The market for government debt is changing across Africa, and in ways that pose risks for local banks as well as for their investors and customers. States are looking to their banks to help bridge funding gaps so they can better ride out the cycle of lower commodity prices and tepid global growth. That means it is harder to raise international funds – such as by issuing dollar-denominated eurobonds – and this has caused a jump in the issuance of domestic currency bonds, of which banks are the main buyers. Analysis from the IMF found a gradual increase in bonds issued for infrastructure, for example, and an overall growth in maturities of debt issues. The list of countries that have recently sold local currency debt that will mature in 10 years or more includes Benin, Burkina Faso, Kenya, Mali, Tanzania and Zambia.
Perspective
However, this can create complications for local financial sectors, not only in terms of exposure to sovereign risk, but also in terms of reducing space for lending. Increased exposure to government debt is a principle risk for African banks in 2017, and it suggests less credit availability to private customers, as banks typically prefer buying government debt to commercial lending. Budget revenue targets are not being met by governments, resulting in high amounts of borrowing and a crowd-out of the private sector. According to a 2017 banking sector report published by Nairobi-based Sterling Capital, banks have been left with a high number of troubled loans due to an unfavourable economic climate and the high costs of borrowing in the region.
Africa’s banking sector looks largely stable, with major lenders posting continued earnings growth and maintaining healthy capital buffers, according to a recent sector study from Moody’s. The ratings agency considers East Africa a standout region, offering the greatest degree of resilience against deteriorating conditions. However, in 2017 sovereign risk will be elevated for the sector as any decline in sovereign creditworthiness will immediately impact banks. South Africa stands out as an example of sovereign risk, with many expecting a ratings downgrade from Moody’s and other main credit ratings agencies. This, in turn, would remove the country from the ranks of investment-grade sovereigns and likely trigger a sell-off of South African bonds, because some institutional investors, pension and mutual funds are allowed to hold only investment-grade debt.
Exposure Rising
The IMF has found that government securities clearly dominate domestic markets in Africa, accounting for 90% of the value of local-currency debt instruments in recent years. This comes in spite of a recent push by African economies to issue eurobonds on international markets. Eurobond issuance soared to record levels from 2013 to 2015, surpassing $6bn in each of those years in sub-Saharan Africa, according to Bloomberg data. This helped lessen governments’ reliance on their local banks to provide funding, although the eurobond sank to $2bn in 2016, the lowest since 2012 on the back of a rising dollar and greater fiscal pressures.
Furthermore, while governments had achieved diversity in creditors between 2013 and 2015, most of their countries’ banks have not managed the same with their debtors. Moody’s coverage of African banks and sovereigns includes 33 institutions rated in 11 countries, and the agency’s analysis found four jurisdictions – Angola, Egypt, Ghana and Nigeria – in which the banking system’s aggregate exposure to government securities exceeded 150% of the value of bank equity. The ratio surpassed 100% in Kenya, Morocco, South Africa and Tanzania.
Figures from Kenya indicate that total debt had jumped by 26.1% from the third quarter of 2015 to the third quarter of 2016. Of the total $7.3bn of new debt accrued in the period, $5.1bn was sold domestically. This is expected to continue as the revised budget for FY 2016/17 cut foreign financing from 6.3% of GDP to 4% and boosted domestic financing from 3% to 4.1%. In addition to the government asking more from its banks, it has also capped interest rates on loans to the private sector, providing an additional disincentive to credit extensions.
Meanwhile, in UEMOA states as a whole, of which Côte d’Ivoire is a member, government debt rose from 18% of banks’ total assets in 2011 to 22% in 2014.
Borrowing
Data from the Bank of Ghana shows that in the country, banking investment in Treasury bills went from 39.2% of the overall total in 2006 to 79.1% in 2015. The feared contraction of credit to the private sector then followed, with the total dropping 6.8% in real terms in March 2016 year-on-year. Relief may be coming from new oil and gas projects about to begin production, which could lessen the government’s need for domestic bonds – potentially even leading to a surplus – but the trajectory highlights the significant impact domestic borrowing can have on private sector lending. African banks’ exposure to government isn’t just limited to securities; loans are a factor as well. Côte d’Ivoire had planned on selling eurobonds in 2016, in part to help finance crude purchases for its oil refinery, and considered a CFA franc-denominated bond as well, before deciding in January 2017 to borrow $220m from Ecobank, Bank of Africa and Coris Bank International. However, these loans may also prove risky if the government is having a difficult time bridging over deficits.
In Gabon a pile-up of invoices in 2014, due to contractors, impacted the banks by increasing non-performing loans (NPLs) to 9.6% of total outstanding credit and by reducing liquidity levels. This resulted in some banks announcing a moratorium on loans to the construction sector and to commercial customers reliant on government work. Moody’s sees a continued risk of troubled loans across Africa as a result of government arrears to private-sector borrowers, especially in the construction sector.
Divergent Narratives
Not all African economies are equally exposed, of course, and there are certainly other factors that dampen either diversity or growth in private sector credit. In Nigeria government bonds and other securities reached 16.1% of banking assets in 2015, and credit to the private sector expanded by 8.4% on the year, and 13.7% to government, according to figures from the Central Bank of Nigeria (CBN). In Nigeria the narrative diverges from the standard one, as bank exposure to the oil and gas sector is a bigger problem than exposure to government, at about 30% of the total loan book. The CBN has responded, nonetheless, having introduced risk-sharing programmes to boost lending to small and medium-sized enterprises. In 2015 it also lowered its cash reserve ratio from 25% to 20%. This was seen as an effort intended to incentivise the banks to use that newly available capital on loans to the private sector.
Despite the increased level of sovereign risk created by government debt exposure, the overall outlook for African banks remains mildly positive. Though the rate of NPLs is expected to rise across most major markets on the back of broader exogenous factors, the reasons vary, from the Central Bank of Kenya forcing more stringent loan classification standards on its banks, which could lead to more loans being considered non-performing, to the spillover impact of high interest rates in Tanzania.
Eurobonds
The three African countries that need to take care of large refinancing obligations before 2018 are Ghana, Côte d’Ivoire, and South Africa. One variable that could change the situation across the African banking landscape is a revived opportunity to sell eurobonds. While many global debt investors perceive Africa to be a high-risk area, others may see the potential for high yields as worth the risk as demand comes from institutional funds that have a mandate to invest in high-risk securities. The issuance of eurobonds often comes as countries need cash to pay off existing debts. In the past eurobonds were structured with large bullet payments rather than monthly repayment schedules, so the existing repayment due dates could be an indicator of sales.
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