Challenges of African Capital Market

For investors seeking higher performance and yield, African bond markets have not received the level of coverage that could have been expected. There remain challenges to a better understanding of these markets, which needs to be addressed. Explaining the dynamics of these capital markets to the global investor community and illustrating their high levels of performance compared to developed economy benchmarks are constructive steps in the right direction.

ACCESS TO DEBT FINANCING

African countries have improved their overall macroeconomic performance over the past decade, which has laid a solid foundation that has helped develop local capital markets.

 In recent years, many governments in  emerging markets  have issued more local currency debt compared to external debt as part of a strategy to reduce their vulnerabilities to external shocks via the exchange rate risk channel.

 Partly as a result and also due to increased investor interest in emerging market local currency debt, the launch of various bond indices, such as the Ecobank Middle Africa Bond Index (MABI) has helped advance the understanding of, and interest in, local currency debt in Africa.

Significant efforts are being made by several key countries in Africa and the AfDB’s AFMI to develop capital markets to help them play a leading role to increase local debt issuance, to spur investor interest in Africa’s capital markets, strengthen participation, and promote capital transformation.

 The AFMI’s most interesting sessions were:

* Primary and secondary market development and the importance of liquidity: This session focused on the need for experienced underwriters and credible auctions to distribute securities. Both should help support benchmark issuance and yield curve extension. Further requirements are the need to develop repo/derivative/swap markets; and traders’ associations.

* Expansion and diversification of the investor base: Without savings there is no investment. However, there is a need to move away from the current reliance of issuers on banks and investors using buy-and-hold strategies to promote more secondary market activity. Growth of local savings institutions is also necessary to boost market liquidity.

* Enhancing settlement and payment infrastructure: To increase savings institutions’ comfort with markets also requires a suite of market improvements to legal and regulatory safeguards for investor protection. Also, necessary is a strengthening of trading, settlement, custody and payment infrastructure. Real Time Gross Settlements is a step several countries like Nigeria have recently taken that boosts investor and traders’ confidence.

* Improving bond market data: Without data the market cannot function. Therefore, this crucial issue requires further efforts by authorities to ensure that secondary market trading data (prices, yields, volumes) are accurately reported in a timely manner, which in turn allows market participants to better understand bond values. Moves toward internationally recognised serial codes (ISIN) is part of this process of disseminating data and improving market transparency.

* Asian bond market development: Following the 1997 East Asia crisis, the authorities recognised the need to reduce reliance on short term bank financing and increase the role of debt capital markets as means to support growth. Africa can learn important lessons from Asia’s experience, although the level of Africa’s interconnectedness to global capital is significantly lower than Asian economies 15 years ago. Lessons to learn include: (i) move from fixed to floating exchange rate regimes; (ii) improve corporate governance; (iii) reduce reliance on short term external credit; (iv) strengthen local bank supervision so as to prevent over lending; (v) manage local inflation and economic policy expectations effectively; (vi) promote alternatives to bank financing (debt and equity markets).

KEY TAKEAWAYS

The AFMI meeting provided a useful framework from which to assess how far markets have developed and what still needs to be done to build debt markets. We think there are several key points to conclude with following the AFMI meeting, all of which point to the significant efforts still required by issuers and other market participants:

1. The most developed debt markets in Middle Africa (Nigeria, Kenya, Ghana, Côte d’Ivoire, Senegal and Togo) appeal to similar investors (domestic and foreign) but each differ to one another in terms of market size, infrastructure and investor base. As a group, they are significantly ahead in terms of market infrastructure, scale and scope of issuance, and secondary market activity when compared to the next group of countries, with the gap likely to widen in the short term.

a. Macroeconomic policy improvements are a necessary part of the move to develop markets given the key role that fiscal, monetary and exchange rate policies undertake as well as their impact on domestic and foreign investors.

b. These markets should also strive to increase the investor base so that demand-led pressures are placed on sovereign and corporate issuers.

c. Investor education and protection are important to support market development and to help investors understand the benefits from adapting buy-and-hold strategies.

d. Legal and regulatory improvements and enforcements are necessary given global competition from other EMs and the interconnectedness of global capital markets. Furthermore, as financial market performance is now clearly understood to be tied to macroeconomic performance, effective regulation of financial markets is extremely important if these financing channels are to be useful over the long term.

e. Decide on either an OTC or exchange-based trading system and develop this system; trying to run both systems in parallel with dilute efforts resulting in a sub-optimal outcome.

2. The second group of countries (for example, Tanzania, Uganda, Zambia, Botswana, Namibia, Benin, Burkina Faso, Mali, Niger, Cameroon, Malawi and Rwanda) are developing their markets relatively slowly, although the pace of development differs between countries. Investments made into these markets are likely to face a variety of challenges depending on the country. There are significant efforts to be made to enhance market infrastructure as well as develop local savings institutions that can play a supporting role in developing these markets. The financial costs and institutional capacity upgrades required are significant, which suggests that these markets are unlikely to reach the level of development currently attained by the first group of countries. Moreover, the smaller size of these economies means that even if markets are built up, liquidity levels will remain low and act as a constraining factor.

3. The third group of countries (for example, The Gambia, Sierra Leone, Liberia, Guinea, Chad, CAR, DRC, Burundi, Equatorial Guinea, Gabon and Republic of Congo) either believe they have limited or no need for debt market financing (largely oil producers) or lack institutional capacity or are too small to develop debt markets beyond money market levels. It is unlikely that these markets will develop into type two markets and the authorities should probably not exert efforts trying to do so. A further issue for many of these countries is that following HIPC and MDRI debt relief, they are reluctant to increase debt stocks significantly. Therefore, bond market development is not seen as a policy priority.

Ecobank Research GB