WASHINGTON, DC – Over the last decade, Africa’s governments have increasingly come to rely on Eurobonds to finance their budgetary priorities. Issuance of these securities – which are denominated in foreign currencies – soared in the wake of the global financial crisis, as many Sub-Saharan countries tapped the international bond market for the first time. The opportunity that Eurobonds imply for ensuring adequate funding for development efforts in Africa is immense, but this potential can be realized only if their use is carefully managed.
Several factors have contributed to the popularity of African Eurobonds. On the supply side, many countries are benefiting from a more favorable macroeconomic environment. Debt-relief initiatives have left governments with healthier balance sheets. The dire need for infrastructure investment, the shallowness of domestic financial markets, and the scarcity of donor aid have all contributed to governments’ recourse to alternative debt instruments.
On the demand side, the well-publicized narrative of Africa’s economic rise – with strong and sustained growth underpinned by young populations – has whetted investors’ appetite for the continent’s debt. Meanwhile, in many developed countries, quantitative easing and unconventional monetary policies have pushed down interest rates, making frontiers with high returns, such as Africa, more attractive.
As a result, demand for African sovereign debt has been rising steadily, and many recent issuances have been oversubscribed. When Côte d’Ivoire issued $1 billion in Eurobonds in February, demand outstripped supply by a factor of four. The same was true for Nigeria’s $1 billion offering last July and Kenya’s $2 billion debut in the bond market last November. Issuance conditions were also favorable, with yields averaging 5%.
In some cases, Eurobonds have been sold in order to balance budgets, clear payment arrears to government suppliers, or finance ordinary outlays. But, as favorable as conditions may be today, an overreliance on Eurobonds may not be the wisest approach.
A Eurobond, after all, is an external debt, with all the risks that such borrowing entails, particularly regarding exchange rates. And, globally, conditions are changing; the United States Federal Reserve has begun tapering its quantitative easing, for example. Yields are likely to rise – pushing up borrowing costs and dampening investors’ appetite.
As a result, most African countries would be better off financing their budgets by issuing government securities in national or regional markets. External borrowing should be reserved primarily for ambitious development projects – for example, bridges, roads, and airports – that can lay the foundations for structural transformation and higher potential output.
Indeed, Eurobonds can be transformative if governments make the right strategic choices. One particularly promising possibility is their use to spur the development of domestic financial markets and increase access to credit for the private sector. Many African markets, including the West African Economic and Monetary Union, have been held back by a shallow investor base in the banking and financial industries. The resulting lack of competition has led to prohibitive borrowing costs for governments and high exposure for banks.
Accompanied by appropriate reforms, greater reliance on Eurobonds as an alternative source of funding could revolutionize these sectors, by pushing down yields on sovereign debt in domestic markets. With governments relying less on domestic credit, lenders should become increasingly interested in providing credit to the private sector, which has all too often been crowded out of the market.
The increased use of Eurobonds already seems to be spurring a virtuous cycle. As countries such as Ghana, Côte d’Ivoire, and Ethiopia seek sovereign credit ratings for the first time, their policymakers are becoming aware of the need to maintain positive outlooks. As a result, many African governments are undertaking large-scale institutional overhauls: reforming public-sector agencies, improving fiscal policy, and enhancing discipline on many fronts.
African governments’ desire to develop their countries’ economies, together with the scarcity of traditional resources, ensures that Eurobonds will remain a prominent source of funding. However, as global economic conditions change, the availability of these securities – and the conditions that accompany their use – will evolve as well. The window of favorable alternative financing may not remain open forever. It is therefore critical that African countries make the best use of their new borrowing space to lock in lasting development gains.
The author is Senior Adviser to the International Monetary Fund’s Executive Director for Africa and former Economic Adviser to the Minister of Economy and Finance of Côte d’Ivoire.
Copyright. Project Syndicate