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Eurobond or Eurobomb?

07.03.2016Cédric Mbeng Mezui, Coordinator, African Financial Markets Initiative (AFMI)

Starting in 2007, a number of African countries have been issuing sovereign bonds in the international capital markets. Sub-Saharan African countries issued a total of $35.9 billion between 2005 and 2015. Ghana issued $3.45 billion, followed by Gabon ($ 3 bn) and Zambia ($ 2.9 bn).

This sudden rush to tap into the international markets was encouraged by a range of factors, including rapid growth and better economic policies in the region, high commodity prices, and low interest rates in developed countries, particularly in the US, Europe and Japan. Since 2009, as enthusiasm for risk assets improved and global interest rates further dropped, international investors carried on their search for yield in a low-interest rate environment, while African countries took advantage of the low international interest rates to fund themselves in global markets.

For African countries, the main reasons for issuing Eurobonds can be summarized as follows: flexibility in the use of resources compared to other types of financing (mainly from Development Financial Institutions); the larger size of funds raised compared to allocations from development partners in the context of the current declining trend of aid flows; sovereign's presence in the international capital markets.

Eurobond prospectuses often indicated that the proceeds will be used to fund infrastructure projects (mainly transport and energy); repayment of the external or domestic debt; easing budget financing pressures; etc.

However, the funds were often not used efficiently. Some of the targeted infrastructure projects were at the early stage (wish list of projects), and were not able to absorb the resources. Sometimes the funds were used to fund routine public expenditures. Currently, some countries that have issued Eurobonds find themselves paying high carrying costs pending the maturation of projects for funding.

Furthermore, the international market situation has changed with the rise of the Fed interest rates, continued sluggish growth in Europe, slowdown in Chinese growth, falling commodity prices, the apprehension of investors, etc. These factors have resulted in lower export revenues for African countries, depreciation African currencies and reduction in their GDP growth.

In such a context, will the repayment of Eurobonds lead to "eurobombs" that can affect the macroeconomic sustainability of these economies?

What needs to be done to prevent the build-up of a debt crisis on the continent?

Different countries, different situations

African countries issuing Eurobonds could be grouped into 3 categories: (i) "investment grade" countries, such as Morocco, South Africa and Namibia; (ii) countries with GDP growth rate higher than interest rate on the debt; and (iii) countries with GDP growth rate lower than the interest rate on the debt.

The cost of Eurobonds for "investment grade" African countries is typically lower compared to the cost for other issuing countries. Credit ratings is particularly important as it allows issuers to diversify the range of funding sources and at the same time, optimize the choices according to their priorities and opportunities. Getting a rating of "Investment Grade" requires implementing sound management of public finances, efficient public debt management and low political risk.

Countries in category 2, with GDP growth rate higher than interest rate on the debt, can still support their debt service as they create enough wealth to meet their obligations. The ratio debt/GDP could be sustainable. However these countries are still at risk if their economic growth rates slow. Countries in category 3 are in relatively vulnerable positions. They are currently under pressure to meet their debt service and the situation may become worse with the anticipated increases in the interest rates in the US. The combination of expensive debt and slow growth will lead to a deterioration of their external and fiscal positions, and then reduce the possibility of new borrowings. They will pay a high premium to gain access to the international capital markets again.

What needs to be done?

To prevent a new debt crisis on the continent, the urgency in 2016 is for International Financial Institutions (IFIs) to team up and provide a credit enhancement mechanism (CEM) and liquidity facilities (LF) subject to the implementation of structural reforms.

CEM should make it easier to secure better pricing and would contribute to reducing the risk perception of African credit through the provision of guarantee products. In exchange, the beneficiary countries would need to agree to implement reforms to reduce the perceived risk, increase macroeconomic discipline and target the achievement of "investment grade" rating on the medium to long term. LF should help to reduce the current pressure on the repayment of accrued interest and the principal of the Eurobonds already issued. The LF should have a longer maturity tenor, a grace period, a fast track processing and competitive pricing to provide headroom for macroeconomic sustainability. In exchange, the beneficiaries should explain the use of the proceeds of the issued Eurobonds and present a credible list of projects that may absorb the resources. Particular attention should be paid to projects that could generate high returns such as power, agribusiness and some transactions in the transport sector.

