African bonds an asset class boosted by the cheap dollar – Momentum’s Lashbrook
David Lashbrook, head of Africa Investment Strategies at Momentum Global Investment Management, puts Africa’s record hard currency bond issuance into context and provides his outlook for the market.
African sovereigns will issue more hard currency bonds. They have the ability to do so because their borrowings are still largely from domestic sources and they have the willingness to do so because they can potentially reduce their average cost of borrowing. By way of example, Nigeria would currently pay approximately 6.5% to borrow dollars for ten years, whilst it would pay at least double that to borrow in naira for the same period.
At an approximate aggregate value of $30bn, Africa’s (including South Africa) hard currency sovereign bond markets are only one tenth of the size of the local currency bond and bill markets. To put this number into context, the entire African hard currency sovereign bond market is smaller than the giant $40bn+ bond issue made by Verizon earlier this year.
Reasons why African countries are uniquely positioned to benefit from cheap dollar debt at the moment:
• African countries have some of the lowest debt/GDP ratios in the world: the median figure is 44% and Nigeria’s ratio is only 18%
• Africa is home to many of the fastest growing economies in the world, implying they can grow their way out of debt instead of inflating their way out of debt. So, as long as the overall level of borrowing remains manageable and the amount of hard currency borrowing is always significantly smaller than amount of local currency borrowing, African sovereigns should take advantage of this opportunity
An increase in rates in developed markets such as the USA could significantly reduce the portfolio inflows that some African countries are currently enjoying but would not necessarily cause stress to those markets. For example, Nigeria is by far the most liquid fixed income market in Africa outside of South Africa and its local and hard currency bonds feature in JPMorgan’s GBI Emerging and EMBI indices respectively. Because of this, Nigeria’s bonds sold off more than many other African bonds during the EM sell off in Q2 of this year. However, Nigeria has significant foreign reserves and a current account surplus, so it is capable of withstanding external shocks. However, the combination of a severe decline in oil price and production and sustained portfolio outflows could bring it under stress.
With smaller FX reserves and twin current account and budget deficits, Kenya could be seen as more vulnerable. Yet, the country withstood the flight of foreign capital before March’s election and Kenya’s local currency bonds (Kenya has yet to issue its maiden international dollar denominated bond) rallied during the second quarter because the base rate was cut by 1% to 8.5% in the face of declining inflation. This shows that Kenya’s sovereign markets are by no means solely driven by foreign portfolio flows.
The controlled issuance of hard currency debt will be good for sovereigns and investors alike. If managed correctly, it could enable sovereigns to reduce their overall cost of borrowing (and create a benchmark bond for their infant state, municipal and corporate bond markets) whilst giving investors exposure to dollar denominated bonds that are currently paying a healthy premium: the Africa premium, something which we believe will not be around forever.