African Eurobonds Will the boom continue?

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1 Research Briefing Emerging markets November 1, 15 Author Oliver Masetti oliver.masetti@db.com Editor Maria Laura Lanzeni Deutsche Bank AG Deutsche Bank Research Frankfurt am Main Germany marketing.dbr@db.com Fax: DB Research Management Ralf Hoffmann African Eurobonds Will the boom continue? Steady issuance, but higher yields. Despite a challenging economic backdrop dominated by falling commodity prices, lower demand from China and the prospects of the Fed eventually hiking rates, Eurobond issuance by Sub- Saharan African (SSA) sovereigns has continued in 15. New issuance was low in the first half of the year, but has accelerated over the last weeks with three sovereigns tapping the market since early October. However, issuers had to offer significantly higher yields than previously and yields on secondary markets jumped to multi-year highs. EM sell-off is no immediate threat to repayments, but weakening currencies raise debt service costs. The current market turmoil is not only raising the costs for new issuance but also causing concerns about outstanding Eurobonds. However, existing Eurobonds are widely shielded by their fixed coupon structure and long maturities, which mean that most principal repayments are still years away. The main risks for existing Eurobond issuers are depreciating currencies, which, if not reversed, will significantly raise the local currency burden of future repayments. SSA Eurobonds issuance set to continue. Although the external environment is likely to remain challenging for frontier markets we expect SSA governments to continue to issue Eurobonds, albeit order books might be smaller and yields higher. The ongoing drop in commodity prices reduces fiscal and external revenues of many countries in the region and, in order to mitigate sharp compressions in fiscal spending and imports that would damage growth, borrowing will have to increase. As local debt markets are still small and illiquid, part of these borrowing needs will be financed through Eurobonds. African bond issuance continues 1 USD bn* Congo (RC) Ethiopia Gabon Ghana Ivory Coast Kenya Namibia Nigeria Rwanda Senegal Tanzania Zambia Mozambique Angola *Sub-Saharan Africa, excl. South Africa Sources: Thomson Reuters, Deutsche Bank

2 Steady issuance, but higher yields in 15 Higher yields at issue % Sources: Reuters, Deutsche Bank Secondary market yields jumped 3 Bond yield, bp change between 3/8/14 and /11/15 Zambia Gabon Ghana Nigeria Kenya Namibia Ivory Coast Senegal Rwanda Source: Bloomberg 4 Eurobond issuance by Sub-Saharan African (SSA) 1 continued in 15. Issuance was low in the first half of the year, but has accelerated in recent weeks. As of early-november six sovereigns Angola, Gabon, Ghana, Ivory Coast, Namibia, and Zambia - have issued bonds worth USD bn. This puts annual issuance volume in line with the record levels seen in 13 and 14 when twelve countries, many of them debut issuers, placed bonds worth USD 1 bn in international capital markets. The continuous issuance comes despite adverse global developments such as the drop in commodity prices, the slowdown in China and the prospect of rising US interest rates as well as domestic developments such as the Ebola outbreak in West Africa or the election uncertainties in Nigeria and Zambia. The increased economic problems of many SSA countries are also evident in recent rating downgrades. As of early- November, 7 out of 3 rated sovereigns in SSA have been downgraded in 15. While the challenging economic backdrop has not prevented new issuance, it has resulted in higher yields. Those countries that did issue in 15 had to offer significantly higher yields than previously. For Zambia and Ivory Coast, primary market yields increased by 7 bp and 1 bp respectively, and for Ghana, even by bp to 1.75% in relation to the last issues in 14. Angola, the only debut issuer in 15, had to offer a yield of 9.5%. Yields increased also on secondary markets, with the increase being highest for commodity exporters with weakening fiscal and/or external fundamentals such as Zambia, Gabon, Ghana and Nigeria. Also demand was less lavish. Zambia s recent bond sale attracted USD.5 bn in orders compared with nearly USD 1 bn for its 1 bond. EM sell-off no immediate threat to repayments, but weakening currencies raise debt service costs The recent global market turmoil has not only raised the costs for new Eurobond issuance, but also caused concerns about SSA s ability to repay its outstanding bonds. We estimate that the outstanding Eurobonds require around USD 4 bn in principal and interest repayment. In USD terms, future debt service costs are highest for Ivory Coast, Ghana, Zambia, Kenya and Gabon. These countries Gabon, Ivory Coast, Zambia and Ghana face the highest repayment burden 4 USD m 8,, 4,, 5% % 15% 1% 5% % Principal (left) Interest (left) NPV, % of GDP (right) Sources: Bloomberg, Deutsche Bank 1 Throughout this paper we only refer to frontier markets in SSA and thus exclude South Africa. For comparing the yield levels it has to be considered that the bonds have different maturities. For example, the Ghana 14 bond has a 11-year maturity whereas the 15 bond has a 15-year maturity. November 1, 15 Research Briefing

