There is no clearer sign of the strength of investor interest in emerging markets than the scramble for African sovereign bonds, but how long can it last? Published in Euromoney, November 2012
Zambia’s debut international bond issue in mid-September marked a new high point of interest in emerging market sovereign debt. Lusaka had set an initial target of $500 million, but $12 billion-worth of orders came in and the scale of the demand led the government to increase the size of the issue to $750 million.
Zambia was just the latest country in sub-Saharan Africa (SSA) to tap into the market. Besides South Africa, which has long been involved, there has been a steady stream of other issuers since 2006, when the Seychelles offered a $200 million bond. In 2007, it was the turn of Congo, Gabon and Ghana. They were followed by Senegal in 2009 and the Côte d’Ivoire in 2010. Last year, Nigeria and Namibia entered the market and Senegal returned to the scene with a $500 million issue.
All these countries have found a ready audience among investors keen to get involved in the growth of African economies, as more developed markets in Europe and the US are struggling. In a research report released in September, South Africa’s Standard Bank went so far as to describe African Eurobonds as ‘Teflon-coated’, which hints at the level of interest and confidence that now exists.
"There has been plenty of liquidity out there for most of the year, and that liquidity needs to be put to work," says Florian von Hartig, global head of debt capital markets at Standard Bank.
With the problems with some European sovereigns, investors are looking for safe havens. Emerging markets have been the biggest beneficiaries of that trend, and any transaction that is reasonably priced from that area, from Africa in particular, will see a strong demand in primary and good follow-through trading. We’ve seen a strong rally in Brazil and Asia over the last few years, but Africa is now the hottest thing."
It is not just bonds that have proven to be of interest. This year, Kenya issued its first international syndicated loan. The $600 million, two-year facility was sold to a group of 13 lenders from the region and beyond, including the State Bank of Mauritius, Ghana International Bank and Bank of India. Citi, Standard Bank and Standard Chartered acted as bookrunners and mandated lead arrangers on the deal.
In a more complex move, Angola agreed a $1 billion, seven-year loan with Russian bank VTB Capital in August with a fixed interest rate of 7%. VTB then sold the debt on to other investors through loan participation notes issued by a special purpose vehicle, Northern Lights III, listed in the Netherlands.
"What we’ve seen over the past year is quite a bit of interest, not only in African bonds but also in emerging market bonds generally, as investors go in search of high-yielding products," says Carmen Altenkirch, a director at Fitch Ratings. "There are a few components to it. One is the search for yields. Added to that, Africa in general is seen as a positive growth story, and a lot of investors want to get access to that. For African countries generally, it is very positive. It opens up another very important source of foreign funding at quite reasonable rates."
Despite all the activity, it is still only a minority of governments that have issued foreign-currency bonds. To date, 13 of the 54 countries across the continent have done so. In most cases, they have substantial reserves of commodities, and the money has been raised to improve their infrastructure, particularly transport.
"Countries with commodities have a better chance of accessing the market as long as they are well governed, have a credit rating and don’t have any conflicts," says Makram Abboud, chief executive for the Middle East and Africa at VTB Capital. "What investors are looking for is stability.
"The biggest need in Africa by far is infrastructure. These countries need railways, roads and ports. They need everything. A lot of it is needed to get their commodities out of the country and get their trade moving. Some of these countries need infrastructure investments worth four or five times their GDP."
While the number of governments that have accessed the Eurobond market has been limited, more might follow in the next year or two. Kenya is expected to issue a bond to repay its two-year loan, and other countries, including Angola, Mozambique, Rwanda, Tanzania and Uganda, are seen as likely candidates to turn to the international bond market in the next few years. Moody’s Investors Service says most will try to raise at least $500 million.
For the governments in these countries, there are a number of reasons to issue. For a start, there is the benefit of having a new source of funding that, given the high level of interest, can be secured at attractive prices. While many governments need to raise substantial sums, they are also keen to reduce their reliance on bilateral and multilateral funding or on domestic sources.
An additional benefit is that sovereign bonds can also provide a benchmark yield for local corporates wanting to issue, helping to broaden and deepen local capital markets.
From the point of view of investors, the bonds are an attractive way to gain access to the strong growth of sub-Saharan economies, particularly commodity exporters. The average growth rate of GDP across SSA was 5.2% in 2011 and is expected to be 5.3% this year and next, according to the IMF.
"The emerging markets space has remained strong this year," says John Wright, a director of the London syndication team at Barclays that helped to manage the recent Zambian bond issue. "Investors looking for growth realize there aren’t many parts of the world that can deliver that right now.
"The range of investors interested in emerging markets is increasing. More speople are trying to get involved. The Zambia bond proves there is the investor appetite. If anyone was sat on the sidelines wondering if the demand is there, they won’t wonder anymore."
There is also a rarity value to African Eurobonds that helps to boost demand. South Africa has gone to the market most years and issued bonds worth $7.25 billion since 2007, but relatively few bonds have being issued by other governments. When they are they are often for relatively low amounts. Nine other sub-Saharan governments have issued 10 bonds between them during the past five years. The smallest was for just $30 million in the case of the Seychelles in 2007.
