When Uganda dropped plans last year to raise money by issuing dollar-denominated debt, some experts faulted the decision and its timing as ill-advised when interest rates on global capital markets were at historic lows.
By stepping back, the country resisted a trend that has gradually become a bond-selling spree in Africa, an attractive alternative for getting money on the cheap to finance crucial infrastructure with less strings attached. And Uganda did not go quietly; it warned other African countries to stay away from dollar-denominated debt because if not properly managed, it could become a major millstone when economic fortunes change.
According to the UK-based Overseas Development Institute (ODI) in a recent report on sub-Saharan Africa sovereign bonds, the region has significantly increased its borrowing through bond sales from $6 billion in 2012 to a record $11 billion in 2014. This year several other countries are expected to tap into the market for sovereign bonds, which are debt securities issued by a country and usually denominated in foreign currency.
The current economic outlook offers sub-Saharan Africa a chance to develop infrastructure on the cheap. Despite apprehensions over falling commodity prices, most significantly oil, Africa still ranks as the second fastest-growing region in the world after Asia. A slump in the rest of the global economy ignited strong appetite among investors for higher yielding debt outside the traditional markets of Europe and the US. The resultant recession drove interest rates in rich countries to historic low levels - even negative in others, forcing investors to seek profitable ventures in developing countries, especially in Africa, where growth has averaged 5% annually over the past decade.
A decade ago, African countries were unable to raise money through bond sales because their economies were considered too risky by international investors. Most were not even rated by credit companies. Today, however, the quest for profitable investments is being powered by an optimistic narrative of Africa's economic prospects dubbed "Africa Rising", fuelled by high commodity prices, sound economic policies and improved governance. As a consequence, and for the first time, several African countries found themselves eligible to raise money by issuing bonds.
First to test the waters was Seychelles, which in 2006 was the first in sub-Saharan Africa, outside South Africa, to issue bonds. It was quickly followed by Ghana, which raised $750 million in 2007, and later joined by several others that included Côte d'Ivoire, Nigeria, Rwanda, Namibia, Zambia and most recently, first-time issuers led by Ethiopia and Kenya, which in 2014 raised $1.5 billion and $2 billion respectively. Kenya's entry into the bond market in June was one of the largest ever debut deals from an African country, according to the Wall Street Journal.
Virtually all the bond sales were hugely over-subscribed, a testimony to the investors' appetite for risk in frontier markets.
Despite the current positive economic outlook for Africa, its debt could pose acute challenges in the face of economic headwinds turned negative from falling commodity prices, a slowing Chinese economy that has been gobbling African commodities, and declining global demand for exports.
There is growing concern that the countries likely to be hit hardest by soaring debt repayments are those that cashed in on low interest rates by issuing bonds. Uganda's ominous warning against piling up debts could prove prophetic.
Already, Ghana and Zambia have appealed to the International Monetary Fund (IMF) for help in repaying debts acquired through sovereign bonds.
Declining prices for gold and cocoa, rising trade and fiscal deficits and a burgeoning debt forced Ghana to reach an agreement with the IMF in February for a $1 billion loan. The money is expected to shore up an economy saddled with unsustainable debt levels of more than 60% of gross domestic product. While Ghana's misfortunes underscore the risks associated with borrowing in dollars, the deal with the IMF was expected to restore investor confidence in what was until recently one of Africa's high-flying economies.
Zambia has also opened loan negotiations with the IMF after it was stung by declining prices for copper, its main export commodity, which accounts for more than two-thirds of total export earnings. As if this was not enough, Zambia had unwisely spent a big chunk of the money from the sovereign debt on salary increases for its public servants.
According to the ODI, Mozambique borrowed $850 million for its national fishing industry but instead spent the money on military boats and equipment.
Not all debt is bad debt
Despite Uganda's misgivings, acquiring debt is not inherently a bad policy; what matters is how the money is spent. Most African countries that raised money from sovereign bonds have used it to pay for infrastructure investment like transport and energy in Ethiopia, Rwanda, Nigeria, Senegal and Zambia. Others, like Côte d'Ivoire and Zambia, used the money to pay for development-related current expenditures such as health and education. The recent outbreak of the Ebola virus has illustrated the need to invest in Africa's poor health systems.
There are several advantages attached to government borrowing through bond sales: they offer an alternative source of finance; the money is not subject to the conditions usually attached to loans from rich countries or multilateral organizations; critical infrastructure can be financed at cheap rates generated by relaxed monetary policies pursued by developed countries; and bonds carry less stringent terms with reasonable periods of repayment. For investors, bond sales by Africa are more desirable because they give them the opportunity to diversify risks and reap higher returns than they would get in rich countries.
Potential risks from bonds
However, debt acquired through bond sales is a double-edged sword. To attract international investors, the debt is issued in foreign currency, usually in dollars or euros. This makes the debt vulnerable to currency risks whenever the value of the dollar or euro strengthens. According to the ODI, sub-Saharan Africa could face more than $10 billion in losses, or 1.1% of its GDP, servicing debt acquired in 2013 and 2014 should exchange rates take a hit from a strong dollar. Furthermore, debts can destabilize economies if investors decide to reduce their exposure to African debt, notes the ODI. Bond sales could also have negative impact in terms of cost and maturity compared to concessional loans from international financial institutions.
Given the potential risks from bonds, the current enthusiasm has prompted analysts to start questioning the wisdom of piling up dollar-denominated debt. A downturn in the global economy or market volatility could have a negative effect on African debt, as evidenced by the Ebola outbreak and the plunge in oil prices. The US Federal Reserve has also signalled it might end the era of rock-bottom interest rates, which could also spell problems for African bond issuers who will be faced with rising debt repayments. Countries like Angola and Nigeria, for instance, which depend heavily on oil revenues, are already feeling the pinch.
IMF managing director Christine Lagarde warned African countries last year against accruing high debt. "Governments should be attentive and they should be cautious about not overloading their countries with too much debt," she told the Financial Times.
Thanks to previous measures that rescheduled or cancelled Africa's debt, robust economic growth and concessional interest rates, Africa's debt burden today is still within manageable range and relatively low compared with the strength of its economies. Hence, it's not yet crunch time for African debtors who have taken advantage of current low interest rates and favourable markets conditions to issue bonds. Prudent use of the borrowed funds backed by sound economic policies will see them weather the storm from declining commodity prices and future interest rate hikes.