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Mapping Out the Future for Rwanda's Capital Markets

21.03.2016Jacqueline Irving, Director & Jim Woodsome, Senior Associate, Milken Institute

How should Rwanda develop its capital markets? This was the subject of a three-day roundtable discussion held last October in Rubavu, Rwanda. The roundtable was organized by the Rwanda Capital Market Authority (CMA) and the Milken Institute's Center for Financial Markets (CFM), with support from FSD Africa. Highlights from that discussion, including points of consensus and debate, are captured in the Milken Institute's new publication, "Framing the Issues: Developing Capital Markets in Rwanda."

Over the past decade, Rwanda has made considerable progress in achieving rapid economic growth and reducing poverty, supported by sound macroeconomic policies. Its business-friendly environment is now among the best in Africa. The government and its international development partners view deepening and diversifying the domestic financial system as essential to Rwanda's goal of transitioning to middle-income status.

Last year, the Rwanda Ministry of Finance and Economic Planning gave the CMA a mandate to produce a 10-year Capital-Market Master Plan (CMMP) to guide reforms to develop Rwanda's capital markets. An overarching goal will be to deepen capital markets so that they intermediate long-term finance for private-sector-led growth and meet the country's infrastructure and other socioeconomic needs.

The October strategic planning roundtable kick-started the process of mapping out capital-market reforms. The event gathered policymakers, regulators, issuers, investors, and capital-market experts from around the world, including senior officials from the government of Rwanda. The roundtable provided an off-the-record forum for frank and in-depth discussion about the opportunities and challenges Rwanda's capital-market stakeholders face, as well as how they can prioritize and sequence reforms. Participants also heard firsthand how other developing countries mapped out and launched their own capital-market reforms.

The roundtable covered core questions that will inform the drafting of Rwanda's Capital-Market Master Plan, including:

 

  • How should Rwanda develop its investor base, both domestically and regionally? What are innovative ways to mobilize household savings?
  • Can other nonbank financing sources-such as private equity, financial leasing, and even crowdfunding-help "incubate" firms for future listings?
  • How can Rwanda strike the right balance in accessing needed foreign-portfolio investment while guarding against risks of overreliance on this investment?
  • How can capital markets in Rwanda and its East African Community partners take a regional approach to attracting new listings?
  • Should the stock exchange target small and medium-sized enterprises (SMEs) in its outreach for new listings-and, if so, how?
  • What can Rwanda learn from other countries about the process of planning and implementing capital-market reforms?

Roundtable participants strongly agreed that an immediate and ongoing priority is for Rwanda to develop a pipeline of prospective listings. Targeted outreach -including education and technical assistance - is critical to increasing the number of firms willing to list. Cultivating a high-growth-potential corporate base could also serve as an incubator for future listings, as would developing the local venture capital and private equity markets.

 

Lessons shared by participants from other emerging markets underscored the importance of sequencing and developing capital markets to complement the banking sector, not compete with it. As an economy grows and becomes more complex, firms and households require a wider range of financial services - from banks as well as other financial intermediaries. Once larger firms begin to rely more on capital markets for longer-term financing, banks may increase lending further down the credit spectrum, to SMEs and households.

Well-functioning, appropriately regulated local and intraregional institutional investors are vital to developing a stable investor base. Several participants flagged the need to mobilize small savers across EAC markets, perhaps through a regional fund, which also would advance financial inclusion. The role of non-EAC foreign investors was more heavily debated, however - particularly the degree to which bond issuers should rely on foreign capital.

Regionalization emerged as a key cross-cutting issue. More cross-border listings and cross-border investment across the EAC's securities exchanges could help overcome local capital markets' impediments such as illiquidity, low market capitalization, and few listings. Greater cooperation across EAC capital markets in developing and sharing market infrastructure and intermediation services could unlock significant economies of scale. Throughout the roundtable, participants returned to the point that capital-market development should not be done for its own sake, but to spur growth of a diversified, inclusive economy that creates decent jobs and improves living standards. And, while best practices exist, there is no one-size-fits-all approach to developing capital markets.

This blog post was originally published on the Milken Institute's blog website. 

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About the Authors

Jacqueline Irving is a Director in the Center for Financial Markets at the Milken Institute. Previously, she was a senior economist at US Treasury, responsible for the migrant remittances and financial inclusion portfolio and a U.S. government delegate to the G20's technical working group on remittances.

Jim Woodsome is a Senior Associate, Program Research Analyst at the Milken Institute's Center for Financial Markets. In this role, he conducts research, organizes events and helps manage initiatives related to the Center's Capital Markets for Development (CM4D) program.

