Ethiopia’s entry into bond market marks a milestone in the transformation
By Abera Degfe
Tigrai Online November 6, 2014
Lately the Ethiopia's decision to enter the international bond markets has been all over the news.
The Ministry of Finance and Economic Development disclosed that the government is aiming for late December to early January at the latest as the time for inauguration into the international capital markets.
However, as it is a new phenomenon to the nation, there is little understanding of what it signifies in terms of the economic transformation we achieved so far and we intend to accomplish in the time to come. Therefore, it appears timely to discuss the matter in depth.
Most countries issue sovereign bonds to access capital markets to finance their development. A sovereign bond is a debt security issued by a national government. Known as a Eurobond, it is denominated in a foreign currency (usually the dollar, rather than, as its name would suggest, the Euro).
Africa is the most dependent on multilateral and bilateral financing and at year-end 2011; those two sources of external liquidity together accounted for more than two thirds of public and publicly guaranteed external debts in Africa. Indeed, half of African countries have no other way of accessing external financing. Bond issuances come with fewer strings attached or tied to the commercial interests of the donor country than money from multilateral institutions. Hence, governments also have more control over where they channel the money.
Capital market conditions are increasingly encouraging governments in sub-Saharan Africa to turn to international markets to raise funds. While until a few years ago South Africa was the only country in the region that regularly tapped international bond markets, seven other rated African sovereigns have launched debut global debt issues totaling nearly $5 billion since 2007. The trend has accelerated over the past two years.
There several reasons for the fast increase in the number of African countries recently entering the international bond market.
The first and major reason is the strong growth of the African continent in the last decade and the forecasted growth averaging 5%-6% over the coming years, similar to that achieved in the 2000s, placing the region among the best performers globally. Indeed, six of the ten countries that are expected to record the fastest growth globally between 2013 and 2017 are located in Africa. This high appetite is also a vote of confidence for Africa’s growth story.
The second reason is the reduced debt burden of African countries because of the IMF’s revision of its policy after many donor countries and major multilateral financial institutions canceled debts of many less-developed countries. That reduced debt burden allows the countries to borrow in international markets without straining their ability to repay. The median government debt–to-GDP ratio in sub-Saharan Africa is now below 40 percent.
The third reason is the large borrowing needs of African nations. Many African countries have significant infrastructure requirements — such as electricity generation and distribution, roads, airports, ports, and railroads. Eurobond proceeds can be crucial to financing infrastructure projects, which often require resources that exceed aid flows and domestic savings.
The existing low borrowing cost in the debt market is also another reason for the acceleration of African bonds. In recent years, African countries have been able to borrow at historically low yields—at times even lower than those of euro area crisis countries—and under favorable conditions, such as longer repayment periods. The interest rates on Eurobonds are often relatively less expensive compared with domestic issuances.
Another reason that incentivizes African countries to issue Eurobonds is the fact that domestic bond issuance is often more expensive. The international capital market can provide a large amount of funds and developing countries have used external public borrowing to supplement their scarce domestic savings and thus finance public projects without crowding out lending to the private sector or recurring to inflationary finance. Moreover, in developing countries where private firms do not have access to the international capital markets, the state often plays the role of financial intermediary by either guaranteeing private external debt or by borrowing abroad and then using the external resources to lend domestically to the private sector.
What benefits does Ethiopia expect to get?
Sovereign bonds have a number of stated benefits. The main benefits of international sovereign bonds are capital expenditure financing, benchmarking and raising visibility with a larger pool of international investors and also increase in remittance inflows.
Financing infrastructure projects was the key reason behind recent bond issuances, and Analysts expect that the rising trend in sovereign issuances will continue for the near future because of the region’s substantial infrastructure needs. Domestic resources remain insufficient to fund long-term projects. For instance, the proceeds of Rwanda’s 2013 bond issuance were earmarked for infrastructure projects, such as financing the development plan for the national airline and for a hydro-power project.
According to data from Moody’s rating agency, Ghana used the proceeds of its 2007 bond issuance to finance energy and transport projects. The proceeds of Senegal’s $500 million Eurobond issuance allowed for the continued construction of a major highway, and the upgrade of the country’s energy infrastructure. In Zambia, the Eurobond was dedicated to promoting infrastructure development (energy, roads and railways) as well as the social sector (health and education). Namibia used the proceeds of its inaugural Eurobond issuance to diversify its sources of financing and fund its Targeted Intervention Programme for Employment and Economic Growth.
Similarly, the proceeds of Ethiopia’s bond sales are expected to provide financing for the various infrastructure projects (such as roads, airports, dams and railroads) the government is undertaking, especially projects that International Financial Institutions have been unwilling to finance like the Great Ethiopian Renaissance Dam (GERD). This in turn reduces the domestic borrowing pressure on the economy lending help to the desire of the government in keeping inflation at single digits.
Another benefit of joining the international debt market is to set benchmark for the development of the domestic bond markets. Benchmarking for the corporate bond markets is the most important development that African economies are experiencing. For instance, following the inaugural $750 million Eurobond from Ghana in September 2007, Ghana Telecom placed a $200 million issue in the international market two months later.
The expected successful bond issuance will make Ethiopia eligible for inclusion in JP Morgan’s Emerging Market Bond Index (EMBIG), which includes countries that raise at least $500 million. This will not only help raise Ethiopia’s visibility with a larger pool of international investors but also set a benchmark yield for local corporations such as EthioTelecom and EEPCo that may issue bonds internationally. This will reduce the burden on the government that currently guarantees the loans of these public corporations.
