Opacity and lack of information make for difficult investment decisions.
When Benin began the roadshow for its debut €500m bond in March, there was a familiar-looking disclosure tucked away in the prospectus that has been attracting increased scrutiny from investors.
The country said it is planning to spend close to US$1bn on a new international airport that is expected to be funded by the Export-Import Bank of China. Such Chinese-funded infrastructure projects are accelerating in Africa, with Chinese loans to sub-Saharan African countries rising to more than US$10bn annually between 2012 and 2017, from less than US$1bn at the turn of the century, according to Moody’s. Last September, China pledged to invest a further US$60bn in Africa over three years.
But as Africa’s debt levels have increased, so too have questions about China’s lending practices and what impact they are having on the capital markets landscape on the continent.
“There are some countries with higher concentration risk with China than others, but it’s something that investors are becoming more and more concerned about when we do due-diligence trips or meetings with officials,” said Kevin Daly, a fund manager at Aberdeen Standard Investments.
Part of the concern is that China’s loans are notoriously opaque. Often they are confidential, meaning there is little data on the size of the loans, the interest payments or when they are due to mature.
“Full and timely information on debt service schedules are virtually non-existent in many of these countries, at least not on a very contemporaneous basis,” said Stuart Culverhouse, chief economist and global head of research at Exotix.
“You might know what the position was two years ago; but when you really need it, when they are in problems, you don’t know.”
That means debt metrics can jump with little warning. In Zambia, for instance, Daly said the country’s external liabilities were US$800m in 2018, but this year they will shoot up to about US$1.4bn, largely because some of its Chinese loans are starting to amortise.
“Investors are having to become more forensic,” he said. “The key question is when do these loans start amortising. You also want to know what the loan proceeds are going towards and whether or not they are inflated, and then thirdly you need to know if they have any future commitments with China. You really have to push hard for this stuff.”
Cameroon, for instance, has a number of undisbursed loans from China that, if drawn down, would likely make its debt unsustainable, Daly said.
For now, such concerns are not denting appetite for the continent’s debt. African countries including Ivory Coast, Senegal and Kenya issued a record US$28bn of Eurobonds in 2018, about US$10bn more than was raised in 2017, according to Refinitiv data. So far this year, Ghana, Benin and Egypt have issued more than US$7bn of bonds between them.
SSA bankers are bullish that this favourable climate for African sovereign bond issuance is set to continue, not least because the US Federal Reserve has signalled it is unlikely to raise interest rates this year.
And while the availability of Chinese loans has probably taken some potential supply away from the bond market at the margins, most bankers view Chinese debt as complementary rather than a competitor they have to pitch against.
“If there are multiple sources to raise money, does that change the number of bonds that are issued in the market?” said Lee Cumbes, head of public sector for Europe, Middle East and Africa at Barclays. ”The likely answer to that is going to be yes, but it’s not as simple as saying if you do one then you won’t do the other,”
Yet as African sovereign borrowers pile Chinese loans on top of the roughly US$100bn of outstanding publicly issued bonds, problems could be being stored up for later were any of these countries to slide into financial difficulties.
“Restructurings will be more complex because of this bilateral lending and the fact it’s not fully transparent,” said Greg Smith, a fixed income strategist at Renaissance Capital.
“At the Paris Club last year, China was represented but they didn’t sit at the table, they sat back as an observer, so China doesn’t have to share data among the formal channels that most other countries have been traditionally working with.”
The China/IMF question
Given China’s close ties with many African nations, some market participants are now trying to gauge whether it might become the preferred creditor in a restructuring scenario and potentially wield greater clout than the International Monetary Fund.
“Everybody is talking about Chinese debt and starting to think about the balance of power shifting away from the IMF as the most senior lender and the one that pulls the strings with regard to bailouts and debt restructurings in favour of China,” said Bryan Carter, head of emerging market fixed income at BNP Paribas Asset Management.
Both Ethiopia and Zambia have recently appealed directly to China for debt relief, and Carter said as default rates creep up across emerging markets it is inevitable more will follow that path, including potentially higher profile and contentious cases.
“The question will be how does it all shake out in terms of the IMF’s role in a China-led debt environment,” Carter said. “That’s what we should be planning and preparing for.”
The IMF has so far been reluctant to provide financial aid to countries that have outstanding debt with China if China is not willing to be part of the restructuring process. The Republic of Congo, for instance, is trying to negotiate a programme with the IMF but has been unable to reach an agreement, partly because about 40% of the country’s external debt is owed to China.
That is one reason why borrowers might prefer to deal with China first. Another is that it is potentially easier to negotiate with one creditor rather than multiple lenders.
“If you can do it on a bilateral basis, that might give you the breathing space that you need,” said Culverhouse.
But bilateral deals can also be problematic. Take Sri Lanka. Having loaded up on Chinese loans to help rebuild the country after its civil war, Sri Lanka quickly found itself in financial trouble and unable to service its debts.
Instead of repayment, China seized access to a deep sea port it had constructed. Some critics accused China of playing debt-trap diplomacy and foisting on countries loans that Beijing knows have little chance of being repaid in order to gain control of strategic assets. But Smith believes these fears are overblown.
“After Sri Lanka, everybody was looking for what’s next but that is a pretty extreme case at the moment and that argument has been a bit too strong, it might become a concern but it just hasn’t happened,” he says. “If a German company bought a Mozambique port to run it, we’d all be fine with that. But because it’s China, it gets a lot more press.”
(See separate article for more on China’s involvement in Sri Lanka.)
Of greater concern to some market participants is the potential risk of a contingent debt ‘iceberg’ heaving into view. Those worries have become more elevated in the wake of Mozambique’s debt scandal in 2016 when the country revealed it had to restructure previously undisclosed loans, causing it to default on its bonds. Since then, investors and policymakers have been trying to gain a better understanding of how much contingent debt is lurking in Africa.
“It’s easy to figure out what public market bonds you have outstanding, but when you get to state-owned entities like national oil companies or power companies, and sub-sovereigns or state agencies, the governments quite often don’t know exactly what legal and contingent liabilities lie at that level,” said Michael Doran, a partner at Baker McKenzie.
“It is complex. That’s why it’s a bit of an iceberg; it’s hard to see what’s under the waves until you’re on top of it.”
The IMF has also warned of mounting debt problems on the continent. Six countries in sub-Saharan Africa are already in debt distress, it says, with a further nine at high risk of joining them.
Yet despite all the concerns, Africa still needs to borrow more money. Moody’s estimates that the funding gap between the continent’s infrastructure needs and its committed financing is somewhere around US$67.5bn–$107.5bn a year.
Cecil Quillen, a capital markets partner at Linklaters, said that while it is difficult to argue with the IMF’s prognosis, part of Africa’s problem is that it is not easy to digest such large inflows of capital during periods of rapid economic change.
“It’s not that borrowers are particularly undisciplined or are on crazed spending sprees, it’s more that there is a lot of capital funding to be done and it’s lumpy and the pacing of it doesn’t always optimally match the micro-cycles of economic development,” he said.
But there are some countries where a lack of fiscal discipline is unnerving investors. Aberdeen Standard Investments’ Daly reckons Zambia, for instance, could end up defaulting on its Eurobonds unless something drastic changes, such as walking away from its future Chinese loan drawdown commitments.
Others worry there is a danger that debt problems in one country could quickly spread.
“There is, I think, a possible regional to continental-wide risk of contagion because of the domino effect,” said Baker McKenzie’s Doran. “If a larger sovereign hits real distress, then without careful handling that has the potential to cause a stampede for the door.”
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