3 African Eurobonds: Will the boom continue? Only small repayment over the next few years 5 USD bn 8 4 Principal Sources: Bloomberg, Deutsche Bank Zambia Angola Namibia Uganda Tanzania Ghana Nigeria IvoryCoast Senegal Congo (RC) Gabon Kenya Rwanda Ethiopia Interest Plunging currencies USD/LC, % yoy, as of 7/11/15-5% -4% -3% -% -1% % Sources: Bloomberg, Deutsche Bank have to repay between USD 7 bn and USD 4 bn. In terms of debt service costs in relation to the size of the domestic economy, Gabon, Ivory Coast, Zambia, Ghana and Namibia stand out. The net present value (NPV) of scheduled repayments in USD exceeds 13% of current GDP in those countries, meaning that they face high repayment burdens. For all other countries the net present value of debt repayments is below 1% of GDP. We think that the near-term risk of the current sell-off for existing issuers is limited. Nearly all sovereign Eurobonds issued in SSA have a plain vanilla fixed coupon structure meaning that repayment costs are not affected by the movements of secondary market yields. Also roll-over risks are low as most bonds were issued only a few years ago and have long maturities (average maturity is 11 years) and hence most of the repayments are still years ahead. Over the next 5 years there are mainly interest payments outstanding, with most of the principal not to be repaid until after. Overall, the combined annual costs of servicing the currently outstanding Eurobonds will remain below USD 3 bn until 1. On an individual country level debt service costs are estimated to remain below one percent of current GDP for most countries until. Only Ivory Coast (in 18, 19), Gabon (17), Ghana (17) and Kenya (19) are set to experience annual repayment costs exceeding this threshold. There is a major bunching of maturities only in 4, when USD 7. bn in principal has to be repaid and Kenya, Uganda, Ivory Coast, Senegal, Gabon and Zambia each have to repay principal and interest of more than three percent of their current GDP. The main longer term risk for SSA Eurobond issuers stems from the depreciation of their exchange rates against the USD. The currencies of all African Eurobond issuers have depreciated against the USD since last summer. The drop has been most severe for the Zambian kwacha, the Angolan kwanza, the Namibian dollar, the Ugandan shilling and the Tanzanian shilling which lost between 51% and % yoy against the USD, as of November 7, 15. As all outstanding sovereign Eurobonds in SSA are denominated in USD the depreciation, if not reversed in the future, will have a direct effect on the local currency value of debt service payments. The local currency net present value of future debt service payments has increased sharply over the last year. The increase is highest for Zambia where the NPV doubled. The depreciation in Namibia, Ghana, Gabon and Ivory Coast and Uganda also has a significant impact on the discounted local currency value of future debt service needs. Weakening currencies push debt service costs up 7 Change in local currency NPV of debt service costs due to the change in the exchange rate between 7/11/15 and 7/11/ % 8% % 4% % % Source: Deutsche Bank pp of GDP yoy (left) % yoy (right) 3 November 1, 15 Research Briefing

