As they struggle for investment to support post-Covid recovery, African governments face the specter of a debt crises that could become as large as that of 1980s.
This crisis can only be solved by a more stable, liquid market in African government bond bonds, argue Daniel Cohen (chair of Finance for Development Lab) and Ibrahim Elbadawi (managing director of the Economic Research Forum) in a recent in an a recent policy brief.
According to the authors, such a market is possible by combining specific tools within a regional African financial arrangement known as the African Stability & Liquidity Mechanism (ASLM).
Unprecedented challenges
The world faces the greatest economic challenges since 2007-08’s financial crisis.
As a result of the Covid-19 epidemic and associated lockdown restrictions, global supply chains continue to be in disarray. Inflationary pressures were already present before the Russian invasion of Ukraine. However, the war has reduced the supply of basic foodstuffs like wheat and vegetable oil from Black Sea importers, driving up food costs. At the same time, international efforts to deter Russian aggression, coupled with Moscow’s response to them, has led to a spike in oil and gas prices.
This is making it harder for African governments to secure investments in post-pandemic recovery, essential infrastructure, and climate change mitigation as part sustainable development. Beijing was once a major source for finance for infrastructural project, but the Chinese government has drastically reduced funding for such investment streams over the years that led up to the pandemic.
Partly because of plentiful Chinese lending – much of it for badly needed projects – the sovereign debt of many African governments has built up in recent years, but they now face much higher servicing costs and greater difficulty in securing new lending.
The African Stability and Liquidity Mechanism – a new safey net
Investors have cut back on exposure to frontier markets due to instability. This includes Africa. Although the picture is not the same across Africa, potential lenders have been dissuaded by rising African debt levels.
Some countries have unsustainable levels of sovereign debt, but even countries with strong foundations are experiencing a liquidity shock that their current financial arrangements cannot manage.
Cohen and Elbadawi believe that an ASLM would provide financial safety net to help ensure macrofinancial stability, reasonable funding costs for African governments, and a stability mechanism instead of a bailout facility.
Hosted by the African Development Bank (AfDB), it could leverage renewed enthusiasm for multilateralism and G20 countries’ commitments to rechannel their special drawing rights (SDRs) issued by the IMF. It would also provide financial support, without the stigma that comes with being part of an IMF programme.
Four ways to increase stability
The ALSM would include four facilities that will boost local financial markets stability, mitigate against commodity price fluctuations, and inject more liquidity into Africa’s sovereign debt market, thereby decreasing financing costs: the Liquidity and Sustainability Facility, (LSF), a commodity hedge facility, a credit enhancement facility, and a debt restructuring facilitation area.
- The LSF has already been launched. It was established by the UN Economic Commission for Africa in November 2021 to reduce liquidity premiums and increase sovereign access to international bond market for African countries. It is expected to save $11bn in borrowing costs during its first five years. The repo market would provide short-term loans in return for sovereign debt collateral.
- Margin calls are used to protect against price fluctuations and would be guaranteed by a new commodity hedging facility. This would provide crucial protection for both exporting and importing countries, as well as indirectly stabilising their debt.
- The credit enhancement facility would provide partial guarantees for new debt in order to prevent panic risks and improve the quality of debt.
- The debt restructuring facilitation facility, which provides cash sweeteners for marginal creditors in times of debt restructuring, would also support debt restructuring negotiations. This would reduce both time and cost of restructuring negotiations. The facility would require a capital source from African countries. It could also be supplemented by donor resources, including the reallocation of SDRs. It would need between $40bn to 80bn dollars of callable capital to be sustainable, according the authors.
These facilities and the ALSM itself “should not bail out countries in unsustainable macrofinancial situations or act as a substitute for a program with the International Monetary Fund. Instead, the ALSM should focus on African specific financial vulnerabilities that are not yet within the toolkits of international financial institutions,” say Cohen and Elbadawi.
“While not aiming at solving problems of over-indebtedness, it can provide important services in
improving management of liquidity and financial stability.”
The Liquidity and Stability Facility – a “repo” market for Africa
A few years ago, the number of African eurobonds in existence was greater than the $100bn mark. Today, it is estimated to be around $150bn. Over 20 African sovereigns have accessed international debt capital market capital markets over the past decade. These issuances were often over-subscribed with investors seeking higher yields.
Despite being attractive, African eurobonds have a disadvantage: they are less liquid that other similar financial products. It is well-known, that African issuances suffered from a risk premium. This meant that issuers paid a higher rate of interest than peers with similar risk profiles.
This is what former executive secretary of the UN Economic Commission for Africa Vera Songwe was trying to rectify when she called for the launch of a “repo” (repurchase) market for African bonds, where these bonds could be used by private investors as collateral for short term loans. To put things into perspective, the US repo market provides more than $3 trillion in funding every day.
This led to the setting up of the LSF. The LSF is already a registered entity, it benefits from the expertise of leading financial institutions such as Bank of New York Mellon, the biggest player in global repo markets, and Citi.
So what should we expect? Songwe believes that African paper should be more attractive to investors, thereby lowering yields and the cost of servicing debt. Once investors know they can access short term loans in exchange for holding African sovereign debt, they will be able not to be tied down once they invest in African paper, it should bring more investors to the African Eurobonds markets.
The initial plan is to start with a sub-section of international sovereign bonds. Songwe, who is the chairman of the LSF board, estimates that once the African Eurobonds repo market is functional, debt servicing can be saved by around $11bn over the next five year.
Source: african.business
