Liquidity, the key to the development of the bond market in West and Central Africa?
The financial markets are gradually establishing themselves in Africa as alternative sources of financing for both governments and a number of large companies, with the bond market broadly leading the way in terms of the mobilisation of resources.
The market capitalisations of the stock markets are relatively modest, even though the number of stock exchanges has increased considerably in recent decades. Indeed, there has been spectacular growth in African financial markets, which have increased from a dozen in 1990 to 29 at the end of 20201, thereby covering the entire continent. Market capitalisations have also grown dramatically, reaching over US$1,282 billion at the end of 2020, with more than 2,500 companies listed on the stock market2. Initial public offerings have increased in number, allowing some banks and other companies to raise considerable levels of funds. This has demonstrated the depth of local savings and the interest shown by domesticinvestors in the stock markets.
Domestic African bond markets south of the Sahara exhibit a dynamic correlated with the monetary reforms undertaken in certain areas, such as the government's abandonment of the policy of financing budgetary deficits by printing CAEMC3 and WAEMU4 banknotes, with the increase in government financing needs (leading emergence programmes, pursuing the United Nations’ Sustainable Development Goals - SDGs), with managing the oil crisis, and more recently, with the response to Covid-19.
It is in this global context that bond markets have been gaining traction in recent years. At the CAEMC level, for example, outstanding treasury stock stood at FCFA 3,588.8 billion ($6.5 billion) at 31 March 2021, up 11.27% from 31 December 2020 and 66.03% year on year, from FCFA 2,161.5 billion at the end of March 20205.
In the UEMOA zone, the IMF expects the sovereign bond market to continue growing strongly: "Member states are likely to rely heavily on regional borrowing during the convergence phase, given the relatively high levels of fiscal deficits (...). Several measures could be introduced in the near term to increase the depth and liquidity of the sovereign security market, including enhancing the role of primary dealers and improving governments’ communication about their borrowing plans".6
The Nigerian bond market is also particularly dynamic thanks to a broader investor base, to the extent that it is included in the JPMorgan Government Bond Index-Emerging Markets GBI-EM (https://www.jpmorgan.com/content/dam/jpm/cib/complex/content/markets/composition-docs/pdf-16.pdf).
With GDP of nearly US$450 billion and double-digit interest rates on government bonds7, Nigeria has long been a favourite destination for foreign investors. However, the economic crisis caused by the Covid-19 pandemic combined with the fall in oil prices has caused public finances to deteriorate and led to high inflation. As a result, negative real yields on government bonds have made them less attractive and the low availability of currencies has made reverse capital flows more difficult8.
At the same time, the international financial markets are also becoming very popular with sub-Saharan governments. For almost two decades, many sub-Saharan countries have been using Eurobonds to meet their infrastructure financing needs, to deal with imbalances in public finances and to refinance public debt.
However, this momentum in the primary bond markets contrasts with the lacklustre secondary market across Sub-Saharan Africa. With the notable exception of Nigeria, which has a stronger investor base than other countries, the WAEMU records very few secondary market transactions8, as do most sub-Saharan financial markets.
This liquidity stress on the secondary market is likely to disrupt all bond financing channels, since the principal investors in primary markets are generally banks. The obligation to comply with prudential ratios (the division or concentration of risks, solvency, financial fixed assets, etc.) is an obstacle for banks in investing on the primary bond markets, which are essential for government financing and therefore development.
In the WAEMU zone, the eligibility of government securities for refinancing by the Central Bank (BCEAO) is an objective obstacle to the development of the secondary market. Banks, which are the main purchasers of government securities (banks are the leading buyers of public securities. According to the IMF, "they held 81.2 percent of the outstanding stock at end-2019" 8), prefer to source liquidity through refinancing with the central bank (on attractive terms), rather than by reselling bonds on the secondary market.
It is therefore becoming urgent for banks to find a base of domestic and foreign investors who are able to buy securities purchased on the primary markets, to enable them to rotate portfolios and to give long-term depth to bond issues.
At the Online Bonds, Loans & Sukuk Francophone Africa Conference held on 24 March 2021 (https://bondsloans.com/livestream/francophoneafrica), a roundtable discussed waysto develop the secondary bond market in Francophone Sub-Saharan Africa with a view to attracting international investors. Three potential options were discussed.
Option 1: The improvement of market infrastructure
By market infrastructure we mean: the Regulatory Authority, the Stock Exchange and the Central Depository. Efforts need to be focused on the international promotion of the markets (communication in international forums, provision of market data, explanation of the regulatory framework - Market Guide, adoption of texts to international standards, etc.).
Option 2: Easing of exchange rate policies (currency regulations)
As African markets have a small investor base, the funds in circulation are insufficient to create transaction dynamics on both the secondary and primary markets. It is therefore important that regional regulatory frameworks are virtuous in order to attract foreign capital (such as international institutional investors - investment funds, pension funds, institutional investors, etc.) with a strong currency.
In the CAEMC zone, an emerging idea is suggesting the establishment of a corridor to facilitate the repatriation of income from portfolio investments made within the zone.
Option 3: The development of custody infrastructure to bring it up to international standards
Market intermediaries must offer services that meet international standards in order to reassure major investors and major clients (Global Custodians) about how they deal with tax matters (regulatory, repatriation of funds) and communications matters (disclosure of information to the market, presentation of investment opportunities, alerts on regulatory changes, the provision of services such as services to issuers (proxy votes at general meetings, etc.)).
1Source: African Markets, May 2021; WFE Annual Statistics Guide 2020
2 CAEMC: Central African Economic and Monetary Community
3WAEMU: West African Economic and Monetary Union
7Source: Bloomberg, March 2021
8Source: Long-term finance in Côte d'Ivoire; Country Diagnostic Report/September 2019; FSD AFRICA