deeper but difficult foreign counterpart when issuing bonds.
Those foreign investors can be fickle with their African allocations — swooping in to take advantage of high yields, only to flee when risk perceptions change or yields elsewhere improve. Domestic investors, such as Africa’s rapidly growing pension funds, could perhaps provide a measure of stability.
So, while both domestic and international markets come with their own risks, up until now the choice facing issuers choosing between the two was fairly obvious. With a deeper domestic market that choice could become more flexible.
“Africa has a favorable demographic pattern and as workforces continue to grow, as GDP per capita continues to grow, as incomes continue to grow, and as their markets mature, you’re going to get this increasing need for domestic denominated assets,” Nalla said.