Bothersome bond build-up

IFR SSA Special Report 2022
18 min read
Jason Mitchell

Rising cost of borrowing could precipitate a wave of Eurobond defaults in Africa. By Jason Mitchell.

Africa's sovereigns have piled on Eurobond debt during the past two decades, creating a real chance that other countries could follow Zambia's lead and default on their bonds over the next few years.

In 2021, there were 23 sovereign bond issuances out of Africa for a total of US$20.66bn, according to PwC. This was up from 14 for US$15.05bn in 2020 and represented a return close to 2019 levels, when there were 22 for US$25.63bn. However, the size of sovereign bond offerings is notably smaller than those from before the Covid-19 pandemic, averaging US$900m in 2021 against US$1.2bn in 2019.

Egypt was the biggest issuer last year, making up 33% of the total issuance, followed by Nigeria at 19%, Ghana at 14% and Benin at 8%. Sovereign bond issuance out of the region has been more muted so far this year.

Africa has 55 countries in total and each faces a different set of debt dynamics. However, alarm bells about rising debt levels started to ring louder in 2019, even before the pandemic struck. While the sovereign defaults in 2020 and 2021 that many people feared did not take place, there is uncertainty about how much medium-term debt sustainability has been eroded. The Ukraine crisis has also started to hit economic growth and the International Monetary Fund is now forecasting that sub-Saharan Africa's economy will only expand by 3.8% this year.

"Absolutely, there is a risk of more defaults during the next few years," said Gregory Smith, an emerging markets fund manager at M&G Investments and author of Where Credit Is Due, a book about African debt.

"During the past few years, there have been two massive shocks that have increased the cost of borrowing: the Covid-19 pandemic and the Ukraine crisis. The US Federal Reserve's rates tightening will also lead to higher borrowing costs in Africa. It's a huge challenge for many governments."

Total supranational bond issuance out of the region amounted to US$11.62bn last year (44 separate transactions) compared with US$6.2bn in 2020 (55) and US$9.4bn in 2019 (98), according to PwC. The African Development Bank has been the biggest player in supranational bond issuance, issuing US$35.2bn over the past five years (US$8.2bn of bonds issued in 2021). The next largest is the Africa Finance Corporation with US$3.8bn issued over the past five years (US$745m in 2021).

The average yield to maturity for supranational bonds has declined in recent years, from 6.48% in 2018 to 2.6% in 2021. Only 32% of sovereign and supranational debt issued in 2021 was of investment-grade status, while 36% was issued for the purpose of refinancing, according to PwC, compared to 19% in 2020.

African issuers – including corporates as well as sovereign and supranational issuers – have raised US$193.4bn of non-local currency debt from 566 transactions over the past five years, according to PwC. The increase in the past year can be largely attributed to the recovery from the pandemic-related economic meltdown of 2020. The total value of sovereign bonds issued increased by 37% between 2020 and 2021, while supranational issuance increased by 87% during the same period.

The issue for many African nations is the high level of public debt built up again since they enjoyed US$100bn of debt relief under the Heavily Indebted Poor Countries Initiative and the related Multilateral Debt Relief Initiative during the past 25 years.

Chinese whispers

Hard figures for African debt – especially that owed to China – are difficult to obtain, but sub-Saharan Africa had total external debt of US$583bn at the end of 2018, according to the World Bank. China is believed to account for the biggest slice of Africa’s external debt at US$152bn, according to the China Africa Research Initiative team at Johns Hopkins University.

As the poor quality of much of its past lending has emerged over recent years, Chinese authorities have sought greater control over new development lending and required more attention to sustainability. Loans are generally now on a smaller and more manageable scale than before and ambitious strategic visions of linking central Africa to China's Belt and Road Initiative – through integrated transport corridors – appear to have been abandoned.

One of the biggest transformations during the past decade has been the nature of the debt that African nations have taken on. Until 2010, it mostly took the form of bilateral or multilateral credit but, since that time, many sovereigns have assumed commercial debt with a wide universe of private sector creditors, including commercial banks, asset owners and managers, commodity brokers, export credit agencies, sovereign wealth funds, hedge funds and non-financial companies.

