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African bonds lose honeymoon feeling

Published:Wednesday | May 21, 2014 | 12:00 AM

By Javier Blas in Kigaliand Rwanda

Few statistics better show the rise of Africa over the last decade than the sharp increase in the number of countries in the region boasting a sovereign credit rating.

With the inclusion last week of Ethiopia, the number of African nations rated by at least one of the three top agencies - Moody's, Fitch and Standard & Poor's - has risen to 26, up from 15 a decade ago and just one in 1994.

Africa has until now enjoyed a honeymoon of maiden ratings and a handful of upgrades. The trend has accompanied a wave of foreign direct investment and cheap funding through sovereign bonds. The African Bank of Development forecasts that foreign flows into the continent will rise this year to a record high of US$84.3bn, up 22.5 per cent from last year and surpassing the record set in 2012.

But for a handful of African countries, the honeymoon is over. They have discovered that sovereign ratings are a painful two-way street. Some have already seen their ratings cut due to mounting fiscal deficits, and the rating agencies have told several others they risk downgrades. S&P has over the past six months put on negative outlook Zambia, Ghana and Nigeria; and it has cut the credit rating of Mozambique, Uganda and Cape Verde.

"We see slippage on fiscal deficit and current account and that triggers the alarm," says Ravi Bhatia, a regional expert on Africa at S&P in London.

Aurelien Mali, analyst at Moody's in Dubai, adds: "Deteriorating fiscal metrics are an increasing risk to public finance stability for some sub Saharan African sovereigns".

Part of the problem is that Africa is the victim of its own success. Mr Bhatia explains that as economic growth accelerates, "countries are sucking in imports, causing the current account to post sizeable deficits". At the same time, "governments are spending lots, partially on development related items, creating big fiscal deficits," he adds.

As a whole, the region looks robust, and is enjoying a virtuous circle of strong economic growth and improved governance that many have called "Africa Rising". Debt-to-GDP ratios remain far lower than in southern European countries. Thus investors remain unnerved, and continue to pour billions of dollars into local equity and bond markets in the region.

But if the trend of rising deficits continues, and spreads, it could derail the surge in investments that have transformed stock markets from Lagos to Nairobi.

African policymakers have already seen some of the negative effects associated with this kind of leap in economic growth.

The government in Zambia lifted public sector salaries by 50 per cent last year, sending its fiscal deficit to 8.5 per cent, up from 2.5 per cent five years earlier. When Zambia returned to the sovereign bond market earlier this year, it was forced to pay a yield of 8.625 per cent for a 10-year US$1bn sovereign bond, up from 5.63 per cent on its bond market debut in 2012.

And Ghana, battling a double-digit fiscal deficit after a 75 per cent hike in public salaries over two years, has had to postpone its return to the bond market.

Add to this mix the impact of the US Federal Reserve 'tapering' its emergency bond-buying programme, and borrowing costs across several African countries, which are expected to surge this year and into 2015. This complicates the task of refinancing existing bonds when they mature over the next 2-3 years, particularly if investors turn away from frontier markets.

Kenya is an example of the refinancing problem. Nairobi earlier this month was forced to negotiate a three-month extension in the repayment of a US$600m two-year syndicated loan due to the delay in issuing its first sovereign bond.

Carmen Altenkirch, a director for Africa at Fitch in London, says that "if a eurobond were to mature at a time when market access were denied, then an issuer might have no alternative but to pay the bond out of possibly limited reserves".

Investors can find some solace: the pipeline of new sovereign ratings seems full. Ivory Coast is likely to get one in the next two months, lifting the number of rated countries in Africa to 27. And Tanzania, Sierra Leone, Guinea and Liberia are future candidates, bankers say. They may be able to prolong the honeymoon.

(c) 2014 The Financial Times Limited.