International financial markets have opened a window for African governments to diversify their sources of funding from traditional multilateral institutions and foreign aid. For example, they can now borrow by issuing Eurobonds – these are international bonds issued by a country in a foreign currency, usually in US dollars and euros.
South Africa was the first to issue Eurobonds in 1995. To date, 21 African countries have sold Eurobonds for a combined total of over US $ 155 billion in international bond markets since 2006. , when Seychelles became the second African country to join the Eurobond market. There is an appetite for more.
Eurobonds are borrowed on commercial terms. Interest rates, bond terms and coupon payments are determined by market conditions. Due to poor credit ratings and perceptions of high risk, African bonds are classified as high yield bonds. They are risky, but they offer high returns. Investors are still scrambling for African high yield bonds.
Eurobonds are expensive for governments. The high returns demanded by investors mean high interest charges for governments. But they are attractive to governments because investors buy them without preconditions. Unlike multilateral concessional loans with policy adjustment conditions, governments have full discretion over the use of funds.
They are, however, offered at high interest rates, high coupon payments, and shorter debt maturities. This means that the government has a shorter period to use the expensive funds and will also pay periodic interest. The average maturity of African bonds is 10 years, with an interest rate of 5% to 16%.
This is unsustainable and has already led to more tax pressure. Interest reimbursement is the highest portion of expenditure and remains the fastest growing expenditure in the budget budgets of Sub-Saharan Africa. For example, Kenya, Angola, Egypt, and Ghana pay 20%, 25%, 33% and 37% of their collected tax revenue to repaying interest.
Investors are not interested in Eurobonds issued by other regions as they offer very low interest rates.
Flavor of the last five years
The rush for Eurobonds peaked in 2017, when $ 18 billion worth of bonds were issued in one year. At the end of 2019, the outstanding Eurobonds on the continent stood at US $ 115 billion.
In the past two years, 10 countries have issued bonds totaling $ 19.8 billion. This would have been more without the outbreak of the COVID-19 pandemic, which has cost issuers dearly. Ghana and Egypt together sold US $ 7.1 billion while Morocco issued € 2.5 billion in 2020 to support their budget budgets.
Ghana and Egypt returned to the market, issuing a total of $ 7 billion in the first half of 2021. Their debt-to-GDP ratios have now risen to 78% in Ghana and 90% in Egypt. Kenya also joined to issue US $ 1 billion, raising its debt-to-GDP ratio to 66%.
Any debt-to-GDP ratio above 60% in developing countries is considered unwise according to the threshold of the International Monetary Fund (IMF) and the African Monetary Cooperation Program. Beyond the threshold, a country will be at high risk of default.
Signs of non-sustainability
The ability to borrow in the financial markets is seen by investors as a sign of competitiveness. Financial markets provide a platform for governments to borrow primarily for capital spending, but not too much. In Africa, this has not been the case.
Here are some key pointers on why African governments should consider ending excessive Eurobond borrowing:
African governments have embarked on a wave of Eurobond issuance, accumulating debt without assessing currency risks and the real costs of debt repayment. The IMF has identified 17 African countries with outstanding Eurobonds as either over-indebted or in debt distress.
Debt servicing consumes on average more than 20% of government revenue, leaving very few resources for other development needs.
All Eurobonds issued in the past three years have been devoted to short-term non-performing recurring expenses and the repayment of maturing bonds. The issues of Benin, Côte d’Ivoire, Kenya, Morocco, Gabon, Ghana and Egypt have raised funds to support the budget deficit and bond refinancing.
The majority of Eurobonds issued have a short to medium term, but their proceeds are used to finance long term projects. In some cases, these are loss-making projects or the funds are not recorded. Ethiopia’s 10 failed sugar megaprojects and Kenya’s loss-making standard gauge railway were both financed by Eurobonds.
Foreign exchange reserves are usually depleted in most African governments as they accumulate debts that must be repaid in foreign currencies. Adequate foreign exchange reserves are important for the government to meet its international financial obligations.
Tax revenues in sub-Saharan Africa have declined over the past 15 years in real and absolute terms, due to weakening fiscal capacity. In a number of economies, tax revenue collection is below the desirable minimum tax-to-GDP ratio of 15%. Such fiscal capacity is insufficient even to finance the government’s core budget.
Continued borrowing on the financial markets led to a strong accumulation of debt. In the wake of the COVID-19 epidemic, some have called for debt cancellation for heavily indebted poor countries. The G20 and Paris Club creditors have also called for multilateral debt relief to be extended to private creditors.
In my opinion, this continued borrowing is unsustainable. It can only increase the fiscal fragility of African governments. It will be irresponsible to accumulate unsustainable debts so that short-term gains are repaid by future generations.
High appetite for bonds
Despite clear signs that Eurobond borrowing is unsustainable, governments continue to flood the market with new bond issues. In some countries, new bonds are issued at higher interest rates than previous issues. Some authorities are starting to recognize that their Eurobond borrowing is pushing the stock of debt to unsustainable levels.
The common misconception around oversubscribing all bonds issued by African governments has not helped. The great appetite for African bonds is considered a success. But attention is not paid to the high returns demanded by investors to buy them.
Investors will continue to buy the bonds as long as they are offered at the interest rate they need.
But there are no checks and balances. Eurobond funds have no conditionalities or lines of responsibility. Unlike multilateral loans, governments are not required to provide detailed information on the specific use of funds or to determine whether the money was used for the purpose for which it was raised. This amplifies the risk of fiscal indiscipline. Studies have shown that some governments opt for irresponsible borrowing to fund unprofitable programs to promote their political interests.
It is inevitable that with increasing debt, if left unchecked, Africa will soon fall into another debt trap. Recent default warnings should not be ignored.
It is necessary to change the structure and form of the loan. It is time to reconsider concessional loans – soft loans with lower than market interest rates and other favorable terms – from multilateral institutions. If governments cannot exercise financial discipline by committing to reduce fiscal deficits and debt build-up, they should be encouraged to seek financial support from multilateral institutions instead. Despite their weaknesses, financing multilateral institutions remains a cheaper option to help economies stabilize.
In addition, instead of borrowing more, governments should focus on mobilizing more domestic resources through efficient tax administration and broadening the tax base. The increase in tax revenues will reduce budget deficits and public debt in the medium term.
Issuing Eurobonds without implementing structural reforms will only exacerbate fiscal challenges.