The instrument of choice has been Eurobonds, according to Smith. This growing issuance has meant African countries have increased their weight in the main emerging market bond indices. The bulk of the issuance has come from Africa’s larger emerging economies, such as Egypt, South Africa and Nigeria. But when compared to the size of their economies, that from the frontier economies of Ghana, Zambia, Senegal, Gabon, Ivory Coast and Angola has been sizeable.

Eurobonds appealed to African countries because they provided a means of quickly raising a decent scale of financing that governments were free to invest as they saw fit. In addition, the borrowing does not have the policy conditions that official lenders often attach to their financing. Sovereign Eurobonds have also been useful as a signal for attracting other capital flows to the private sector, as they provide a benchmark of country risk. Investors familiar with the country context are more likely to invest in a company from that same country.

While large, advanced economies such as the United States or Japan borrow in their own currencies, most African countries have a greater dependency on borrowing in another country's currency, which they are unable to print.

"This volatility, combined with the foreign currency risk and high cost of borrowing, can make Eurobond borrowing hazardous," said Smith. "While these risks can be managed by many of Africa’s emerging and frontier economies, market access does not currently make sense for all African countries. Many economies remain too small for the minimum scale of lending the markets require or lack the foreign exchange earnings to service borrowing beyond their access to concessional loans."

Hard-won access at risk

The access to international debt markets was hard-won. African countries pulled in the capital by turning their economies around after a prolonged crisis in the 1980s and 1990s.

Between 2007 and 2020, 21 African countries accessed international debt markets, many for the first time. The stock of African Eurobonds reached US$140bn in 2021, according to M&G Investments. Longer-dated bonds of 30 years, or more, have been issued and countries are utilising in euros as well as US dollars.

However, more than 20 low-income African countries were in debt distress or at risk of debt distress in autumn 2021, according to the IMF. Most sovereigns are current on their debt obligations but the debt servicing costs have started to gobble up an increasingly painful proportion of the countries’ taxation revenues.

For example, Kenya, Angola, Egypt and Ghana were respectively paying 20%, 25%, 33% and 37% of their collected tax revenue towards interest repayments in 2019, according to the World Bank. Africa has US$185bn in debt repayments due between 2022 and 2024, according to One, the global movement campaigning to end extreme poverty.

In February this year, Standard Bank red-flagged Ghana, Kenya, Angola, Ethiopia and Zambia, calling them the 'fragile five' and warning that they could soon face serious debt risks. It said Ghana would probably need an IMF bailout to be able to restore confidence in investors.

Kenya is considering cancelling plans to sell US$1bn of Eurobonds by the end of June because rising yields globally would make the borrowing more expensive.

Bond spreads for Ethiopia and Ghana have blown out since the Ukraine crisis started. Tunisia’s economy has been brought to its knees by recent wheat and medicine shortages. Egypt faces immediate debt servicing pressures, according to JP Morgan.

"I think many African sovereigns are in pretty shaky shape financially and that they have been so for a while," said Moritz Kraemer, chief economist and head of research at LBBW.

"I have little doubt that the outlook will become more difficult for them. For example, Ghana has become quite problematic and I do feel it was scraping the barrel with its zero-coupon bond issue last year. I interpret this kind of bond issue as a way of diversifying the investor base – it's a sign of weakness.

"We have been seeing a spike in yields and, in my opinion, the day of reckoning for many African sovereigns is coming closer. I think we will see a number of defaults in coming years."

Ratings, repayment and restructuring

In February this year, Moody’s downgraded Ghana’s long-term foreign currency sovereign rating from B3 to Caa1, with a stable outlook. The Ghanaian government was unhappy about the move and complained to the African Peer Review Mechanism, an organisation under the African Union, which undertakes routine reviews of rating outcomes assigned by international credit ratings agencies.

Zambia became the first African country to default since the pandemic started but others may now follow suit. In November 2020, it missed a US$42.5m Eurobond repayment. It is Africa’s second-largest copper producer and, as copper prices plummeted between 2017 and 2020, servicing repayments on its estimated US$11bn debt pile became increasingly difficult. Of Zambia’s external debt, 46% is owed to private lenders, 22% to China, 8% to other governments and 18% to multilateral institutions, among others.

Currently, Zambia is in arduous talks with its creditors about restructuring its debt. Mozambique and Seychelles have already managed to restructure their Eurobond debt.

