April 6, 2017    4 minute read

What Lies Ahead for the Sub-Saharan Bond Market?

Growing Interest    April 6, 2017    4 minute read

What Lies Ahead for the Sub-Saharan Bond Market?

The downgrading of South Africa’s credit rating to non-investment grade (BBB- to BB+) serves as a reminder of how significant political shifts are to the prosperity of national economies. For South Africa, it was the firing of finance minister Pravin Gordhan which acted as the trigger for credit rating agency S&P to downgrade the country.

However, this event is not a reflection of how African economies have been doing as a whole over the past few years. Generally, African countries have seen stable economic growth. This has come at a time where sub-Saharan countries have looked at foreign currency debt more favourably – particularly Eurobonds.

What Is a Eurobond?

A Eurobond is a type of bond issued in any currency other than that of the originating country.  It is called a Eurobond as it was first issued in Europe. So for example, Canada could issue a Eurobond in US dollars and sell the bond to Australia. Canada would be able to sell the bond in any country other than the United States.

The key benefit derives from the flexibility of being able to choose a country of issuance with a more favourable regulatory market and interest rates.

Why Are Sub-Saharan Eurobonds Thriving?

Seychelles kickstarted sub-Saharan involvement with such bonds in 2006 with the issuance of a $200m Eurobond. Since then, a further 12 sub-Saharan countries have issued Eurobonds and the total value of yearly issuances has risen from $200m in 2006 to roughly $6.3bn in both 2014 and 2015.

Investor interest, notably from the US and Europe, has been so high that almost all of the issuances have been oversubscribed. Leading the way in oversubscriptions was Zambia’s $750m bond issued in 2012, which raised considerably more at $11bn.

The success of these bonds in raising capital can be attributed to two key reasons. Firstly, the continent has sustained a period of very sound economic growth over the past decade.

And secondly, interest rates have been low globally. The lower interest rates have prompted investors to look at other investments and sub-Saharan Eurobonds, with their much more attractive higher yields, have provided a good alternative option.

What Happens Next?

As noted above, the low-interest rates set by central banks (notably the Federal Reserve), have turned investors towards Eurobonds. However, it is widely expected that the Fed will hike rates on more than one occasion during the remainder of this year. If interest rates continue to rise, this may have an adverse effect on the appeal of sub-Saharan bonds.

Despite this concern, the subscription to the bonds should not be too widely affected if the countries on the continent focus on reducing fiscal deficits and stabilising macroeconomic frameworks. This can be seen in an analysis by economist John Mbu which concludes that markets tend to ‘reward’ countries with positive macroeconomic balances with lower interest rates on their bonds.

For example, Senegal’s economic growth from 2.4% in 2009 to 3.5% in 2014 is reflected in the fact that for each subsequent Eurobond they issued (three in total), paid interest rates were lowered on each occasion.

Beware of the Dollar

The continuing surge in the strength of the dollar is also a cause for concern. The vast majority of sub-Saharan Eurobonds are issued in US dollars, and so as the value of the dollar has risen, the nominal value of the bond has also increased.

In order to circumvent this, countries will need to consider financial instruments, in particular derivatives, with a view to stymie the increase in bond nominal values. Cameroon has already explored this option by taking out a €500m currency swap for its 2015 $750m bond issuance.

Conclusion

As political uncertainty continues to brew (Trump, Brexit, Greek debt crisis, China’s economic slowdown), this does not bode well for the interest rates that sub-Saharan countries will have to pay on their bonds.

The onus is therefore on the countries to implement risk management structures and institutional frameworks for debt management. This should allow the Eurobonds to continue to be a viable way of raising capital.

High interest rates mean that the capital raised will not be cheap and thus the nations will need to use the money wisely and focus on urbanising areas in an attempt to bolster GDP and economic growth. At a time where African countries continue to grow, issuing Eurobonds is likely to become a more common practice in the continent.

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