At the country level, a strategic agenda to unlock domestic financial systems should be implemented. We cannot build prosperous economies in the long term without efficient domestic financial systems. "I did a lot of infrastructure development in my life, to fund them with foreign currency is madness. OK? Madness" said Mr. Tidjane Thiam in October, 2015.

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About the Author

Cédric Mbeng Mezui has extensive experience in the African financial sector and is also an accomplished researcher and author in the sector. He was appointed Coordinator of the African Financial Markets Initiative (AFMI) in December 2013, and leads the implementation of the African Development Bank's (AfDB) local currency bond markets development programme. Cedric previously led innovative finance work for regional mega projects having worked on more than 30 investment transactions across Africa.  Cedric has a Master's degree in Banking and Financial Engineering from Toulouse Business School (France) and Master's degree in Money, Economy and International Finance from Claude Bernard University of Lyon (France).

African Municipal Finance Blog Series - Part 1

08.02.2016Professor Jeremy Gorelick, Managing Director, Affordable Housing Institute

At the annual African Union for Housing Finance conference in Durban, Making Finance Work for Africa spoke with Professor Jeremy Gorelick following his talk, "Positioning Cities for Housing-Related Capital Flows". Based on his professional and academic experiences in supporting sub-sovereign entities to access funds for capital-intensive projects, Prof. Gorelick has been invited to write a series of blog posts about municipal finance across Africa.  The series will discuss substantive current events in the field and feature interviews with politicians, practitioners and other stakeholders.  

 

In an era of increasing decentralization, sovereign governments across Africa are constitutionally shifting more responsibilities to cities than ever before. Along with these new mandates, though, municipal leaders are forced to be more creative in finding money to cover rapidly rising costs associated with such traditionally-central government programs as social housing, underground infrastructure, and solid waste management. Most cities continue to rely on transfers from central governments, while some have additionally opened dialogues with multilateral development finance institutions, like the African Development Bank, or bilateral development finance institutions, like the French Development Agency or the United States Agency for International Development.  Still more have looked for assistance from grant-making bodies like the Rockefeller Foundation or the Bill & Melinda Gates Foundation.  Other cities, like Dakar, have turned to the debt capital markets for assistance through the issuance of municipal bonds. 

The municipal finance gap in Africa is over USD 25 billion per year, in contrast to the current investment capacity of African local governments-approximately USD 10 billion over ten years (according to a 2012 report, Financing Africa's Cities: The Imperative of Local Investment). Despite this pressing need, most African local governments have limited access to capital markets and private sector finance for their infrastructure projects. Essential and impartial supporting capacity - such as rating agencies - are in short supply. In addition to Dakar's attempt, only cities in South Africa (including Johannesburg, Cape Town, Tshwane and Ekurhuleni) have issued municipal bonds not backed by the central government. This can be attributed, in part, to the enabling environment created by South African government's Municipal Finance Management Act. 

Contrast this with the realization that one-third of the world's urban population resides in developing countries, and this portion is growing rapidly. While only about one-tenth of the world's largest urban areas are in least developed countries, thirty of the thirty-five most rapidly growing large cities worldwide are located there.  In other words, the world's fastest-expanding urban agglomerations are now in the Global South.  The magnitude of the urban demographic shift is staggering. Rural-to-urban migration, combined with the effects of urban population growth, could add another 2.5 billion to the world's urban population by 2050.

The growth of cities and towns from urbanization makes functional and fiscal decentralization more viable and more necessary, and in many countries local autonomy is growing. Increasing the capacity of local officials can not only improve urban resilience and quality of life, it empowers cities and towns to contribute in important ways to national, social and economic development goals.

While the responsibilities delegated to local governments by law vary considerably from one country to the next, cities often have constitutional mandates to provide: (i) local basic services and infrastructure, including water, sanitation, public transportation, public lighting, and solid waste management, among others; (ii) resilience building, and climate mitigation and adaptation, including energy efficiency, flood management, and public building retrofitting, among others; and (iii) local social services and infrastructure, including health, education, and childcare facilities, among others.

