Eurobonds are debt instruments issued by a country in a currency different from its own. Eurobonds have risen to prominence in Africa because they have opened a window for governments to diversify their funding sources from traditional concessionary loans offered by the International Monetary Fund (IMF) and foreign aid, both of which are declining. In addition, multilateral loans were becoming unpopular because they set strict conditions about austerity which are designed for governments to reduce spending.
A bond functions as a loan in which an investor gives a borrowing entity an amount of money for a specific period of time in exchange for periodic interest payments. South Africa issued the first African bond in 1995. To date, 21 African countries have issued Eurobonds worth a combined total of an estimated US$155 billion on international bond markets. Institutional investors from Europe and the US buy these instruments. Misheck Mutize, an expert on Africa sovereign debt, explains why the system isn’t working in favour of African countries.
Which countries are the latest issuers of Eurobonds? Why are they issuing them?
South Africa issued two international government bonds on 14 November 2024, amounting to US$3.5 billion. One bond was valued at US$2 billion, with a coupon rate of 7.1%. The other was valued at US$1.5 billion with a coupon rate priced at 7.95%.
The coupon rates reflect a fixed interest that the country in question will be paying bondholders semi-annually. These rates are high. They are set by bond issuing syndicates based on expected demand.
All African bonds issued to date have been oversubscribed by more than 2.5 times. A bond is oversubscribed if the bond seller receives more orders than the amount available for sale.
Nigeria also issued a US$1.7 billion Eurobond on 3 December 2024, which was oversubscribed 5.4 times. Nigeria will pay an interest rate of 9.625% per year on its bond with a duration of 6.5 years, and 10.375% for its 10-year bond.
Coupon rates below 5% would be reasonable to support such recurring expenditures. The rates are high, maybe even too high for South Africa and Nigeria to repay. Low repayment obligations would allow government to save resources for other developmental needs.
A number have been oversubscribed. What does this mean?
South Africa and Nigeria’s bonds are among many issued by African governments which have all been oversubscribed by at least 2.5 times over the past decade.
African governments celebrate oversubscription of bonds as a sign of strong investor confidence in African economies and high appetite to invest on the continent. It is portrayed as huge success.
This is not the case.
The oversubscription of bonds is a situation when demand exceeds the amount of instruments that the issuing country intends to sell. It means that investors want to buy more bonds than are available.
When the demand for bonds exceeds supply, the coupon rate should come down, not go up. The oversubscription of bonds shows that the bond interest rates that are being set are too attractive to investors and could be reduced.
High interest rates are more favourable to investors, but they mean high repayment costs for the borrowing government.
African governments are failing to use the strong demand for their bonds strategically. They could instead bargain for more favourable terms:
longer tenor – the period before the principal must be repaid. Africa should shift to issuing bonds over 30 or 40 years. This allows a country to invest proceeds into longer term projects.
low coupon rates – a fixed amount that the government will pay to bondholders semi-annually until maturity of the bond. It should be less than 5% per annum.
Accepting high interest rates has cost Africa billions in debt servicing costs, which is threatening the continent’s debt sustainability.
There is one reason why this is happening. The uneven power balance between African governments and those managing the actual issuing of the bonds.
But, in my view based on my sovereign debt management experience, governments could and should be smarter in their approach.
It would be better for the African bonds to be undersubscribed having been priced at their intrinsic value with favourable terms. The only risk of undersubscription is negative market sentiment, which may affect future capital raising efforts. Undersubscription happens if demand for the bond is less than supply. Potential investors might think there’s something risky about the issuer. But, with time, market jitters will flatten out.
Do other developing countries have the same problem?
Unsustainably high borrowing costs have been a challenge faced by all developing economies across the globe. Nevertheless, African goverments are paying 4% more interest rates than Asia and Latin America with similar credit ratings. One of the major contributors to this situation is the bond issuing syndicates.
Several parties play important roles in the issuance of a bond – known as the bond issuing syndicate. For example, there is a lead manager – typically an investment bank – which structures the Eurobond issue, sets the terms, mobilises investors and manages the entire issuance process. They also organise the underwriters. Underwriters are financial institutions that agree to buy the entire bond issue from the issuer if there is no uptake and resell it later on the secondary market. They assume the risk of unsold bonds.
In the case of African countries, lead managers and underwriters would not want to issue a bond that would not sell. They want to make a profit and reduce risk. Hence they structure bonds with terms that favour oversubscriptions and maximum profits at the expense of the issuing government.
At the same time, African governments enter into Eurobond issuing arrangements with weak negotiating power because of limited financing options – compared with other issuers. Governments are issuing bonds to finance recurring expenditures in their annual budgets. More than 10 Eurobonds issued since 2020 are used to finance fiscal recurring expenditures such as civil service salaries.
In addition governments are entrusting the issuance, sale and management of Eurobonds to syndicates, with little or no option to influence the terms and processes. It is important for finance ministries to be highly involved in these processes.
What needs to be done?
The oversubscription of African Eurobonds doesn’t address the fundamental economic challenges faced by many African countries. High debt levels, exposure to currency risks, reliance on external capital, and potential future financial distress, are all reasons why oversubscription should be met with caution rather than celebration. Oversubscriptions will make these problems worse.
Sustainable debt management and long-term economic strategies should be prioritised over short-term financial success.
African governments need to use oversubscription to bargain for lower interest rates and longer bond tenor. It is critical to coordinate with bond issuing syndicates to bargain for a decrease in interest rates comparable to other countries that have similar credit ratings.
Egypt did it in September 2021 on its US$3 billion issue. It resulted in interest rates being lowered by 0.33% on the 6-year and 12-year bonds, and by 0.13% for the 30-year bonds. This would save Egypt approximately US$53 million in interest repayments.
Misheck Mutize is affiliated with affiliated with the African Union as a Lead Expert on Credit Ratings
This article was originally published on The Conversation. Read the original article.