The good news is that, while overall debt levels have generally risen during the past few years, help from development finance institutions and multilateral lenders has meant many African countries have been able to support their economies without taking on too much additional private debt.

The IMF has allocated Africa US$33bn in special drawing rights, providing an immediate liquidity boost without adding to the debt portfolio.

During the pandemic, the G20 put in place the Debt Service Suspension Initiative to temporarily pause official debt payments for the poorest countries, but it comes to an end this year, forcing participating countries to resume debt service payments.

China is among government lenders that have agreed to a longer debt repayment schedule for Zambia but private lenders, including banks, have so far resisted the move. At the start of 2021, Zambia applied for debt relief under a scheme known as the Common Framework, which was coordinated by the G20 and aims to help countries restructure their debt and deal with insolvency and protracted liquidity problems. However, Zambia has not yet had any debt cancelled.

Last year, Chad and Ethiopia also applied for debt relief under the Common Framework. The IMF says it has not yet been agreed, partly because it requires private creditors to participate 'on comparable terms to overcome collective action challenges and ensure fair burden-sharing'.

The Common Framework has not worked smoothly because of difficulties in coordinating the Paris Club and other creditors, as well as multiple government institutions and agencies within creditor countries. The IMF says new creditors – including relevant domestic institutions – need to gain comfort with restructuring processes that would allow all creditors to work together in providing relief and enable the IMF to lend to countries facing debt difficulties. That takes time.

Its implementation has also been complicated by China’s uneasiness with the central and independent role played by the IMF in determining how much a country can afford to pay through its debt sustainability analysis. Public and private sector lenders in the West have also been concerned over a lack of transparency in the total amount of debt African countries borrowed from China.

"I do not think we will see a deep, generalised debt restructuring this time round like in the HIPC era," said Clemence Landers, a policy fellow at the Center for Global Development, a Washington DC think tank. "Many African countries fall into two groups: those with a liquidity problem and those with a longer-term insolvency crisis. There are no major debt rollovers this year but African governments will have to make tougher decisions in coming years."

She said that a generalised debt restructuring is not likely this time round because the economic fundamentals of many African countries are better and because the universe of creditors is a lot broader.

"It is not clear that an enormous number of African countries are suffering an insolvency crisis," she said. "They have liquidity problems, that's true. It is also a lot harder to undertake a generalised restructuring today than during the HIPC era because there are so many types of creditor to coordinate today. The Common Framework has been an attempt to expand the architecture around restructuring but private creditors have not yet signed up to it."

She said most African sovereigns want to maintain market access and they are concerned about sending any signals, such as a debt restructuring, which could hinder future access.

The IMF says the Ukraine crisis is hitting Africa hard at a time when many "countries have little to non-existent fiscal space to buffer the shock". It recommends that the fiscal response by government must be targeted at protecting vulnerable people from the harsh economic realities brought about by soaring food and energy prices. This must be done in such a way that it does not complicate the region's 'debt vulnerabilities'.

Few winners

Higher oil prices may generate a windfall gain for the region’s eight oil exporters. However, for the other 37 countries in the region, they could worsen trade imbalances and increase living costs.

"Nigeria has had to pay quite a premium on its recent Eurobond issues," said Isaac Matshego, an economist at Nedbank. "In November 2018, it was able to issue a US$1.2bn bond with a coupon of 7.625%, but its latest issue had a coupon of 8.375%, so there has been a jump of 750bp. This is mostly down to the effects of the Covid-19 pandemic. The country witnessed a slump in oil prices and its fiscal position weakened considerably."

This year's surge in oil prices has started to benefit African oil producers such as Nigeria and Angola, he said.

"If it were not for this jump in oil prices, they would be paying even higher coupons. Some emerging African economies – including Nigeria and South Africa – have also been benefiting from institutional investors having to make a shift in their allocation away from Russia. Their money must find a home somewhere. The South African rand has been a lot stronger than many people had anticipated. International investors have been buying South African bonds and equities. In the case of Nigeria, they have been purchasing the country's bonds but will not invest in the stock market because of capital controls,"said Matshego.

Africa has been battered by two big crises in recent years: the pandemic and the invasion of Ukraine. Some African economies are benefiting from the recent hike in oil prices but most of them have become a lot more indebted during the past few years. Their governments must work hard to keep their finances under control so that they are not forced into a default.

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