In the past, most cities would not have had the autonomy, information technology, or knowledge of trends in the urban sector worldwide to embark on significant development projects or to prepare multi-year investment plans. But with the increasing interconnectedness of cities around the world and the growing competition among them, this has changed.

Even so, while needs and aspirations may grow, the financial options available to cities across Africa have not kept pace with the growth and increasing complexity of the cities themselves. Cities are stuck in a vicious cycle of limited resources leading to a constrained response, while the population of the city and the demand for services continue to grow.

Ironically, many local government capital investments have high economic and social returns, and therefore should be prioritized. For instance, transportation signals that reduce congestion free people's time for more productive purposes. Investments in drainage that reduce flooding in commercial areas reduce trading days lost to post-flood recovery. In these cases, domestic private capital should be available to finance municipal investments that cannot be financed through grants.

Mobilizing resources to finance investments and improve services at the municipal level is one of the most challenging aspects of local development, especially if the goal is to provide resources on market-like conditions in a sustainable manner, for instance from loans or bonds.  Even when government transfers are predictable and generous (which is the exception), they are rarely adequate to finance major infrastructure improvements in growing cities. The capital investment financing that is available to local governments is often provided by national agencies whose own access to capital is highly constrained. Winning funding allocations from national budgets requires local governments to compete with line ministries and other priorities of the government in power.

As a result of these conditions, cities are realizing the importance of diversifying their resource base to meet tremendous population growth coupled with an increased list of constitutional responsibilities.  Along with providing a crystallization of the current state of municipal finance across Africa, a critical purpose of this blog series will be to highlight best practices and provide a roadmap for municipal leaders eager to leave a positive legacy on their respective cities.

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About the Author

Since 2011, Professor Jeremy Gorelick has served as the Lead Technical and Financial Advisor for the City of Dakar's Dakar Municipal Finance Program. He has previously worked in structuring public debt obligations at BNP Paribas and Dresdner Kleinwort Wasserstein, and has taught classes on finance, international development and business analytics at the Johns Hopkins University since 2010. For more information on Professor Gorelick, contact him at LinkedIn.

Upcoming events:  

African Municipal Bond Forum - Dakar, Senegal 

Innovative Domestic Resource Mobilization in Africa

25.01.2016John Mbu, Financial Economist, African Development Bank

On 25 September 2015, world leaders adopted the Sustainable Development Goals (SDGs) at the United Nations Headquarters in New York. The 17 SDGs will serve as an economic development blueprint for the developing nations for the next decade and half. Developing countries, particularly those in Africa, now have the herculean task of mobilizing the required finances to fund their economic transformation. Although private capital now forms a significant proportion of development finance, the main "take home message" from the three major development finance conferences (Monterrey in 2002, Doha in 2008 and Addis Ababa in 2015), is that there should be a significant boost in domestic resource mobilization. In addition to tax revenues in Africa, which stand at about $550billion per annum, financial institutions particularly banks, sit on huge financial resources.

It is interesting to note that even with the "not-so-rosy" global economic reality, with economic slowdown in China and other emerging markets, plunges in commodities prices, the Greek debt crisis, Europe's migrant problems, the crises in Ukraine, Syria, Libya, Iraq and Yemen, financial institutions in Africa have been boosted by rising assets. Africa's 200 biggest banks have total assets worth $1.5trillion - almost half of the entire continent's GDP. Their total loans rose by 5% from $749billion in 2011 to over $789billion in 2015, whereas the total deposits rose from $1.012trillion to $1.019 over the same period, as can be seen in the figure below.

Source: The Africa Report October-December 2015 Edition

Worthy of note is the fact that the assets of the 23 biggest banks ($965billion) represent over 65% of the total assets of the 200 biggest banks as can be seen in the figure below. Standard Bank Group of South Africa, Africa's largest bank has assets worth $169billion, about half of South Africa's GDP.

