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On 3 November, at the United Nations Climate Change Conference
(COP26), the UN's Economic Commission for Africa (UNECA) announced
it had launched its Liquidity and Sustainability Facility (LSF) to
improve the liquidity of sovereign debt issued internationally by
African borrowers. The initiative was initially announced on 23
March 2021 to incentivize sustainable development initiatives,
particularly the issuance of Green and marine-focused Blue bonds by
sovereign issuers in the region.
Key Points
While the announcement claimed the new facility would raise
USD3 billion from on-lending of SDR allocations, no specific detail
is yet available on such commitments.
UNECA has targeted a USD30 billion size for the LSF.
Although risk-positive for the region, the annual benefits
claimed by UNECA are relatively modest, crudely equating to under
40 basis points in annual savings on the end-2020 regional debt
stock.
These benefits could be largely offset by the future impacts of
US tapering and eventual monetary tightening.
Despite ambitious claims by UNECA, transformational relief for
the region is likely to need wider debt forgiveness and additional
aid.
Special Drawing Rights (SDR) reallocation to give
liquidity to the facility as yet undefined, with private-sector
support also initially unclear
UNECA stated that the facility initially would raise USD3
billion of liquidity to fund the program by seeking on-lending of
SDRs recently allocated to developed countries within the IMF's
general allocation of SDRs (worth some USD650 billion). Such funds
would enable African Export Import Bank (Afreximbank) to provide
liquid funds to holders of government debt willing to lend their
holdings out temporarily through sale and repurchase or "repo"
agreements, a widely used feature in the trading of government
bonds in developed economies. However, it did not specify any
country which has specifically committed to such provision.
In an article in the New African magazine on 14 October,
Hippolyte Fofack, Afreximbank's Chief Economist and Head of
Research noted that only USD33 billion or 5% of the IMF
distribution had been allocated to "the whole of Africa - where it
is most needed", while 60% (65% including mainland China) had been
delivered to developed countries, with the EU alone receiving
USD119 billion. IHS Markit calculations are slightly different: we
calculate Africa's share at 5.25% of the total, for USD35.6 billion
equivalent in SDRs. By contrast, the G20 received just under a 58%
share of the total allocation, for USD437.5 billion equivalent in
SDRs.
The mechanism for on-lending appears already in place: the IMF
lists an ample group of developed countries which have signed
agreements for voluntary trading arrangements in SDRs. These
include the United States, European Union, European Central Bank,
large EU member states, and mainland China and Australia, among
others. Given that the LSF has been under preparation since March
and the SDR allocation undertaken in late August, we assess that
the lack of specific backing is an adverse indicator for initial
momentum with the LSF, but one that could be swiftly rectified by
significant commitments in the next few months. More positively it
claims that it also has "received interest" from a number of "large
asset managers", with Amundi participating in a pilot transaction:
Citigroup also is actively involved as a structuring agent.
UNECA is targeting USD30 billion facility
size
Despite the above early uncertainties over exact sources of
funding, UNECA suggested that the LCF could reach USD30 billion in
size, with the goal of "providing African governments with a
liquidity structure on a par with international standards", while
looking to "dramatically increase" the volume of Green and Blue
(marine sustainability-focused) bonds issued within the region and
facilitate their provision at more affordable rates. An initial
USD200 million transaction, funded by Afreximbank, is currently
being prepared.
UNECA claims important, transformational
benefits: our assessment is that these are
important but unlikely to have a dramatic overall
impact
UNECA presents the new LSF as an important development, claiming
it will "lower the borrowing cost for African sovereigns", with the
development of a repo market in their debt potentially transforming
"African sovereign bonds into liquid assets", while encouraging
Environmental, Social, and Governance (ESG) issuance and
"enhancing…debt sustainability". It specified that "thanks to the
LSF", the region could save USD11 billion during the next five
years through lower borrowing costs.
IHS Markit assesses that the potential reduction in borrowing
costs is clearly risk positive for debt sustainability, while also
reducing contract-related risks and the need for increased taxation
in beneficiary countries. However, we are less convinced about the
"transformational" nature of the development.
Using World Bank data, total external debt in SSA reached USD702
billion in 2020, having risen from USD492 billion in 2016.
Excluding middle-income countries, it rose over the same period
from USD411 billion to USD588 billion. In approximate terms, to
save some USD2.2 billion annually is important in absolute terms
but if spread evenly equates to 31 basis points per year in
potential interest cost savings using the 2020 stock as the base,
if spread over the full region, or 37 basis points if applied only
to the lower-income group.
The USD3 billion funding base for the facility also is modest,
even if used on a leveraged basis. As a comparison, the stock of
German Bunds is EUR5.75 trillion, while that of the UK Gilt market
is GBP 2 trillion. The ECB reports that daily average secured
borrowing turnover was EUR402 billion, looking at the largest 47
banks in the Eurosystem.
Benefits could be offset by tapering, higher rates, and
greater risk aversion - other policy measures appear potentially
more beneficial for regional debt sustainability
Overall, we assess that the LSF is at a very early stage of
development. If it achieves the cost savings suggested, this is
clearly a positive development for the region, but not an indicator
of fundamental change in its debt sustainability. A 30-40 basis
points annual saving - if realized - could be offset relatively
quickly by the impact of US tapering and an eventual move towards
tighter policy rates in major developed economies. Even this
hypothetical benefit is untested, and we would caution that African
debt markets remain fundamentally smaller than those in developed
European markets, so will have materially less liquidity even after
the benefits of this facility are made effective. Overall, we
continue to view wider and more sizeable initiatives to offer debt
relief covering private-sector as well as official bilateral
borrowings (an area that has proved sticky to date) and expanded
provision of grants to help the region's countries fund climate
transition as likely to have a potentially greater impact on the
region's fiscal position and debt sustainability.
Nevertheless, existing debt relief initiatives (DSSI) also have
proved relatively modest so far. They do not cover private-sector
debt: participation by private-sector creditors is entirely
voluntary and to date, none have participated. It also excludes
multilateral lenders, notably the World Bank, and is instead
limited to official bilateral creditors (i.e., those of the Paris
Club). China is not a Paris Club member and has participated
separately on an ad-hoc basis, so the DSSI is still missing
Africa's (by far) largest creditor.
A significant positive initiative for the region is the
Resiliency and Sustainability Trust, which aims to raise USD100
billion equivalent in SDRs recycled from wealthy economies. The
trust would finance projects related to climate mitigation and
vaccine rollout. If this is prioritized, given the political
urgency for COVID-19 vaccination and climate transition
initiatives, this focus might reduce the volume of SDR allocations
supporting the LSF.
In summary, we view the new LSF as welcome and risk-positive.
However, we are concerned by the initial absence of specific
pledges of resources to finance the facility, given that work has
been undertaken on it for over six months, although this could be
rectified quickly if major governments of developed countries - and
large private institutions - become actively involved. On balance,
we assess that the LSF will make the region's debt marginally more
attractive and provide at least some welcome cost savings but view
it as less likely to transform the trading liquidity of the
region's debt. Ultimately, liquidity is a function both of the
stock of an outstanding debt instrument - far larger in highly
developed markets like the USA, EU, and UK - and the depth of the
investor base for such securities, which is highly sensitive to
their credit quality, an obvious constraint for the depth of the
market in African debt.
Posted 09 November 2021 by Brian Lawson, Senior Economic and Financial Consultant, Country Risk, IHS Markit and
Chris Suckling, Associate Director, Economics & Country Risk, IHS Markit