Will interest taper off?
Africa’s sovereigns had been exploiting a flood of money competing for little new paper, until tapering talk caused a sharp pullback. Yields are still attractive, but investors will now be taking a closer look at, and be more demanding of, developing nations before committing their dollars.
Investors are always looking for something shiny and new, usually an asset class where rewards are bigger and ultimately risk is too. In recent years, quantitative easing measures led by the Fed and pursued with vigour by leading central banks, convinced institutional investors to channel capital into some thoroughly shadowy places.
Emerging markets profited across the board, but no cluster of nations benefited more from the Fed’s largesse than Sub-Saharan Africa, a region containing a few rising economic stars, and a lot of troubled or pariah states. Yet the money sloshed in, from hedge funds and mutual funds and endowments.
For a while, the main issue was not demand but supply. Christopher Palmer, head of global emerging markets at Gartmore Investment Management in London, said the main challenge across SSA was an “awful lot of money trying to find its way into a very small keyhole of investable shares and markets”.
That imbalance has been catnip to African nations dishing up sovereign bonds. Nigeria, South Africa and Ghana kept investment bankers busy in London and New York. Even tiny Rwanda joined the game. The central African state, failed and war torn two decades ago, finalised its debut sovereign bond in April 2013, raising US$400m. According to Thomson Reuters data, SSA sovereign debt sales raised US$5.4bn in 2011, US$6.9bn in 2012, and US$4.2bn in the current year to September 12, despite a summer slump that saw global funds flee emerging market securities.
Nor was this mere wilfull optimism. In most cases global investors were responding to the continent’s first protracted economic boom in nearly half a century, thanks to huge inflows of infrastructure and portfolio investment from China. Suddenly, there seemed no limit to Africa’s potential.
That changed on May 22, when Fed chair Ben Bernanke pledged to start scaling back debt purchases by the US government, signalling the beginning of the end of the QE era. The great taper caper was called off, albeit briefly, on September 18, when the Federal Open Market Committee surprised everyone, opting to delay a decision on QE, likely to December.
Yet the Fed’s May announcement was enough to roil markets across the emerging world in general, and Sub-Saharan Africa in particular. Two interlinked factors will now affect the region in the year ahead: yield and the demand for new issuance.
Through most of the first two quarters of 2013, Africa was a hot destination for yield-hungry investors. Bernanke’s words changed that. Some of the worst-hit bonds were those issued over the past 12 months by SSA governments. Ten-year eurobonds issued by Nigeria, the region’s second-largest debt issuer, started the year with a yield of 4.01% but topped out at 6.24% in late June. Senegal’s 10-year bonds spiked to 8.45% on June 25, nearly 200bp above January 1 levels.
The same happened with Cote d’Ivoire’s 20-year Eurobonds and super-steady Namibia’s 10-year Eurobonds. Yields, said Shilan Shah, Africa economist at London based Capital Economics, rose fastest in countries that “consistently run large fiscal debts”. Key transgressors include Ghana, Zambia and Rwanda.
Fork in the road
SSA debt could now go one of two ways. Issuance could fall off sharply in all countries bar a few investor darlings. Or investors could breathe for a minute, rationalise the situation, mull over the Fed’s September surprise, and remind themselves that yields in the US and Europe are likely to inch up only very gradually.
At least some investors appear willing to take the path of greater resistance. Yields on SSA debt have inched down since hitting year-highs on June 25, despite a smaller, secondary yield spike in August.
And issuance continues. Nigeria sold US$1bn in 10-year bonds, priced to yield at 6.375%, in the direct wake of the Fed’s announcement. In late July, Ghana issued its first overseas bond since 2007, raising US$750m on orders of US$2bn. Capital Economics’ Shah believes US$1bn US dollar-denominated bonds sales planned by Kenya and Tanzania late in the fourth quarter could now be brought forward to October. “With lower yields, Kenya’s bond could easily be upgraded in size, to US$1.5bn,” he said. This was prior to the attack by Islamist militants on a Nairobi shopping centre.
Tough times remain ahead for the region, at least in the longer term. Some SSA frontier markets, said Benoit Anne, head of emerging market strategy at Societe Generale, will find it “particularly hard coming to market over the next few months”.
Peter Attard Montalto, chief emerging markets economist at Nomura, highlights a few pockets, including Nigeria and Kenya, where “strong buying will remain”, but said “SSA countries would no longer simply be able to issue debt at will”.
Koon Chow, head of emerging market strategy, FICC, at Barclays, draws comparisons to the crowded airspace around airports. “We’re in a holding pattern at the moment, which will persist for one to two years,” he said. “It’s the end of the peak period for easy money for emerging markets. [W]e aren’t going to return to a high-demand period soon. That era is over.”
Perhaps the bigger challenge for the region is the slow pace of maturity, plus the likelihood of existing or future debt issuances going sour.
The first issue relates to virtually the entire region. A few countries, notably Nigeria, can credibly claim to be toughening institutions and cracking down on corruption. But few others have followed their lead.
Economic growth has soared across the region in recent years, but precious little of the new capital generated internally or earned from external sources has been channeled into nation building, or into strengthening frail social security frameworks.
And for investors, that matters. Gartmore’s Palmer reserves most of his ire for nations where the “democratic process is up in the air, or where there’s a rising political risk”. He also points to western African nations that have struck oil or gas – a classic example here is Liberia – but are largely yet to erect rigs or derricks. “If you’re buying debt based on [that country] becoming a big commodities exporter I’d be skeptical of that,” he said.
Global investors are also reappraising their assumptions about individual countries. One Miami-based fund manager, a regular buyer of frontier-market African debt, has sat through more than one roadshow where risk was predicated on little more than lazy economic geography. “In the good times, a banker might suggest I buy debt from this poorly run country because it’s located right next door to a much-better-run country,” he said. “You’re taking unprecedented risks if this is your approach.”
Ultimately, much future activity will depend less on broad-brush confidence than on investors’ ability to keep faith with specific nation-states. “There is appetite out there for new issuance, but the market is getting choosy,” said one Africa-focused London banker. Nonetheless, several Sub-Saharan African nations are in a better state than they were a few years ago, a fact that should help the likes of Angola and Cameroon issue debt in the months ahead.
Others, in a future tapering world, will struggle to attract buyers. Investors already have some pretty telling negative benchmarks in mind. Zambia’s US$750m 10-year dollar bond was issued in September 2012 at a yield of 5.625%, yet at its peak in mid-2013, it was yielding around 6.9% and trading at a shade over 89.
A final note of anxiety, usually unspoken – it’s a touchy subject – also lingers in investors’ brains. In this scenario, frontier-market economies, struggling to repay their bonds, blame sponsors either for charging usurious rates of interest, or for selling debt they knew or suspected the borrower could not repay.
It’s a nightmare scenario for everyone: just ask bondholders of Cuban or Argentine debt. “In the future you could see claims of victimisation by [some SSA nations] who overborrowed during the good times,” said Gartmore’s Palmer. “And if some of these countries see reason to default they may [do that], claiming that they were misled during the sale process.”
At that point, risk-loving investors might remind themselves not of the mixologist Doug Coughlin’s aphorisms, but of his bloody demise. Everything else is always something, but it isn’t always better.