African countries will have to find new ways to mobilize its domestic resource. For example, the Government of the Federal Republic of Ethiopia in 2011 passed a law obliging commercial banks to allocate 27% of their loan portfolio for the purchases of treasury bills. Proceeds from these are then sent to private entities that are engaged in manufacturing and investing, and particularly for large infrastructure projects such as the $4billion 6000MW Grand Renaissance Dam Project. If Africa's 200 biggest banks, which constitute between 60-70% of the total number of banks in the continent, were mandated to allocate 27% of their loan portfolios to fund economic development initiatives, as is the case in Ethiopia, about $213billion will be raised just in 2015 - almost twice Africa's annual infrastructure needs, estimated to be about $100billion.

However, although such a model is commendable, proponents of "free market economics" may argue that this could cause distortions in the market, as the allocation of resources should be based entirely on market forces. Whilst the argument is justifiable, it is also true that moral suasion is a long standing phenomenon in economics - this is simply a situation where a monetary/financial authority pressures (though not by force) market participants to act in a certain way in order to achieve a particular objective or objectives. A good example is the United States Federal Reserve's $85billion monthly bond purchases program (referred to as Quantitative Easing) that was initiated in response to the 2008/2009 financial crises. The bond purchases were used in combination with near-zero interest rates to boost investment and stimulate the US economy that was in reels after the credit and financial crisis of 2008/2009.

The SDGs, which are a motley of economic development goals have to be funded. Financial and monetary authorities in Africa therefore have a huge task ahead of them and "innovative finance" is a statement that they will have to get used to. If moral suasion can be used for Africa's highly liquid banks to allocate 25%+ of their loan portfolios to fund economic development and economic transformation, finance officials may not have to worry so much about the plunges in commodities prices.

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About the Author

John Mbu is a financial economist and is presently an economic and policy analyst in the Office of the First Vice President & Chief Operating Officer at the African Development Bank(AfDB) in Abidjan, Côte d'Ivoire. Prior to this, he spent two years as an economic analyst in the Evaluation Department of the African Development Bank, focusing on private sector evaluations as well as regional integration evaluations. Before joining the AfDB, John worked as a management consultant for Pricewaterhouse Coopers in Douala, Cameroon and in Lagos, Nigeria. John holds two Masters Degrees, in Development Finance from the University of Cape Town, South Africa, and in International Finance from Durham University in the UK.

The Role of Institutional Investors in the Egyptian Capital Market

13.12.2015Alissa Amico, Project Manager, OECD & Maged Shawky, CEO, Beltone Financial

The Egyptian Exchange (EGX) is the oldest in the Middle East and North Africa region and one with a fascinating history of development, having gone through nationalisation in the 1950s and having been revitalised only in the early 1990s. The passage of the Capital Markets Law in 1992 and the introduction of the Asset Management Programme in 1994, which facilitated disposal of government stakes, were key to the revitalization of the Exchange. While the number of listed companies peaked at 1100 in 2001 with market capitalisation of $24 billion USD, the market remained illiquid and lacked transparency. 

Eventually, in order to bring liquidity and improve market quality, over 800 companies were delisted by 2005 for failing to meet regulatory requirements. In an effort to bring further transparency to the market, the Egyptian regulator introduced a voluntary corporate governance code for listed companies in 2005, and some of its recommendations were eventually transcribed in the listing requirements of the EGX. Over the years, enforcement activity has grown and in 2014, the Exchange started to publish all violations on its website and through the trading terminals. 

Yet, substantially improving governance practices in listed companies remains a challenge due to the low levels of participation of institutional investors in the capital market. While only 15% of market capitalisation remains in the hands of retail investors, they account for close to 80% of trading, similarly to other MENA markets. Furthermore, institutional investors, both domestic and foreign, remain rather passive unlike in developed markets where, especially following the financial crisis, the expectations and stewardship responsibilities placed on institutional investors have been growing (e.g. the Stewardship Code in the UK). 

The lack of engagement by domestic investors can be explained by the type of institutional capital present in equity markets, notably state-owned pension funds and insurance companies which continue to hold sizeable stakes in the market, having "inherited" them following the nationalisation programme. Their investment decisions are delegated to investment committees composed of the executive management and board members whose investment approach is usually characterised by conservatism and scepticism of capital markets. In addition, limits for capital market investment by pension funds and insurance companies are below international standards. 

