Financing Africa: Moving Beyond Foreign Aid to Issuing Eurobonds

Most sub-Saharan African countries have long had to rely on foreign assistance or loans from international financial institutions to supply part of their foreign currency needs.  But now, for the first time, many of them are able to borrow in international financial markets, selling so-called eurobonds, which are usually denominated in dollars or euros. 

South Africa has issued eurobonds for a number of years.  But more recently, countries such as Angola, Côte d’Ivoire, Gabon, Ghana, Namibia, Nigeria, Rwanda, Senegal, Seychelles and Zambia have been able to raise funds in international debt markets.  Kenya, Tanzania and Uganda are expected to issue eurobonds in the near future.  In total, more than 20 percent of the 48 countries in sub-Saharan Africa have sold eurobonds.

This sudden surge in borrowing in a region that contains some of the world’s poorest economies is due to a variety of factors, including rapid growth and better economic policies, low global interest rates, and continued economic stress in many major advanced economies, especially in Europe.  In several cases, African countries have been able to sell bonds at lower interest rates than in troubled European economies, such as Greece and Portugal.

Whether the rash of borrowing by sub-Saharan African governments (as well as a handful of corporate entities in the region) is sustainable over the medium-to-long term, however, is open to question.  The low interest rate environment is likely to change at some point, which will raise borrowing costs for these countries and reduce investor interest.  In addition, strong and sustained economic growth may not continue, which would make it harder for these countries to service their loans.  Moreover, political instability in some African countries could also make the situation more difficult for borrowers and lenders alike. 

To assess whether the favorable climate for bond issuance is likely to persist, it is useful to focus on factors that drive the cost of borrowing and determine the direction of capital flows.  So-called push factors affect the general climate for bond sales to international investors; pull factors are country-specific and depend to a degree on a country’s policies.

When global interest rates increase and concerns about the global financial crisis abate, governments in sub-Saharan Africa will have to compete for funding with other issuers.

Push factors indicate that the capital inflows driving the purchase of eurobonds issued by sub-Saharan African countries are sustainable only in the short term.  One reason for this is the currently record low interest rates in the United States are likely to increase in the medium term.  The other is a change in the risk appetite of foreign investors, which has been increasing as they search for higher yields than they can get in the U.S. and other safe havens.  This greater appetite for risk favors eurobonds from sub-Saharan Africa.  However, when global interest rates increase and concerns about the global financial crisis abate, governments in sub-Saharan Africa will have to compete for funding with other issuers.

Pull factors also indicate that capital inflows are sustainable in the short run.  Whether African countries will pull in capital over the long run depends on the ability of the policymakers in these countries to strengthen their policies.  Low-income countries in sub-Saharan Africa have been helped by stronger policy frameworks, improved governance, favorable commodity price trends and sharply reduced external debt burdens (at least for now).  The strength of projected growth in the region is also helped in part by supply-side factors, including an expanding natural resource sector.  According to IMF projections, the near-term outlook for the region remains broadly positive and GDP growth should reach 5.4 percent in 2013.  But downside risks have intensified, mostly stemming from the uncertain global economic environment.  

The spate of international borrowing by sub-Saharan African countries, at rates sometimes below what many euro-area countries are paying, is probably unsustainable in the long run, unless these countries are able to generate high and sustainable economic growth rates and further reduce macroeconomic volatility. 

Policy actions are therefore important.  First, short-term policy actions must continue to focus on achieving macroeconomic stability, maintaining debt sustainability, ensuring adequate use of proceeds from financing and investment in projects with high economic “multipliers,” avoiding the buildup of balance sheet vulnerabilities from currency and maturity mismatches, and managing the risk of significant slowdown or reversal.  Second, long-term policy actions should focus on developing domestic capital markets and institutions, and adequately sequencing the liberalization of capital accounts. 

Taking examples from a variety of countries, African policymakers could aim for successful second-best policies, and then transition to the best ones.

However, countries must also consider the net benefits of unconventional policies, because more conventional policies will take time to develop and implement.  For example, developing a well-functioning domestic bond market to attract domestic and foreign savings, especially in the long term, is not easy.  To that end, the conventional advice is that African countries must improve macroeconomic policies; debt management; and their regulatory, legal and market infrastructure, as well as develop their investor base.  Money markets are the cornerstone of capital markets and a natural place to start reforms.  Commercial banks are typically the largest investors in Africa and a well-functioning interbank market is key.  Ensuring the liquidity of domestic markets should also be a priority.

Implementing these conventional policies takes time, however.  Taking examples from a variety of countries, African policymakers could aim for successful second-best policies, and then transition to the best ones.  

First, regional solutions are promising.  By strengthening common institutions, the governments in the West African Economic and Monetary Union are increasingly able to mobilize domestic savings from banks and other investors in the eight union countries and issue Treasury bills and bonds separately from each other.  

Second, the diaspora should be better engaged.  Ethiopia has tapped savings from nonresident nationals by issuing diaspora bonds and Nigeria is planning to do the same.  Kenya marketed an infrastructure bond issue to retail diaspora investors and nonresident Kenyans can now send money back home using mobile phone payment systems. 

Third, natural resource wealth creates challenges that must be addressed, including how to ensure the efficiency of public spending arising from this wealth.  Nigeria and Angola have set up sovereign wealth funds which have the potential to fund infrastructure or other long-term projects.  

Most importantly, African policymakers must continue innovating if they want to raise the vast resources needed to finance the continent’s development needs.  Innovation will be risky but aid is simply not large enough and eurobond flows are just not stable enough.