In addition, there have been strong improvements in financial management and governance in many countries in the region, which act as a boost to the confidence of investors.
"Sub-Saharan Africa has made enormous economic progress over the past decade or two, especially in respect of macroeconomic stabilization," says Daniel Zelikow, global head of the public sector group at JPMorgan. "By that I mean stronger fiscal and monetary policies, less reliance on fixed exchange rates to preserve monetary stability, more effective regulation of financial systems and more transparency overall.
"I’m not suggesting there’s a parity of good economic management and strong central banking throughout the continent, but it’s fair to say that in South Africa there’s a long tradition of a strong central bank and in Nigeria there has been particularly effective leadership in cleaning up some of the problems that have beset the banking system over the past couple of years.
"In general, the resilience to the 2008/09 crisis and sustained GDP growth experienced recently by several SSA economies owes much to economic reform and macroeconomic stability, both on the part of governments and central banks."
However, despite all the improvements, there are still risks for investors and defaults can happen.
Another constraint is that relatively few governments are covered by the big three ratings agencies. Standard & Poor’s and Fitch rate 16 countries in SSA, while Moody’s rates just six. Between them, they cover only 20 countries in the region.
In the case of countries that do have ratings, it is not just investors that are taking a chance with the Eurobonds. There are some risks for the governments too. In particular, the international bonds expose governments to a higher degree of foreign-exchange risk.
For some commodity exporters, that should be manageable, given that much of their earnings will be in dollars. However, while the recent commodity boom has led some central banks to become more sophisticated in how they manage their reserves, not all countries are equal in this area.
Peter Sullivan, head of the public sector group for Africa at Citi, says there are some clear leaders when it comes to reserve management. "It is a function of size," he says. "Countries that are blessed with commodities are the ones that need to address this first. The larger ones – South Africa, Nigeria and Kenya to a degree – are probably the most sophisticated and hands-on, providing leadership for the region."
A senior official at a finance ministry in one small but relatively fast-growing African country adds: "The main challenge we have is capacity constraints. In my experience, there is a very small pool to draw from and government remuneration is quite low compared with the private sector."
Many governments, while grappling with such challenges, will be hoping that, as public finances become more sophisticated, the same thing will happen with private-sector firms. A key motivation for issuing Eurobonds is to encourage local corporates to issue their own bonds to international investors. The jury is still out on how quickly this will happen.
"Over the medium term, issuance by the region’s sovereigns will promote further issuance from government-related institutions, local governments, corporate and financial institutions," predicts Aurélien Mali, senior analyst at Moody’s and the author of a recent report on international sovereign debt issues in Africa.
He suggests that financial services companies and those involved in infrastructure and commodities are among the best placed to follow the lead of their governments. Indeed, he points out that this is what happened in Ghana after its inaugural $750 million Eurobond in September 2007. Two months later, Ghana Telecom placed a $200 million issue in the international market.
There have been few other examples, but VTB Capital’s Abboud says more deals could emerge in the second half of next year. "What always happens is that you start with sovereign issues, and then you have corporates and financial services companies following," he says.
"There will be some deals in 2013. Perhaps not in January 2013, but by the third or fourth quarters some will be coming into the market. It will start in the stronger countries, and with corporates that are quasi-government businesses and that are involved in commodities, whether oil or minerals or diamonds."
However, the small scale of many enterprises around the continent means that the potential for this to happen remains limited for now, according to others.
"There are not that many corporations that could absorb a $300 million to $500 million Eurobond," says von Hartig. "There are some in the big economies, such as Nigeria and Kenya, but in the smaller economies there may be just one or two potential corporates that could take advantage of the Eurobond market properly."
Another trend that could pick up momentum is the interest among African investors in putting more money into the continent, but again the potential in the short term is limited.
"There’s a lot of thought going into sub-Saharan African banks should be investing in Africa rather than the EU," says Citi’s Sullivan. "The answer is yes, but it depends on the depth of the local capital markets and the risks. I wouldn’t be surprised if in the next few years there was more recycling of these reserves through the region."
Among those considering greater investments is the South African government-owned Public Investment Corporation. At a conference in London in early September, its chief executive, Elias Masilela, laid out its evolving attitude to investing in the rest of the continent.
"We’ve been in business for over 100 years," he said. "For the first time we are looking beyond the borders of South Africa. As the largest asset manager in the continent, we’ve seen the continent as the next wave of growth globally. [We want to] make Africa more dependent on its own savings in terms of capital raising to fund investment on the continent."
Ultimately, whether it is regional or international funding African governments are trying to attract, the long-term viability of international bonds for them will only become clear when the current generation of bonds starts to reach maturity – something that will not happen for several more years.
In the meantime, investors and others will also keep a close eye on how the money raised from the bonds is invested and what sort of returns it has brought, not just to the buyers of the bonds but to the countries themselves.
"We’ll watch very closely from a rating perspective to see how effectively they utilize the money from this bond issue," says Fitch’s Altenkirch of the recent Zambia bond. "You don’t want to see that money being frittered away and spent on higher wages for civil servants. One of the things we’ll focus on for the next rating is getting a very clear idea of how the money is being spent; what infrastructure projects it’s tied to."