Remarks at the Plenary Discussion on "Unlocking Capital to Deliver Prosperity for Africans" at the Annual General Meeting of the Afreximbank in Accra
Kotecha spoke on June 20,2023 in Accra at a plenary session of the Afreximbank's Annual General Meeting on "Unlocking Capital for Africa." The discussion was rich with speakers that included the CEOs of the Bank of Industry (Nigeria), the Central Bank of Tanzania, Ecobank Transnational Inc., and EXXAIR as well as the Deputy CEO of the EXIM Bank of India, the EVP of Afreximbank, Private Sector VP of the African Development Bank, Chief Economist of the West African Development Bank, and Head of Africa of the Agence Française de Développement (AFD).
While there is evidence that investments into Africa have risen over the years, the levels remain well below projected needs. So he offers five suggestions on how to close the gap.
1. First, there are investors who think the issue is not funding but a lack well-structured and bankable projects. Their concern is with weak project development and documentation. So one way forward is to unlock their capital by deploying the skills of Afreximbank and other development banks to propose bankable projects for private investment in Africa.
2. Second, while investors cite political and economic risks as a constraint, there is insufficient use of global capacity de-risk projects with guarantees. In fact, the 2022 Capital Adequacy Framework Report of the G-20 expert group recommends greater use of guarantees and insurance by MDBs. The Report also recommends an "originate to distribute model" under which development banks would continue to originate loans and sell down the loans to private sector investors to make room on their balance sheets for more loans. So Kotecha's second suggestion is to scale up the use of guarantees, insurance, and loan sales by MDBs so they can originate more loans.
3. Third, increasing capital flows to Africa requires reducing the real risks that are inherent in all cross- border investments. Over the years, there has been much progress in reducing real risks in Africa. Most recently, the African Continental Free Trade Area (AfCFTA) seeks to broaden and unify a fragmented African market by bringing together the 55 countries of the African Union (AU) and eight (8) African Regional Economic Communities. At the national levels as well, many African countries have improved macroeconomic management. But more progress can and must be made.
A recent example of this is Nigeria where promising steps have been taken within weeks of inauguration by President Bola Tinubu. In rapid succession, he has removed petroleum subsidies, unified the exchange rate and is poised to appoint a new Governor of the central bank to reform a weak monetary and bank regulatory regime. The rating agencies and the markets have noticed.
So the third suggestion is to address the real risks of investing in Africa, reducing them slowly over time as the opportunities present themselves.
4. Fourth, one must acknowledge and address the perceptions of African risks. Despite issuance of African Eurobonds, the market confidence in African risks is fragile given political instability (e.g., Mali, Burkina Faso, Sudan, etc.), a lack of transparency, low levels of economic development, high levels of debt service compared to revenues, narrowly based economies, and limited fiscal buffers against shocks. It was thought twenty years ago that if an African country was rated, it would be compared by investors with other similarly rated countries (or projects) and capital markets access would increase. In fact, credit ratings helped foster an African Eurobond market where issuance has reached some $300 billion. But new African Eurobonds are largely on hold as interest rates have risen and debt distress is spreading: from Zambia, Ethiopia and Chad to Ghana and perhaps even to Kenya. And widespread rating downgrades have inevitably led some to question whether African borrowers are fairly treated.
Some have gone so far as to propose an African rating agency as an alternative to the "big three". There already are rating agencies in such countries as China, Japan, India, Malaysia and Nigeria. Local investors rely on ratings from such rating agencies. So African investors could also rely on African rating agencies. But the credibility of any new rating agency – especially one handing out higher ratings than others – will be discounted by investors until the new agency is perceived as credible and independent.
Rating agencies say their metrics are rooted in a long history of sovereign and corporate defaults spanning seventy plus years. They say African ratings are low because of such factors as low levels of economic development, relatively undiversified economies, limited financial flexibility, and high political risks. But rating agencies are also known to have erred from time to time. So they should be encouraged to recognize the real and rising African strengths and to understand such insufficiently documented positives as the informal economy, strong cross border trade among neighboring countries, and the global carbon transition benefits of Africa's vast natural resource endowments.
So Kotecha's fourth point is to undertake sustained efforts to "nudge along" the rating agencies towards higher African ratings. While such rating upgrades will take time, they are achievable if improvements are made on both real and perceived risks. We must promote strategies to address both. This requires understanding how ratings are done and developing effective rating upgrade strategies. It requires identifying real credit strengths that address the rating agency criteria and then helping correct their perceptions of risk. As a rating advisor of 25 years, Kotecha can say with confidence that this is eminently doable. The Fitch rating upgrades of the First Bank of Nigeria and Afreximbank – both in 2022 -- show the way.
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5. Finally, there is widespread view that borrowers from the continent pay an African premium. This is true but there is some divergence of views on how big it is. Some econometric studies of spreads covering many years conclude that the premiums are of the order of 300 basis points. But Eurobond market participants say that such premia are a third or lower when liquidity risks are adjusted out and comparisons made rigorously based on like maturities and ratings. Moreover, the premia change over time. So Kotecha's final suggestion is to publicize a robustly constructed "market index" of African premia which could attract investors seeking to profit from the excess relative values African credits may offer. If successful, trading in the index -- and the underlying issues -- could in principle help drive down via diversification and/or arbitrage any excess premia not justified by fundamental African risks.
Mahesh Kotecha, born in Uganda and a naturalized U.S. citizen, is President of Structured Credit International, which advises African supranationals, banks and governments. He is a member of the Bretton Woods Committee, International Advisory Panel of the East African Development Bank, Advisory Council of UN Capital Development Fund, Chatham House, and the Council on Foreign Relations, where he directed a Roundtable on Capital Flows to Sub-Saharan Africa, which recommended in 2002 that African governments seek sovereign ratings to reduce perceptions of risk and to attract capital, helping spawn African Eurobond markets.
