| Published: 05 January, 2015 |
The market for African Eurobonds is buoyant, but there are fears that its growth will impede the development of liquid, local currency-denominated assets.
African Eurobonds have enjoyed a remarkable bull run throughout 2014, with analysts expecting this to continue for the foreseeable future as developed economies continue to pursue dovish monetary policies.
While the renewed strength of the US dollar made life tough for emerging market bonds in the early weeks of November, African debt held firm. Total returns on JPMorgan’s global Emerging Market Bond Index fell by 1.05%, and losses were particularly significant in Venezuela, Russia and Ukraine. Africa Eurobonds performed relatively well, losing just 0.48%.
Explosive demand
The market for such instruments, issued by countries and companies on the continent wishing to borrow without exposure to volatile domestic currencies, has exploded in the past decade. The notional amount of outstanding African sovereign Eurobond debt, which stood at $4bn in 2005, has now reached more than $60bn. In the same period, the Eurobonds issued by African corporates has increased from $7bn to $42bn. Investors are hungry for more – a $2bn debut issuance from Kenya in June was four times oversubscribed.
"Africa’s Eurobond market has grown exceptionally in recent years as offshore investors have sought higher returns they could not find in Western markets. It is unlikely to slow while global monetary accommodation remains so supportive,” says Stephen Bailey-Smith, head of Africa strategy at Standard Bank in London.
In particular, Mr Bailey-Smith points to the growing likelihood of the European Central Bank introducing a quantitative easing programme to ward off deflation as a positive development for African Eurobonds. This, coupled with low and stable long-term US Treasury yields, should see a return to form in the coming weeks.
This is good news for the borrowing ability of African countries, but many market participants are concerned that Eurobond issuance comes at the expense of genuine domestic liquidity and deeper, more flexible African capital markets in general.
Short-term solution
“Frankly, the rise in Eurobond issuance is not good for trading in African capital markets in the long run,” says one head of Africa trading at a large South African bank. “It doesn’t improve local liquidity, and makes it hard for participants to access and hedge exposure in individual markets.”
Excluding South Africa, only 13 sub-Saharan African countries are equipped with an investable local bond market. The situation is little better with regard to African currencies. The sub-Saharan region is still one of the most heavily dollarised on earth.
In 2012, six countries in the area had more than 30% of deposits denominated in dollars. In a further five, between 10% and 30% of deposits were in dollars. The South African rand is the continent’s only currency to feature anywhere near the top table of the foreign exchange market, making it to 18th place in the Bank for International Settlements’ 2013 survey of most traded currencies.
Attempts by African countries to address this issue have been sporadic and largely unsuccessful. The main focus has been de-dollarisation, pushed by central banks and governments keen to have more control over monetary policy. Zambia and Angola have made high-profile efforts in the area in recent years. In 2012, Zambia attached a 10-year jail sentence to the use of foreign currency in domestic transactions. The same year, oil and gas companies operating in Angola were required to pay tax and settle local contracts in kwanza only.
Both countries failed to secure the necessary buy-in from participants in the local economy and were soon obliged to retract these unpopular policies. “Attempts at de-dollarisation are often made through changes to the monetary supply and rules around the denomination of transactions, which can impose onerous burdens on financial market participants and ordinary companies,” says Nema Ramkhelawan-Bhana, Africa analyst at Rand Merchant Bank in Johannesburg.
De-dollarisation dilemma
Policy-makers in these two countries were caught up in a chicken-and-egg dilemma. De-dollarisation is generally initiated to improve liquidity and sophistication in local capital markets, but a certain level of liquidity and sophistication is required in the first place for it to succeed. When de-dollarisation was introduced in Angola, for instance, the limited local currency supply meant that oil producers operating in the country struggled to buy enough kwanza to pay tax revenues.
The sudden exposure to additional local currency risk also made life difficult for many firms. “Forward curves on most African currencies are extremely steep, so it is very expensive to hedge currency exposure. You have to be pretty certain that there’s going to be a big move to make it worth your while,” says Mr Bailey-Smith. “Involvement from institutional participants is therefore low, and corporates who absolutely have to hedge end up paying through the nose.”
Hedging currencies on the continent may become a little easier with the launch of a clutch of rand-settled African FX futures on the Johannesburg Stock Exchange (JSE) on October 4, 2014. The Zambian kwacha, Kenyan shilling and the Nigerian naira can now be hedged against a number of G10 currencies in three- and six-month tenors. The JSE hopes to expand into one-year tenors in fairly short order, and add the Botswanan pula and the Mauritian rupee to the product.
However, similar futures ventures, such as the US dollar/Zambian kwacha product set up by the Zambian Bond and Derivatives Exchange in April, have failed to attract significant volumes. Large South African banks have not been overly enthusiastic toward the JSE’s project, believing that the appetite for conversion of sub-Saharan currencies into the rand is currently too limited to make it worth providing liquidity in such products.
Opening up markets
In the face of weak demand, there is only so much that private ventures such as the JSE can do to boost currency and capital market activity on the continent. Market participants feel the real impetus must come from regulators. There is frustration that policy-makers have been focused on grand schemes such as de-dollarisation, rather than implementing smaller scale changes.
“For conditions to improve, regulators need to believe that freeing up markets is a good thing and will create depth, reduce costs and lead to stability. Most policy-makers across the continent do not share that view. Many are still concerned about large inflows into their markets having a destabilising effects,” says Mr Bailey-Smith.
Restrictions on capital market activity in Africa are legion. Ghana forbids foreign market participants from buying its sovereign bonds in tenors of three years or under at primary auctions. Angola does not yet have a stock market and the launch of a secondary debt market was still in development in mid-December.
Nevertheless, there are promising signs. The East African Community, comprised of Kenya, Rwanda, Uganda, Tanzania and Burundi, has announced it will eliminate restrictions on capital market activities within its borders, including bond and stock purchase and borrowing and lending from abroad, by 2015.
Meanwhile, South Africa aside, Nigeria has made the most progress in opening up its financial markets. Chief among the changes has been the encouragement of a diversified market in financial products. In April 2013, the first Nigerian exchange-traded fund was launched on the New York Stock Exchange. Real estate investment trusts and collective investment schemes have also been introduced. “These products took the mind of the traditional investor away from the normal manner of investing in individual stocks and expecting a 200% return, as was the case before the 2008 crash. The bond markets also saw a resurgence, with some instruments being traded on the Nigerian Stock Exchange, which enables small investors to buy small units of bonds traded on the floor of the exchange,” says Tope Fasua, chief executive of Global Analytics Consulting and a former banker in Nigeria.
These moves have helped boost confidence in Nigerian capital markets which, according to Mr Fasua, were widely seen as a ‘gambling den’ five or six years ago. However, there are still issues with market depth. Many major, well-capitalised foreign firms have refused to access the market due to concerns over volatility – although Nigeria appears to have quelled the ebola outbreak within its own borders, it still faces significant political instability from the conflict with Islamist groups in its northern territories. Falling oil prices add another element of danger.
To kick-start further financial markets activity, the Nigerian government introduced a five-year exemption on capital markets value-added tax in late October 2014. It is this sort of flexible, open-minded policy-making that Mr Fasua believes other African policy-makers can learn from.
“Nigerian regulators have bent over backwards and eliminated many of the things that may have been said to have impeded market development. They have also acquired a global-standard knowledge of capital markets over the years, bringing in expertise from some of the advanced jurisdictions abroad,” he says.
The Banker
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