Lelo Nxumalo: Submitted My Thesis Today

Debt Management Considerations for Sub-Saharan Africa’s Eurobond Issuers

A combination of factors has led to increased participation in international capital markets by frontier economies in Africa. Not least of these has been the post-crisis global liquidity environment, characterized by low interest rates in the United States. As a result, many investors– in search for yield– have been experimenting with sovereigns beyond the traditional emerging markets.

For developed regions with budget problems, austerity measures may also have slowed the flow of bilateral and multilateral financing that has traditionally been a key funding source for many African sovereigns [1]. Several economies in Africa including Kenya, Tanzania, Zambia, Rwanda, and Ghana among others have taken advantage of the low global interest rates to issue sovereign bonds to finance infrastructure and other spending [2][3][4]. In this policy paper I look at the potential fallout with regards to debt sustainability brought about by this relatively new source of financing.

I study the riskiness of Eurobond issuance through an analysis of the covariance of external debt service (including coupon payments of these Eurobonds) with revenue streams of many of these issuers (commodity exports); the global business cycle; and the global interest rate (measured by the libor rate). The purpose is to quantify the risk this new borrowing implies for African sovereigns. I expect strong positive co-movement in the global business cycle and commodity prices; negative co-movement between the global interest rate and commodity prices; and the same for debt service and commodity prices. In the first instance, a growing economy is characterized by increasing demand for production inputs, which in turn may raise the price of commodities, ceteris paribus. Frankel (2008) observes that real interest rates are an important determinant of real commodity prices[5].

According to Frankel (2008), there are various channels from interest rates to commodity prices but they all imply a negative relationship between the two variables:

High interest rates reduce the demand for storable commodities, or increase the supply, through a variety of channels:

High interest rates increase the incentive for extraction today rather than tomorrow.
High interest rates decrease firms’ desire to carry inventories by encouraging speculators to shift out of spot commodity contracts, and into treasury bills.

A decrease in real interest rates has the opposite effect, lowering the cost of carrying inventories, and raising commodity prices, as happened in the 1970s, and again during 2001-2004 (ibid). With regard to debt service: increasing borrowing costs make debt service costly, hence the hypothesis of a positive covariance. As such the commodity-dependent country that faces a terms of trade deterioration or low export prices obtains lower fiscal revenues and thus faces a greater likelihood of default or balance of payments crisis. If my hypothesis holds, then a borrowing mechanism that addresses such covariances of commodity prices and ability to pay (a function of export revenues and the world business cycle) is needed, particularly as non-concessional borrowing gains prominence.

I study debt service in Zambia (copper exporter), Ghana (oil, cocoa, and gold exporter), Gabon (oil exporter), Angola (oil) and Nigeria (oil) on the basis of the commodity intensity of their export and fiscal revenues, which affect ability to service debts. Moreover these countries have issued Eurobonds or are close to doing so[6] as shown in the image on my cover page. There are sections in the paper where I also contrast these countries with South Africa a more developed issuer with diversified exports including manufactures and minerals, among other things.

While the motivation for this research is Eurobond issuance, the key variable is debt service throughout this paper. This is because public and publicly guaranteed debt service is the sum of principal repayments and interest actually paid in currency, goods, or services on long-term obligations of public debtors and long-term private obligations guaranteed by a public entity. Data are usually reported in current U.S. dollars or as a percentage of GDP. Debt service includes the coupon payments from the Euro bond. Moreover to study a longer term behavior of the implied commitments from Eurobond issuance debt service is a common and more standardized series than spreads.

Methodologically, I first use time series analyses to study the daily behavior of individual bonds of Gabon (2007–17 euro bond), Ghana (2007–17 euro bond), Zambia (2013–18 euro bond), and Nigeria (2012–22 euro bond) in order to understand such factors as shock persistence and stationarity. This helps us understand the impact on bond price (hence yield) of shocks to commodity prices and the world business cycle as these could have far reaching implications on debt sustainability. I then use the World Bank’s World Development Indicators (WDI) database, to estimate the variance-covariance-matrices of the world business cycle, world interest rate, and commodity prices. I estimate country fixed effects regressions of debt service to export ratios against the dollar price of their commodity exports, the world interest rate, and the world business cycle. I conclude the methodology section by running the same analyses but with debt service denominated in commodity volume instead of dollars.

I find that after linking debt service obligations to commodity prices the sensitivity of debt service to fluctuations in primary commodity prices and other global macroeconomic variables is reduced in most countries. This supports the argument for a form of borrowing that does precisely this. This leads me to the policy alternatives section in which I argue that commodity bonds provide such insurance for commodity dependent countries. This is not a new idea so I discuss this policy option at length with a focus on impediments to its operationalization. I am grateful to Professor Frankel (my advisor) whose extensive work on commodity price volatility in low income countries informs this thesis.

In terms of deliverables this policy paper will:

Inform international financial institutions primarily the IMF, the World Bank, and the African Development Bank (through the Making Finance Work for Africa Program –MFW4AP), which give macroeconomic and financial advice to African countries.
Provide a basis for improving the periodic Debt Sustainability Analyses (DSAs) conducted by the IMF/World Bank.
Serve as a reference to policy makers looking to issue government debt in international capital markets, and keep debt sustainable in the long run.