Ethiopia’s Growing Debt Appetite and Eurobond
By Ezana Kebede
March 16, 2014
The Ethiopian government has significantly increased its borrowing in recent years. Debt-to- GDP ratio has reached an all time high of 35 percent and continues to grow. Lately, the country has also been shifting slowly from concessional loans to market based loans. The Ethiopian Ministry of Finance & Economic Development (MOFED) data shows that, since the beginning of the 2008 world financial crisis through 2013, Ethiopia’s external debt has grown by 156 percent from USD 4.35 billion to USD 11.17 billion. The total public outstanding debt was at USD 16.11 billion, excluding domestic lending to State Owned Enterprises. During the same period, IMF was estimating Ethiopia’s GDP at Birr 877.5 Billion (USD 46 billion).
At the moment, Ethiopia has a government guaranteed soft loan program with a rate below 2 percent, a grace period of up to 10 years, and longer duration loans with multilateral development banks, The World Bank loans maturing in 40 years and the African Development Bank loans maturing in 50 years. Both institutions require a service charge of 0.75 percents.
Looking at the current debt structure, Ethiopia has also borrowed at low rates from non-Paris Club lenders, particularly China and India. But most of the loans with China are floating or adjustable rates ranging between LIBOR 6 month +1.5 basis points to LIBOR 6month + 3 basis points, with a grace period of up to 6 years and maturity of 15 years. Ethiopia was able to get this low rate due to captive funding from the likes of Huawei and ZTE. Huawei and ZTE have been lending to Ethio-Telecom making this government owned company solely dependent on Chinese telecommunication equipment providers.
Lately, MOFED has initiated discussions with credit rating agencies with the intention of tapping into the sovereign debt market in search of financing for large investment projects. Ethiopia has not yet issued sovereign debt but is in the process of getting a sovereign rating. One of the renowned credit rating agencies, Moody’s, has visited Ethiopia and met with various stakeholders. This process will enable Ethiopia to be part of the list of countries whose financial standing and credit worthiness is known and thus has the opportunity to gain access to sovereign bonds.
The Prime Minister of Ethiopia, Hailemariam Desalegn, has recently announced that the government has hired the boutique French investment bank Lazard Ltd. as an advisory service to help facilitate the country’s credit rating in order to issue a sovereign bond. Most likely the underwriters will be a consortium of French banks. Credit rating is a mechanism that provides access to the international debt market. But in the end, it all boils down to the perception of the country’s ability to pay its debt. Until now, Ethiopia had no plan to get a credit rating and so far is unable to issue debt instruments on the international capital market. There is a strong indication that Ethiopia is headed towards borrowing at market rate. As reported on Bloomberg news,” the country has plans to issue not only Eurobonds but other bonds as well.”
Eurobond is a foreign currency denominated bond, usually in USD, EUR or JPY. According to Deutsche Bank AG, fourteen sub-Saharan African countries, namely Senegal, Zambia, Gabon, Nigeria, Namibia, Tanzania, Republic of Congo, Rwanda, Mozambique, Ghana, Ivory Coast, South Africa, Seychelles and Namibia have issued Eurobond. The average sub-Saharan Eurobond is paying an approximate yield of 6.9 percent, but this low rate will not remain low forever. The main reason for the recent growth in Africa’s sovereign borrowing is due to low yields in Europe and US sovereign bonds resulting in a strong demand from investors to look at emerging market bonds, such as those in Africa. The 2008 global financial crisis and global economy has also made grants harder to come by and donor funds usually come with attached conditions such as good governance.
For Ethiopia, obtaining a credit rating and issuing Eurobonds will create greater transparency and encourage sound public debt management policies. Moreover, as the current Growth Transformation Plan (GTP) 2010-2015 nears its end, Ethiopian authorities should re-focus their energy on establishing both primary and secondary markets for government and private debt issuance, where bonds are traded.
Two of the reasons luring African countries to explore the Eurobond market as an alternative source of financing with cheaper funding costs are inflation and fluctuating exchange rates in African countries. Inflation and fluctuating currencies make it more expensive to issue local bonds in the local markets. However, the story in Ethiopia is different in that the country does not have a well-developed primary market. In the absence of capital markets, domestic bonds were not adjusting for inflation, and investors (bond holders) were not getting the true market value.”
Furthermore, African countries that are reliant on commodities export to finance debt with Eurobond will be faced with difficulties to meet their debt obligations. Ethiopia is no different, for example, if there is a significant drop in the price of coffee on the international market, the Birr will as a result depreciates against major currencies and the cost of repaying debt will be higher. Regardless, it seems authorities in Ethiopia are determined to get additional funding by issuing sovereign bond.
Over time, foreign currency denominated bonds issued by African countries will not continue to be less costly. Especially when we take into consideration the ongoing development where the US Federal Reserve is tapering its long term asset purchase program which will set the US interest rate to rise, emerging market investors will be flocking back to the US market to capture higher returns. In order to attract investors African countries will have to issue their bonds at higher coupon rates, which also means authorities in Ethiopia and elsewhere in Africa will pay higher borrowing costs.
