An all-time low in yields attracted international investors to emerging markets such as Africa, says Grant Flanagan, managing director, Amigo Partners.
The potential for Africa has been well documented in recent years. At no point in the last fifty years has Africa been in such good economic shape. Whilst aid agencies, mining companies and peace keepers have been important, the continent’s main saviours have been its own people. Higher literacy rates, greater accountability from leaders and the embracing of modern technology have all contributed to a welcome transformation of the continent. Improved investment in transport, power and communication networks that physically enable regional integration will help accelerate and sustain Africa’s growth and development and improve productivity.
Underinvestment in infrastructure has been prevalent for decades. Ernst and Young estimate that $90bn of investment a year is required between 2010 and 2020 in order to bridge the gap between levels of infrastructure in Africa and other emerging markets. Traditionally these infrastructure programmes have been the responsibility of individual governments, whose funding was a combination of bilateral and multilateral facilities, augmented with expensive domestic borrowings. According to estimates from the Infrastructure Consortium for Africa, in 2010, African taxpayers provided $35bn of investment whilst multilateral institutions, the G8 and other private sector funds invested $50bn in African infrastructure. Austerity measures since the onset of the global financial crisis will slow this flow of bilateral and multilateral funding. The private sector will pick up some of the slack but for many African Sovereigns these are crucial investments that have to be funded by public debt.
Demand for fixed income
Global capital market conditions, therefore, could not have come at a more fortuitous time. An all-time low in yields attracted international investors to emerging markets such as Africa. Initially the attraction was the high domestic bond yields relative to those in the developed markets. For example, domestic bond yields in Ghana climbed to over 20% in 2012 whilst in Kenya and Nigeria domestic issues have yielded between 10% and 16% over the last twelve months (local currency). Limited liquidity in these domestic issuances made them marginal investments for many large institutions. South Africa presented the perfect solution with its deep and liquid debt markets, becoming a major beneficiary of this carry trade. Sadly, South Africa has also demonstrated the currency risk associated with investing in domestic issuances. The currency has fallen 23% against the US Dollar over the last twelve months devastating the effective US Dollar yield on the investment and possibly even resulting in capital losses.
These losses have not diminished investor demand, which, alongside higher domestic funding rates, has increasingly encouraged governments in sub-Saharan Africa to turn to international markets to raise funds. Not long ago this would have been unthinkable as the state of sovereign finances would have made a credit rating implausible. Now, S&P rates 16 countries of which only South Africa regularly tapped international bond markets pre-2007. Since 2007 seven African Sovereigns rated by S&P have launched debut international debt issuances totalling nearly $6bn. The graph shows the yields of eight rated sub-Saharan African Eurobond issuers (excluding South Africa), the latest issuer being Rwanda which launched it maiden issue at a yield of less than 7%.
These yields are tremendously attractive in global terms and provide much needed cheaper funding for Sovereigns. There is a downside to this access given that the bullet maturities require careful fiscal management. Sovereign issuers also have to internalise the exchange rate risk on foreign currency debt which traditionally has been held by the investor. Whilst yields for investors have increased on these bonds since May 2013, it is questionable as to whether or not the yields that these bonds were launched at were correctly priced.
This serves to highlight an opportunity for investors seeking yield that presents itself in Zimbabwe. A most important consideration with regards Zimbabwean debt is that the country is fully dollarized whereby all commercial transactions take place in a foreign currency. The preferred currency, and that which all contracts are denominated in, is the United States Dollar and as such there is no domestic currency risk. This is important as it removes the reliance on the responsibility of the Sovereign to manage foreign currency reserves in order to repay debt.
Zimbabwe historically had a deep and diverse capital market, with active equity and fixed income markets. On the fixed income market, primary issuers included the sovereign, state owned enterprises, municipalities and corporates, offering credit diversity and most importantly provided a yield curve. The fixed income market now is only just beginning its recovery. In keeping with its African peers, it suffers from a lack of liquidity and small issuances as demonstrated by the 2012 three year Infrastructure Development Bank of Zimbabwe bond which raised $30m with a coupon of 10%. Given that total deposits in Zimbabwe are around $4bn and the estimated demand for credit exceeds $12bn (twice the size of the equity market) there is huge potential for the market to return to its former standing. Some secondary market activity is already occurring so opportunities should become more accessible as a yield curve emerges and markets deepen. Meanwhile yields remain high enough and durations short enough to justify investors holding issuances to maturity.
The most interesting immediate potential exists in exposure to corporate debt. According to the African Development Bank (July 2013), Zimbabwean merchant banks weighted average lending rates to corporates as at the end of May 2013 were 17.02%, a 250bps increase on the rates being offered in May 2012. Whilst the issuance of paper by corporates has been limited post hyper-inflation, where issuances have taken place yields have been as high as 20%. For the investor the question is whether or not, in a world devoid of yield, investor demand for interest has overridden the risk of capital losses. In the case of Zimbabwe we believe the answer is no. Being dollarized provides foreign investors with the opportunity to earn US Dollar returns at yields normally reserved for domestic currency issuances, which even when adjusted for risk we believe makes for an attractive proposition.
We remain excited and very positive about Africa generally and Zimbabwe specifically. That is not to say that we are unquestioning optimists, rather we are realistic optimists. For too long Afro-pessimism has been dominant and we believe you need a positive mind-set to succeed in Africa. Over the past decade winners have outnumbered losers in Africa. With improving infrastructure, better technology, growing urbanisation and the rising trend of the “return of the African diaspora”, this will continue. The investment case is complex and substantial challenges remain but that is the opportunity and now is the time.