On the other hand, foreign investors' passivity can be explained by a number of factors, including their relatively small stakes in listed companies - most as part of an Emerging Market Index investing - leading to a lack of incentives for them to engage. In addition, recent years have seen an outflow of foreign capital and reduced activity by foreigner investors due to political instability, as well as hurdles in profit repatriation and foreign currency scarcity. As a result, foreign institutional investment dropped to 36% of the total market capitalisation. 

In a forthcoming report on exploring the participation of institutional investors in the Egyptian capital market, we put forth recommendations on encouraging institutional investors and especially sovereign investors such as pension funds and insurance companies to act in their stewardship capacity. Doing so would yield positive results both for the state as their ultimate owner, for the general public which is the beneficiary of their services, as well as for improving the quality of the governance of listed companies. 

We propose obliging certain categories of institutional investors to develop voting policies and vote their shares. This was already implemented in some countries such as Chile, specifically for the pension funds, with positive results. In addition, we propose that the Egyptian Capital Market Association (ECMA) and the Egyptian Investment Management Association (EIMA) be used as a platform to introduce self-regulatory standards for institutional investors. 

*The views express in this post do not represent the official views of the OECD or its member countries. 

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Further recommendations and analysis is presented in the study The Role of Institutional Investors in the Egyptian Capital Market.

About the Authors

Maged Shawky Sourial is the CEO of Beltone Financial Holding since 2012, and Chairman of Beltone Exchange Traded Fund Company. Mr. Sourial is the Ex-Chairman of The Egyptian Stock Exchange since July 2005 till July 2010 after being the Deputy for the chairman for almost a year. During the period of 2002 till mid 2004, he represented the Regulator (Capital Market Authority) in the board of directors of the Exchange for three years. He held the position of Senior Assistant to the Minister of Economy and Foreign Trade for Securities Markets issues for around 12 years since 1995. He holds a Masters Degree in Financial Economics from Queen Mary, University of London, United Kingdom.

Alissa Amico is responsible for overseeing OECD's work on financial markets and corporate governance in the Middle East and North Africa. Alissa joined the OECD in 2005 to establish a regional programme on private sector development in the MENA region with the relevant Ministers in the region. In this capacity, Alissa provided technical support to a number of governments in the region the design of regulatory initiatives and institution building. Alissa holds a Bachelors degree in Business Administration from the Schulich School of Business, York University (Canada) and a Masters degree in Political Economy with a specialisation in the Middle East from the London School of Economics and Political Science (UK). She is a member of the French Institute of Directors' International Commission, and was named one of the Top 100 Leaders in Europe and the Middle East by the Centre for Sustainability and Excellence in 2011 and was recognised by Columbia Law School as the Rising Star of Corporate Governance in 2014.

 

International Transmission of Shocks via Internal Capital Markets of Multinational Banks: Evidence from South Africa

30.11.2015Adeline Pelletier, Assistant Professor, Instituto de Empresa

It is well documented that global banks contribute to international shock transmission via cross-border lending. Yet, global banking has taken another form over the recent decades with the expansion of banks abroad via branches and subsidiaries. This expansion has especially happened from and to developing and emerging economies, as countries have opened up their banking sector to foreign investors (Claessens and van Horen, 2012).

Multinational banks operate internal capital markets through which they (re-)allocate capital between their headquarters and their different foreign affiliates in response to financial or real economic shocks. In developing countries where interbank and capital markets are underdeveloped and a large part of the population is unbanked, the ability to receive funding through internal capital markets at low cost and in large quantity might present a significant advantage for foreign banks' affiliates. However, as internal funding reallocation can alter the funding position of a bank's affiliate, this may in turn lead to adjustments in foreign affiliates lending in their host market, thus creating another channel of international transmission of shocks (Cetorelli and Goldberg, 2012).

Impact of a financial crisis on capital re-allocation inside banking groups

In a recent study, I explore this issue by using a novel database on banks operating in South Africa, which includes information on internal loans and deposits from and to the banking group.