Moreover, in 2013 Ethiopian central government’s total domestic outstanding debt was at USD 4.9 billion, of which USD 634 million was issued as government bonds. The total domestic debt consists of Treasury Bill USD 1.37 billion at 59 percent and Direct Advance (MOFED overdraft from Central Bank) USD 2.9 USD billion, at 27 percent of the total domestic debt outstanding.
The current economic policy in Ethiopia is government led and policy makers should take into account that the growing public debt borrowing will not cause a “crowding out effect” on private sector funding. The government of Ethiopia is borrowing 31 percent of its debt locally. Unless there is a strong commitment by the government of Ethiopia to reform its financial sector, such as updating its commercial code and securities laws, it is less likely that the recently issued agency debt instruments, the Millennium Bond and the Diaspora Bond, will be successful.
Indeed, there is a strong case for establishing a domestic debt market in Ethiopia. Good examples are the low subscription of the agency bonds, EEPCO Millennium Corporate Bond Rate (Face Value 100, fixed interest rate between 4-5 percent and maturing between 5-10 years), and the Renaissance-Dam Bond ( Face Value USD 50, adjustable rate between LIBOR+125 basis point to LIBOR +200 basis point, maturing between 5-8 years).
Bloomberg news, quoting Berket Simon, the former Minister of Information of Ethiopia, reported “Birr 5 billion has been raised from the public by selling bonds.”Birr 5 billion translates to USD 263 million which is a small fraction of the USD 4.5 billion estimated funding needed to build the Grand Ethiopian Renaissance Dam.
There are several reasons for the meager Ethiopian government bonds subscription. (i) The double digit inflation rate at the time the bonds were issued gave bond holders a negative return on their investment. Agency bond holders in Ethiopia are unable to realize the true market value of their investments in government bonds and could only redeem the full amount at maturity; (ii) Economic and political risk considerations should have been addressed. Dilip Ratha World Bank Lead Economist and an expert on Migration and Remittance, was once quoted on Diaspora Bond and political risk considerations stating; “The Diaspora purchase bonds as long as they believe they have influence on policies”. ( iii) The inadequate bond subscription should have been avoided by establishing a well organized market similar to the Ethiopian Commodities Exchange Board for both primary and secondary bond markets, for domestic borrowing by the public and private sector, before venturing out to issue government bonds in the primary market.
Experts on Ethiopian economy stated, “the primary capital market in Ethiopia is characterized by low yield, markets are entirely dominated by state owned enterprises and there is a lack of competition. Therefore, under the current condition it is difficult to think of a secondary market.”
MOFED had a total projected expenditure of Birr 690 billion (USD 36 billion), 80 percent allocated to capital expenditure of which only 27 percent, or Birr 150 billion, was earmarked for road construction during the 2010-15 GTP.
Ethiopian policy makers should not only focus on the foreign currency needed for capital expenditure, but should rethink the country’s ownership and banking laws as well.
National Bank of Ethiopia (NBE) is showing some positive signs like the current move toward establishing a centralized credit bureau system for individual borrowers which could also extend for institutional borrowers through the formation of debt markets.
Ways to achieve sound public debt management and encourage the public sector include: (i) having no restriction on private corporations and financial intuitions from issuing debt financing in the local market; (ii) making sure that banking directives and regulations are predictable and not arbitrary, giving confidence to the private sector to participate in economic development of the country; (iii) making sure that NBE regulators are working in consultation with the banking industry and private sector at large; (v) and finally, while it is a positive sign that policy makers are aggressively looking to obtain credit rating to raise debt capital, they should also continue to strengthen the NBE’s capabilities.
In conclusion, in order to engage the private sector and retail investor (small investor) in the economic development of the country, Ethiopian policy makers need to establish a properly functioning primary and secondary market for debt issuance. There should be a regulated primary market for initial public offering of newly formed share companies. The current privatization program should jump start the financial intermediary functions of brokers and dealers, enabling the retail investor to participate in the acquisition of government owned public enterprises as a share company. But without a policy change and properly functioning primary market the privatization program will only benefit the highest bidder and not promote wealth distribution across the board.
The writer: is a graduate student in finance at Johns Hopkins University and could be reached at Ethiopia.firstname.lastname@example.org
Deutsche Bank-Capital Markets in Sub-Sahara Africa
Ethiopia Ministry of Finance and Economic Development, Source for Borrowing Cost: Public Sector Debt Statistical Bulletin
FDRE: Growth Transformation Plan (GTP) 2010-2015. Volume 1 Main Text
National Bank of Ethiopia USD/Birr exchange rate of 18.8598 on October 10/13/2013 was used.
LIBOR is the (London Inter Bank Borrowing Rate) is an index for floating rating or adjustable rate