Africa and Local Bond Markets
May 20, 2008 – 4:10 pmGreat article by Peter Nixon on the Development of Local Bond Markets in Africa.
He outlines the following benefits from having Local Bond Markets:
- Reduced volatility and easier debt management
- Long-term fiscal budget stability
- Increased investors confidence
- Reduced conflict of interest between devaluation of currency to spur export growth and appreciation of currency to ease debt payment
- Local participation in the debt market
- Free capital by providing low-risk local currency government bonds which allow investors with an appetite for medium-risk exposure to invest in high-risk investments, such as SMEs and Startups.
- Lower capital adequacy requirements from banks because of availability of local-currency government bonds
- Allows the operation of enterprises with lower risk appetites –(particular pension funds)
- Local bond markets provide key investment information, including interest rate expectations, inflation rate expectations, yield curves.
- Better fiscal and monetary planning because of knowledge about market expectations
- Government over-borrowing is restrained by inflation and economic decline and would therefore in theory be restrained, foreign lenders share in the cost of excessive lending.
- Interest on government debt increases the revenues of the local investors, which in turn can increase the tax revenues of government.
Foreign versus local currency
Risk management and investment
Monetary policy
Shared costs of inflation targeting between public and private sector
Information
Market forces
Debt/investment cycle
He also describes why Local Bond Markets have not developed in developing countries:
There are many possible explanations why African countries initially chose foreign loans over local bonds – a lack of local capital, an abundance of apparently cheap foreign capital, the lower administration costs of foreign loans over issuing bonds – but once this decision was made, it became a self-reinforcing cycle. As the foreign loans drain local capital and foreign exchange reserves, more foreign capital and currency is required. As the economies stagnate for a variety of reasons, local capital becomes more scarce and more expensive, whilst foreign capital is readily available at cheaper rates. Any weakening of the currency reduces the relative size of local capital and increases the need for foreign exchange. A government eventually has no interest in issuing local bonds at very expensive rates, which will not provide vital foreign exchange. From the foreign lenders’ point of view, they would have no interest in buying local bonds carrying additional currency risk, when they are able to issue debt in the currency of their choosing. As the economic situation declines in the country, the lenders will insist on having their loans denominated in foreign currency so as to limit their risk. Eventually the multilateral institutions are brought in and, in an attempt to help, offer the countries even more foreign debt at even lower rates. A bond issued in local currency at market prices stands little chance of competing against these cheap and relatively freely available loans.
The topic is also discussed at Ecorica.
Topics of this post: africa, developing countries, Discussions, local bond markets, sovereign debt