Another benefit that Ethiopia may get from this move is an increase in remittances as the Diaspora gets the opportunity to invest in corporate bonds of major public enterprises. The establishment of mechanisms for facilitating cost-effective transfers and savings of funds received through remittances, which is a rapidly emerging source of private capital in developing countries, can also contribute to economic growth.
According to Standard and Poor’s analysis, the governments in the West African Economic and Monetary Union are increasingly able to mobilize domestic savings from banks and other investors as Ethiopia, Ghana, and India have tapped savings from nonresident nationals by issuing Diaspora bonds By strengthening common institutions. However, Ethiopia faces systemic problems in getting the most out of this diaspora bond sale.
In an illustration of this point, Prime Minister Hailemariam said:
Well, the lion share support to the construction of the Ethiopian Grand Renaissance Dam is from the Ethiopian people. More than 9 billion birr has been pledged by all segments of the population including the civil servants, the military, children and others. We were able to collect around 6 billion birr and I hope we will collect the remaining too. [Ethiopian Herald, Sept 9/2014 - Ethiopia needs peace and peaceful neighborhood: Premier]
Ethiopia’s inclusion to JP Morgan’s Emerging Market Bond Index (EMBIG) after its January bond issuance will solve this problem of raising funds from the Ethiopian diaspora by enabling Ethiopians abroad to invest in Ethiopian corporations.
Is there a cause for concern?
Joining international bond market means borrowing more and increasing our total debt and it is logical for questions to be raised about the increase in our debt. However, the prospects are bright.
Our external debt (what we owe to foreign creditors) is about 11.5 Billion USD (excluding the near 2.5 Bn USD debt relief expected after the end of ongoing negotiations). Out of this 6 Billion USD is owed to Multilateral Creditors such as AfDB, IMF and WB while 4 Billion USD is owed to Bilateral Creditors. Therefore our external debt is only about 23 percent of Ethiopia’s GDP and that is considered as “low risk” of by the WB and IMF. The World Bank in its June 2014 report stated:
Ethiopia’s risk of external debt distress remains low despite substantial non-concessional borrowing commitments in 2012/13. According to the 2013 Joint Bank-Fund Debt Sustainability Analysis, Ethiopia’s risk of external debt distress is low. It is imperative that the authorities proceed with fiscal prudence and take measures to improve export competitiveness in order to maintain a low debt distress risk rating. (World Bank, June 2014)
There are two main tools to measure the debt sustainability of a country, a Debt-to-GDP ratio and a credit rating.
A Debt-to-GDP ratio is a common tool used to measure the level of indebtedness of a country. However, there is no consensus on an optimal level of debt that a country should sustain. Several studies suggest various figures as a healthy debt threshold.
An often cited “prudential” limit is a debt-to-GDP ratio of 60% for developed countries and 40% for developing and emerging economies. This suggests that passing this point will threaten fiscal sustainability hence should be sustained on a long-term.
Most studies suggest that as long as there is additional capacity in the economy or unemployment and as long as the interest on the debt is less than the annual increase in nominal GDP, the debt need not be of concern since it will be a shrinking fraction of GDP. Thus, the growth-hindering effects of an increase in debt-to-GDP ratio can be surmounted by a proportional increase in growth-inducing projects.
Therefore, what matters is the composition of debt, on what it was used the total value of debt. Ethiopia’s use of its debt in profitable infrastructure projects that generate growth are therefore in line with the prevailing economic theory.
Analysts also believe Ethiopia is better positioned than many Sub-Sahara African countries because of its total debt to GDP ratio of 35%, which is much lower than Kenya’s 51% and its budgetary structure that makes it a lot more debt reliant and therefore could easily exceed the success of Kenya.
Another common tool used to measure of debt sustainability of a country is a credit rating value given by rating agencies that conduct a debt analysis taking the state of an economy into account. If there is a cause for concern about the sustainability of public debt, it will be reflected in downgrades of a country’s credit ratings.
Ethiopia obtained her first ever credit ratings from Standard & Poor’s, Moody’s and Fitch, the top three credit rating agencies in the world. her ratings of B and B+ (stable) are fairly good and in par with major African economies like Ghana and Kenya. These ratings led to an expectation of a record success in her upcoming bond issuance.
It is therefore fair to assume that there is no cause for concern at the current state of Ethiopia’s economy. In contrary, Ethiopia’s joining of the international capital market testifies its economic success and the development of the economy into another stage.
Implication of Ethiopia's entrance to the market
Before concluding this piece, we should highlight a few points to elaborate the fact that Ethiopia’s entrance into the international bond market is an outcome of the economic growth and transformation.
One point is that even though more and more African countries have been able to raise funds in international debt markets only 14 of the 48 Sub-Sahara African countries managed to issue bonds. This is due several factors.
The first one is that only a few countries could raise a $500 million Eurobond internationally without distorting their financial balance. According to African Development Bank, the countries for which a hypothetical $500 million issuance would represent below 5% of GDP, and a debt increase below 10% are South Africa, Nigeria, Angola, Kenya, Ethiopia, Ghana, Tanzania, Côte d’Ivoire, Cameroon, Zambia, Uganda, Congo DRC, Mozambique, Senegal and Mauritius. Hence, Ethiopia is to be among the top 14 SSA countries that managed to gain the confidence of international investors.
The other factor is the institutional capacity and capability of bond issuers to mobilize resources through the international markets, which is a certain degree of transparency and sophistication demanded by international investors. Therefore, Ethiopia’s entrance shows the state of economic leadership of the government.
In conclusion, international bond sale is generally the preferred source of external finance as loans are generally medium to long-term in nature and no conditionality is attached to the funds. This is a break for a country like Ethiopia that yearns for external finance free of ideological conditions.