Who are these new belles of the ball? Investors are filling their dance cards with debt issued to fund infrastructure, from roads to power plants, in sub-Saharan Africa, the world’s poorest region. Tiny countries such as Tanzania and Rwanda are making 2013 bond debuts on the international stage and Kenya, also a new player, is slated to have a $1 billion offering this autumn. Altogether, the region is offering $7 billion in debt this year, far more than ever before.
Investors, who were once put off by Africa’s reputation for corruption and power-hungry dictators, are snapping up these bonds, despite their junk credit ratings. Demand is so strong from investors in countries including China, Japan and the United States that bonds are selling out in a few days. In the past there was scant interest.
Extremely low yields on other bonds from developed countries are the main driver. People are searching for alternatives and Africa is one of the last untouched regions for investment, said Stuart Culverhouse, London-based chief economist at Exotix Fixed Income, a boutique investment bank. Many sub-Saharan bonds are sold at yields more than double that of US Treasuries. In April, for example, Rwanda raised $400 million with its debut Eurobond offering that sported a 6.87% yield compared to 1.66% for 10-year US Treasuries, which are widely considered to be safer bets.
Plenty of risk
For all that reward, there is plenty of risk that investors might not see or understand. Like any frothy investment, investors need to examine the underlying assets and their potential for both default and strong returns.
“Unfortunately, investors tend to see this region as all good or all bad,” said Mark Rosenberg, a senior Africa analyst at Eurasia Group, a political research and consulting firm. “But these countries deserve investment just like any other frontier country.”
For starters, some countries in sub-Saharan Africa are new to the debt markets. There is not much of a modern track record for repayment, said Culverhouse. Political risks add to the complications.
“Will an existing government change its mind about repaying a previous bond?” said Culverhouse. After all, the Ivory Coast defaulted on its Eurobonds in 2011 amid political turmoil.
Despite rising democratic gains, some nations are still struggling with corruption. Angola, Kenya and Uganda ranked near the bottom of the 2012 corruption index prepared by Berlin-based Transparency International, a non-governmental organization. Angola, which plans to raise $1 billion through a bond offering this year, was ranked 157 out of 174 countries; Kenya was 139.
Some other sub-Saharan countries are seeing growth that could last decades and less risk of political upheaval, lessening the likelihood that bondholders might not get paid. Still, even these “safer” bonds have risks. Many sub-Saharan countries depend on one commodity, such as oil or gold, so country currencies can go up and down with the value of that commodity, which can damage the underlying economies.
Rosenberg said that stable governments in Nigeria and Ghana make them safe bets. He is more bearish on Zambia and Uganda, where there is political unrest. “It won’t be a linear story,” said Rosenberg.
Sub-Saharan governments are becoming more stable though, and more peaceful transfers of power are occurring, said Larry Seruma, chief investment officer of Nile Capital Management, an asset management firm that invests in Africa. In the past, it was not uncommon for a country such as Nigeria to see coups when power shifted but the country has had several peaceful elections. Rwanda, once known for its bloody genocides, has been aggressively stamping out corruption.
As the politics have smoothed out, growth has accelerated. The dozens of sub-Saharan countries, which include the Ivory Coast, Ethiopia and Zambia, comprise the second-fastest growing economies after Asia, according to the International Monetary Fund. The subcontinent is expected to grow 5.6% this year versus just 1.2% for developed economies, the IMF estimates. Angola, the second largest producer of oil in Africa after Nigeria, saw its economy grow 7.4% last year. Tanzania, a major gold producer, grew 6.9%.
That growth is expected to continue apace for many years, said Richard Ottoo, a finance professor at Pace University in New York City. The region is, for the most part, starting from the bottom. Indeed, sub-Saharan Africa’s gross domestic product per capita was $2,475 in 2012, ranking at the bottom of the list of the world’s poorest economies. As these countries grow, they are less reliant on loans and donations from the IMF and the World Bank. They can now turn to the bond markets to plug deficits.
Yet even with the increased issuances in the last few years, countries in the region are no longer saddled with lots of debt. Debt is now low, relative to GDP. In 2012, the percentage of debt to GDP in several sub-Saharan countries was less than 50%, lower than developed countries such as Belgium or Austria. Some African countries are making fundamental economic changes and managing inflation well, said Seruma.
Given their stronger balance sheets, these mid-African countries are turning to bond markets to plug deficits and fund much-needed infrastructure repairs such as roads, bridges and power plants that they — and many bond investors— believe will fuel continued growth and stability.
Some countries with bond offerings, such as Tanzania, do not even have credit ratings yet.
“You’ll have to do your own due diligence,” said Seruma.
Investors can look at country reserves and balance-of-payment deficit figures published by the IMF, he said. Bonds supporting power plants are also safer than ones for roads or bridges, he added. Seruma also recommended sticking with countries and bonds that are already rated. Rating agencies Standard & Poor’s and Moody’s are stepping up their ratings for African countries, which may also help eventually, he said.
Risk-averse investors should stick with dollar-denominated bonds, said Seruma. These bonds do not have the currency risks that African bonds in local denominations carry. They also tend to be more liquid, he said.
Of course, for most investors, the promise of a booming Africa is not what is driving the $155 million flowing into bonds from European investors and the $1.8 billion from the US so far this year, according to EPFR Global, which tracks fund flow data. Rather, a deep hunger for yields is at the heart of the African bond boom.
What will end the flow? Higher US Treasury yields, according to Seruma.
“When the money dries up, a lot of political risk will still be there,” said Rosenberg.
As the politics have smoothed out, growth has accelerated.