Africa must not become overly reliant on foreign investment: Jacqueline Irving interview

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Jacqueline Irving, consultant senior economist at the World Bank

Sub-Saharan Africa’s capital markets have assumed new importance in the wake of the financial crisis. The World Bank estimates foreign direct investment (FDI) in the region will fall to 2.8% of developing countries’ GDP in the medium term, from a peak of 3.9% in 2007.

Given that FDI accounts for 20% of total investment, the need for alternative sources of financing is acute, and an increasing number of countries in the region are turning to the bond markets to raise funds.

Jacqueline Irving, a consultant senior economist at the World Bank, is well placed to comment on Africa’s bond markets. She assessed local sources of financing for a World Bank programme evaluating African infrastructure development; she has participated in operational work for the IMF on African countries’ access to foreign private capital, and published papers and articles for the World Bank, IMF and Economist Intelligence Unit.

Here, she discusses potential benefits and challenges associated with the development of bond markets in sub-Saharan Africa.

Aid flows to African countries have fallen in the past few years. Can bond markets make up the shortfall?

Bond markets cannot make up for declining aid flows. Official development assistance remains a critical source of external financing for a number of African countries. Domestic sources of development financing are still limited, while bonds issued on international debt markets would have high country risk premiums and carry the risk of currency mismatch.

This is particularly the case for bonds issued to finance infrastructure projects, where revenues are typically earned in local currency.


Many countries that have severely underdeveloped infrastructure and financial markets are also less stable in overall macroeconomic terms. This makes access to private sources of external finance either prohibitively costly or nonexistent. As we saw most recently during the global financial crisis, capital flows to emerging markets reversed as investors fled markets perceived as riskier.

Those countries prone to macroeconomic and political instability and with low levels of financial intermediation would be particularly vulnerable to these sorts of capital flow reversals. So in these cases, official development assistance is still often the only available source of external financing.

However, efforts over the past decade or so by a number of African countries to develop local bond markets – including by extending maturity profiles of government securities (where sensible and relevant) and promoting further diversification of the local investor base – could have merit, both as a means of improving debt management (by restructuring outstanding debt to reduce the risks of frequent rollovers of short-term paper), and to provide foundations for later development of corporate bond markets. But beneficiaries of debt relief will have to be vigilant in managing the proceeds from bond financing to ensure that they are channelled into viable, development-oriented projects that reap sufficient returns, and to avoid borrowing amounts that again raise debt burdens to dangerous levels.

And local currency bond markets are not immune from sudden slowdowns or reversals in capital flows. Other potential negative effects that would be associated with significant foreign investment flows to underdeveloped African countries’ local bond markets are a potential dampening effect on external competitiveness where the currency appreciates due to large inflows and impeded monetary policy effectiveness due to any large foreign portfolio inflows (and outflows). It will be important for countries to give priority to improving their data collection and other systems for monitoring new sources of foreign capital inflows, to ensure to ensure that policy is continuously evaluated to encourage more stable investment that would have a more positive impact on socioeconomic development.


How could domestic bond markets help these economies?

Local bond markets could help African countries improve debt management by restructuring outstanding debt to reduce the risks of frequent rollovers of short-term paper. They could also be a source of financing for local infrastructure projects.

Bonds are better suited to these types of projects than local bank lending because the liabilities of bonds better match the longer terms of infrastructure projects. And a successful local bond market could help make more bank finance available for lending to smaller businesses, which continue to face difficulties in accessing bank credit in a number of these economies.

A well-functioning local bond market could improve the effectiveness of financial intermediation, and boost domestic savings for further productive investment. There are challenges and potential vulnerabilities associated with the development of domestic markets, however.

Which sub-Saharan African countries have established domestic bond markets?

Around 27 countries’ governments have issued local currency bonds in sub-Saharan Africa, and there are a few others reportedly planning to issue bonds. But with the exception of South Africa, most domestic bond markets, where they exist, are still underdeveloped and have little trading activity; government debt securities predominate.

A few of the government bond markets are beginning to see increases in trading activity, however. For example, increased trading activity in Kenya’s government bond issues has been helped by an upgrade of the market’s trading system from manual to electronic. This has enhanced price dissemination and improved the overall transparency and efficiency of trading activities.

What are the short-term prospects for corporate issuance in local bond markets?

Corporate bond markets in sub-Saharan Africa, where they exist, still tend to be underdeveloped, illiquid and very small, with relatively little issuance to date. South Africa is the exception to that. The vast majority of corporate bond markets in sub-Saharan Africa have only just begun to operate in the past several years, and typically with limited secondary market activity. The nonexistence of a benchmark yield curve in many of these markets is among the factors that have impeded corporate bond issuance so far.

However, there have been a few recent local currency corporate bond issues, including in the infrastructure sector. Guaranty Trust Bank listed a bond on Nigeria’s Stock Exchange last month, which was the first corporate bond to list on the exchange in the past four years. A handful of banks in Nigeria reportedly have plans for bond issues, and there may be issues in the power and telecoms sector.

In Kenya, electricity utility KenGen and mobile phone company Safaricom are among the companies that have recently tapped the local bond market, and investor interest was strong. On the Uganda Securities Exchange, too, there have been a few corporate bond issues listed in the past several months, although in each case by financial institutions.

There may be an upcoming bond issue in the next month or so on Kenya’s local bond market by cement manufacturer Athi River, to finance construction of a new plant in Tanzania. What is interesting about this is that the company reportedly plans future cross-listings on the exchanges in Tanzania and Uganda, to draw on a wider potential investor base. More cross-border listings and cross-border investment within the region could hold significant promise for financing cross-country infrastructure projects.

Are these issues attracting foreign investors?

There are signs that foreign portfolio investment flows to several African markets have begun to pick up again in the past year, although foreign investor risk appetite remains constrained compared with the pre-financial crisis period. Although data on foreign investors’ participation in these markets is lacking, it’s been clear that much of the recent interest from investors has been coming from overseas. Whether more overseas investors will be attracted to African local bond markets in the coming months will depend largely on global and local market developments.

An important step towards developing these markets is to encourage greater participation of local institutional investors. Further development and more appropriate regulation of local institutional investors would help them realise their potential as financing sources for infrastructure development. And, as seen in the past few years, local currency bond markets can also be subject to sudden reversals in foreign portfolio investment, which points to the need for these markets to strike an appropriate balance in accessing local and foreign sources of financing.

What are the obstacles to market development?

The illiquidity that characterises most African countries’ bond markets can be a major impediment. When foreign investors come to dominate a segment of such a small market, a sudden shift in sentiment could lead to large movements in interest rates and the exchange rate.

This risk is amplified where foreign investors with short-term horizons play a prominent role; the macroeconomic repercussions for the country could be severe. This points to the need for countries to strive for a healthy balance between local and foreign investors and to expand the local institutional investor base to deepen demand for longer maturities. They also need to regulate institutional investors more effectively, while simultaneously relaxing overly onerous investment allocation ceilings to enable a more balanced portfolio approach.

However, local institutional investors in a number of African countries have begun taking a more diversified portfolio approach in allocating assets, and have begun to emerge as more prominent participants in some bond markets, particularly where privately managed pension funds have evolved.

On the issuer side, fostering a corporate culture of increased transparency, including by encouraging prospective issuers to first improve their financial reporting practices and apply for ratings, is important in developing a corporate market. Policies and a regulatory framework promoting a healthy, strong and efficient banking and financial sector overall are also crucial in helping to protect against destabilising capital flows.

The views expressed in this interview are those of the interviewee (unless otherwise cited) and do not necessarily represent the views of the World Bank.

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