In exploring the impact of the 1997 East Asian Crisis on capital re-allocation inside banks, I found that that South African affiliates belonging to banking groups with high exposure to East Asian Crisis countries (in terms of total banking assets of the group in crisis countries) experienced a significant drop in their net internal funding position during the crisis, relative to South African affiliates of less exposed groups. The South African foreign affiliates of highly exposed multinational banks both received less internal funding from their group during the East Asian Crisis period than before, and lent more to their group, relative to the affiliates of less exposed groups. This result suggests that parent banks of more exposed groups reallocated capital away from South Africa to support their affiliates in east Asia.

Exploring the link between internal capital funding and domestic lending

Do foreign affiliates that receive internal capital from their group expand their local bank credit? Using an instrumental variable technique, I found that a 10% increase in the outstanding volume of internal funding resulted in a 5.6% increase in the volume of mortgage advances. As such, foreign affiliates do not only use this extra capital to acquire government securities or to invest abroad, as it has been reported in Africa where banks are often highly liquid but lend relatively little domestically (see Beck, Maimbo, Faye and Triki, 2011).They also "pass it on'' to the local economy by expanding their domestic lending.

Policy implications

This study suggests that foreign affiliates have ambiguous effects for the financial stability of the host country. On the one hand, being part of a foreign group reduces the risk of bankruptcy of foreign affiliates by allowing for the reception of internal capital from the group.

On the other hand, internal capital markets are a channel through which financial crises are transmitted from one country to another, when abrupt capital reallocations inside the group take place. However, the strength of this channel will partly depend on the legal structure of the foreign affiliate. Indeed, the organisational form of the foreign affiliate, either as a branch or as a subsidiary will have an impact on the stability of the banking sector and the local supply of credit through the internal capital market channel, as branches are more integrated to their group via this channel than subsidiaries.

A potential policy implication of this research for bank regulators may be that favouring organisation of foreign affiliates as subsidiaries rather than branches, through specific banking regulations, may reduce the potential transmission of foreign crises via internal capital markets. One caveat, however, is that if a banking crisis occurs in the host country, a parent is fully responsible for all losses incurred under a branch structure. Under a subsidiary structure, a parent's obligations are only limited to the value of the invested equity, which makes it more likely to walk away from the operation (Cerrutti et al., 2007; Fiechter et al., 2011). That said, if a foreign affiliate has systemic importance for the health of the banking group, its parent is more likely to support it through transfers of internal liquidity, regardless of its organisational form.

Bibliography:

Beck, Thorsten, Samuel Maimbo, Issa Faye, and Thouraya Triki. 2011. Financing Africa: Through the crisis and beyond. Washington DC: World Bank.

Cerutti, Eugenio, Giovanni Dell'Ariccia, and Maria Soledad Martinez Peria. 2007. “How banks go abroad: Branches or subsidiaries?” Journal of Banking and Finance 31 (6):1669-1692.

Cetorelli, Nicola and Linda S. Goldberg. 2012. “Liquidity management of U.S. global banks: Internal capital markets in the great recession.” Journal of International Economics 88 (2):299-311.

Claessens, Stijn and Neeltje Van Horen. 2012. “Foreign Banks: Trends, Impact and Financial Stability.” Working Paper WP/12/10, IMF.

Fiechter, Jonathan, Inci Otker-Robe, Anna Ilyina, Hsu Michael, Andre Santos, and Jay Surti. 2011. “Subsidiaries or Branches: Does One Size Fit All?” IMF Staff Discussion Note SDN/11/0, IMF.

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This blog post is based on the MFW4A Working Paper Series "Internal capital market practices of multinational banks: Evidence from South Africa".

Adeline Pelletier is an assistant professor at IE. She was previously a postdoctoral researcher affiliated to the Centre for Economic Performance at the London School of Economics, researching mobile payment services for the unbanked. She obtained her PhD in Business Economics from the London School of Economics in 2014, with a thesis on the performance, corporate financial strategy and organization of multinational banks in Africa. Prior to her doctoral studies she completed a MPhil in Development Studies at the University of Cambridge (2011) and she also holds a MPhil in Economics from Sciences-Po Paris (2006).

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