Financial Inclusion in Africa: What Role for Microfinance*

21.03.2016Professor Sylvanus Ikhide, University of Stellenbosch Business School

Financial inclusion is important for economic growth because it plays a dual role. While creating access especially to operators in the informal sector, it will enhance financial deepening thus embracing both breadth and depth dimensions of financial development.

In other words, financial inclusion to be relevant for economic development must focus on the core elements of financial intermediation such as savings mobilization and asset transformation, risk mitigation and enhancing efficiency in the corporate sector by monitoring management and exerting corporate control. Polices of financial inclusion that rely mainly on transactions rather than the whole gamut of intermediation while creating access may not translate into usage broadly defined to include credit and may not necessarily lead to financial deepening and hence economic growth.

Among different strategies for increasing access to finance in Africa, microfinance stands out as a mechanism with strong potential for reducing poverty and inequality and promoting entrepreneurial finance. Microfinance Institutions are critical providers of finance to small and micro enterprises that are unable to raise credit from commercial lenders due to information asymmetry and the high costs associated with lending. Micro, small and medium scale enterprises are the biggest job-creators and contributors to economic growth in many developing countries; and finding alternative ways to finance them has placed microfinance in the epicentre of the financial inclusion debate (Robinson, 2001).

With the general trend in microfinance, which places emphasis on financial sustainability, MFIs can fully recover costs and make profits. Such commercially oriented microfinance should finance their loan portfolios through savings mobilization, commercial debt, and retained earnings; and charge interest rates that will enable cost recovery from income generated "from the outstanding loan portfolio, and to reduce these costs as much as possible" (Meesters, Lensink & Hermes, 2008:2); and "generate a profit" (Robinson, 2001).

Literature supports the view that sustainable microfinance will have outreach and impact, hence the push towards sustainable, commercially oriented MFIs (Conning, 1999:51; Cull & Morduch, 2007:F107; Manos & Yaron, 2009:101; Robinson, 2001). Quayes (2012:3432) takes this argument further by concluding, "attainment of financial sustainability is not an impediment to outreach efforts, and may actually facilitate greater depth of outreach". When MFIs that leverage on deposits are regulated, they are generally sustainable and expand outreach (Bayai and Ikhide, 2015, Haiyambo and Ikhide 2015). An enabling regulatory environment not only makes MFIs sustainable but also enables them to grow.

In the African context specifically, microfinance presents a viable opportunity to drive financial inclusion for the unbanked and underserved, as most African financial systems are still nascent and incapable of addressing the more pressing challenges of rural poverty and unemployment. Microfinance broadly defined to include microloans, microsavings, microinsurance and remittances/money transfers should receive policy focus. Microfinance, so defined, has been proven to improve access and enables the poor to manage and build their asset base gradually.

Formal microfinance in Africa has increased during the last two decades through the expansion of the scope of formal institutions (downscaling, linkage programs), emergence of new formal institutions focused on microfinance, reforms of state-owned financial institutions and the introduction of new microfinance programs through governments. However the formal operations concentrate mostly on providing credit facilities. Savings mobilization has yet to receive adequate attention.

Government sponsored microloans programmes are very common in many SSA countries because of the political attractions that such schemes hold more for vote catching in elections and less for poverty reduction. Microfinance programmes that target enterprise finance rather than consumption have better chances of reducing poverty through boosting employment. This is also why the present preoccupation with mobile phone banking in many parts of Africa must now begin to migrate to the next phase involving credit creation rather than the obsession with money transfers. Many mobile money users are not otherwise included in the formal financial system-in Kenya 43% of adults who report having used mobile money in the past 12 months (2012) do not have a formal account; in Sudan 92% do not (AfDB, 2013). In the same breadth, the present preoccupation with microloans in many SSA economies might be misplaced. Microloans do not make microentrepreneurs.

Microfinance institutions have emerged in Africa largely to meet the unfulfilled financing needs of the self-employed and of micro, small and medium scale enterprises. For such endeavours to develop, fledgling entrepreneurs must have long-term access to capital. In most of the surveys on this sector, access to finance and energy feature prominently on the list of MSME's needs. MFIs have been able to fill this demand because they focus their loan analysis on clients' character, cash flow, and commitment to repay the proposed loan, rather than on collateral or business experience. In this way, MFIs take into account the special characteristics of the new private sector in this region. What this calls for is a well-articulated microfinance strategic framework in these economies to complement overall financial sector development.

*Excerpt from Inaugural lecture on "The Finance and Growth Debate in Africa: What Role for Financial Inclusion" University of Stellenbosch, Stellenbosch South Africa, November 2015.

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About the Author

Sylvanus Ihenyen Ikhide is Professor of Development Finance and Head of the Doctoral programme in Develoment Finance at the University of Stellenbosch Business School, Cape Town, South Africa.

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).

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