US Fed tightening shows Africa needs domestic debt, foreign equity, S&P says

By David Whitehouse
Posted on Thursday, 19 May 2022 06:02

Traders work on the floor of the NYSE in New York
US Federal Reserve interest-rate increases mean volatility on the horizon for African sovereigns. REUTERS/Brendan McDermid

The prospect of a series of interest-rate increases by the US Federal Reserve highlights the need for African countries to increase savings rates so that banks can provide debt finance in local currencies, S&P Global Ratings sovereign specialist Frank Gill tells The Africa Report.

Debt levels in Africa are now higher than before the pandemic and rising US interest rates are increasing the risk-free rate globally, Gill says.

Research from S&P predicts that the Fed will raise rates at least another three times this year, by 50 basis points each time. S&P projects a further four or five increases in 2023. So the danger is that the flow of non-resident debt finance into Africa will be “highly volatile,” Gill says. Building up domestic savings rates to insulate against resulting volatility in non-resident lending inflows is “clearly the best way forward.”

Gill gives the example of Ghana, where in the 12 months to August 2021, non-resident holdings of domestic debt increased by one-third, only to decline by 18% in the following six months, contributing to downward pressure on the cedi. Research from S&P shows that sovereigns have historically defaulted on local currency debt only half as often as they have on foreign currency obligations.

  • Yet African countries are constrained from reducing their foreign debts by low domestic savings rates, Gill says.
  • Debt can in theory be used to create growth, but in practice is used to prop up fiscal deficits, he argues.
  • So Africa needs foreign equity investment much more than it needs foreign debt. “That is clearly the key challenge.”

Domestic indigestion

Zambia, Kenya and Egypt are the African countries which have the highest requirement to roll over domestic debt in 2022, Gill says.

All three countries have to renew domestic debt worth between 20% and 30% of GDP in 2022, Gill says. Out of the three, Zambia is the country with the smallest banking system in relation to its GDP, which means it faces “constraints on its ability to refinance.” The country’s debt burden of over 120% of GDP is among one of the largest in Africa. Still, Zambia’s creditworthiness is supported by five-year highs on copper prices, and a sharp decline in external debt servicing after Zambia’s foreign currency debt default, S&P says.

In Kenya, the local currency rollover ratio exceeds one-quarter of its total debt, Gill says. S&P’s base case is that Kenyan banks will be able to meet the government’s reduced future borrowing requirements without denying resources to the private sector, assuming fiscal consolidation and strengthening banking profitability. The country has shown the way forward in terms of domestic savings by building up its domestic pension system, Gill says.

Banks in Egypt have the greatest exposure to their sovereign relative to their total assets, at 40% versus 19% among African sovereigns rated by S&P. The cost of debt remains very high, with the country paying about 9 percentage points of GDP to service debt, Gill says. He expects Egypt to be able to refinance its domestic debt due to the large banking system.

  • The country’s banks have strong liquidity positions, high annual deposit growth due to the low base of financial inclusion, and relatively few options for private sector lending, S&P research shows.

Mark Bohlund, senior analyst at REDD Intelligence in London, points to Uganda as an example of a country that is set to increase its share of external borrowing, amid signs that the domestic market is struggling to absorb new government debt.

  • The probability of a debut Ugandan eurobond sale this year or next is increasing after the government struggled to roll over domestic debt in the first quarter, Bohlund says.

Bottom line

The end of an era of low global interest rates puts the onus on African savings rates as a driver of debt sustainability.

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