4 SSA Eurobond issuance set to continue Although the external environment is likely to remain challenging for frontier markets, with commodity prices unlikely to recover to past record highs and the Federal Reserve eventually raising interest rates, we still expect that sovereign Eurobond issuance in SSA will continue. Issuance yields might be significantly higher and order books smaller, but African sovereigns will continue to tap international markets. This conjecture has been strengthened by the wave of issuance since early October. Commodity price drop raises the need for borrowing... SSA faces rising financing needs 8 % of GDP Fiscal balance Current account Source: IMF Eurobond issuance will be primarily driven by rising borrowing needs of Sub- Saharan African governments. The recent drop in commodity prices sharply reduces fiscal and current account receipts for many commodity exporters in the region. The IMF estimates that SSA s aggregate fiscal deficit will increase from 3.5% of GDP in 14 to 4.% of GDP in 15 and the aggregate current account deficit from 4% of GDP in 14 to 5.% of GDP in 15. The aggregate numbers, however, hide stark differences across countries in the region. Especially affected by the drop in commodity prices are Africa s large oil producers Nigeria, Angola and Gabon, as well as copper-dependent Zambia. These countries face significant revenue shortfalls in 15 and, in the absence of alternative revenue sources they either have to cut fiscal expenditures and imports or increase borrowing. As governments usually prioritise current spending on wages and salaries, spending cuts would most likely fall predominantly on capital investment. In Nigeria, for example, hardly any capital investment project was initiated in H1 15. A lasting reduction in capital investment, however, would halt the necessary upgrade of Africa s dysfunctional infrastructure and thus significantly harm growth prospects. To cushion the magnitude of these required spending cuts and to mitigate the effect on growth and job creation, we expect that many countries will opt to bridge the funding gap by ramping up borrowing.... which is difficult to finance domestically. Shallow domestic debt markets 9 Outstanding domestic bonds, % of GDP Sources: Thomson Reuters, Deutsche Bank Borrowing can theoretically be obtained from domestic as well as international sources. However, SSA s ability to finance rising fiscal and current account deficits domestically is limited by its mainly small and illiquid domestic debt markets. With the exception of South Africa, which has a highly developed capital market, debt markets are still in the early stages of development and capitalisation is usually very low. Nigeria, the largest market after South Africa, has roughly USD 5 bn in domestic bonds outstanding, but this corresponds to only around 1% of GDP. Besides South Africa, only two countries, Mauritius and Ghana, have a domestic bond market capitalisation exceeding 4% of GDP. Therefore, in many cases an exclusive reliance on domestic markets for financing large deficits would quickly crowd out credit extension to the private sector and further cloud the growth outlook. Additionally, liquidity in African debt markets is low and the markets are characterised by low turnover rates as most investors adopt a buy-and-hold strategy. The lack of size and liquidity, in combination with the currency risk associated with investing in local currency bonds as well as the risk of capital controls, means that many international investors are relatively reluctant to buy domestically issued local currency debt. Eurobonds are thus a potential way to tap a broader investor base. This is also facilitated by the fact that most SSA Eurobonds are included in global bond indices. In contrast, after JP Morgan s decision to exclude Nigeria from its local currency government bond index in early September 15, no country in SSA (with the exception of South Africa) is included in a major local currency bond index. 4 November 1, 15 Research Briefing

5 Another impediment for funding large deficits domestically is that many SSA countries face troubles in raising long-term debt domestically. Bond issuance with a maturity of more than five years is relatively rare and most debt markets in the region are dominated by short-term instruments, mostly Treasury bills. Nearly % of outstanding local currency debt instruments in SSA have a maturity of less than three years. International debt securities, on the other side, offer the possibility of longer-term financing. The average maturity of the outstanding Eurobonds stands at 1 years. There is scope for further external debt in most countries. Lower external debt in SSA 1 % of GDP 7% % 5% 4% 3% % 1% % Sources: World Bank, IMF Bonds still account for only a small share of SSA's external debt 11 % of total external debt SSA South Asia Europe/Central Asia MENA East Asia/Pacific Bonds Latin America Other private creditors Bilateral Source: World Bank % % 4% % 8% 1% Commercial banks Multilateral Eurobond issuance will contribute to rising external debt levels in SSA. Especially countries that borrowed heavily over the past few years and are suffering from plunging currencies which reduce GDP measured in USD, such as Zambia, Ghana or Angola, will see strong increases in their debt-to-gdp ratio. However, low external debt stocks on average mean that most other countries in the region still have scope to increase their external indebtedness without jeopardising external debt sustainability. Also partly thanks to substantial debt relief in the past, SSA s total external debt level stands at a low 14% of GDP (basically unchanged from 8) and less than a quarter of the countries in the region exhibit external debt levels exceeding 3% of GDP. Among existing Eurobond issuers only Mozambique, Ghana, Senegal and Ivory Coast have external debt levels of more than 3% of GDP. Regional heavyweight Nigeria, on the other hand, has an external debt level of only around 3% of GDP. Eurobond issuance is also likely to change the composition of SSA s external debt. Despite the recent increase in international issuance, bonds still account for only a small fraction of SSA s external debt. The share stands at only % compared to 44% for Latin America, for example. Most of SSA s external debt still takes the form of multilateral or bilateral official debt. However, the share of debt held by private creditors is on the rise. It increased from 11% in 3 to 8% in 13 and is set to increase further. This increase will be supported by a rise in the amount of bonds outstanding. Besides continuous sovereign issuance, this might be facilitated by nascent corporate Eurobond issuance. By creating a benchmark, repeated issuance of sovereign Eurobonds has set the stage for corporate issuers in SSA to tap international markets. Corporate issuance, mainly by banks, has already followed sovereign issuance in Nigeria, Ghana, Zambia and Kenya. Given the current market turmoil and weakening currencies, foreign appetite for SSA assets is likely to remain muted and corporate Eurobond issuance rare in the short term. However, in the longer run, attractive yields and the huge growth potential of domestic consumer markets might make SSA corporate issuers look increasingly attractive. Oliver Masetti ( , oliver.masetti@db.com) 5 November 1, 15 Research Briefing

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