Assessing Recent Determinants of Borrowing Costs in Sub‐Saharan Africa

• Published date: 01 November 2016
• Author: Aleksandr V. Gevorkyan,Ingrid Harvold Kvangraven
• DOI: http://doi.org/10.1111/rode.12195
• Date: 01 November 2016

Assessing Recent Determinants of Borrowing Costs

in Sub-Saharan Africa

Aleksandr V. Gevorkyan and Ingrid Harvold Kvangraven*

Abstract

This study explores macroeconomic implications of the sovereign bond rush that has been taking place in

sub-Saharan Africa since 2006. The focus is on the sub-Saharan sovereign bond yields as proxies for the

region’s ability to raise new funds on international markets. Despite the subcontinent’s tour-de-force

entrance to the international bond market, this paper reveals that recent (since early 2000s) borrowing in

foreign currency is not without macroeconomic risk. Empirically this paper finds that sovereign bond

yields are significantly influenced by global volatility, commodity prices and global liquidity—all factors

that are out of the control of the sub-Saharan economies in question. These findings suggest that

portfolio repositioning by institutional investors prompted by improved growth prospects and implicit

monetary policy tightening in the advanced economies or heightened risk perceptions, are likely to result

in increased borrowing costs for the sub-Saharan bond issuers and affect their ability to raise funds in

international markets. Furthermore, a change in borrowing costs might lead to higher debt-service costs

and policy uncertainty, which in turn could lead to suboptimal investment levels and, ultimately, hinder

economic development.

1. Introduction

As advanced economies struggle to regain traction with their subpar post-crisis

macroeconomic conditions, excess liquidity and a recent (mid-1990s–2000s)

commodity boom in global markets have allowed many sub-Saharan African (SSA)

countries to issue sovereign bonds on the international capital market at a relatively

low cost, despite their highly speculative ratings. This paper explores the determinants

of the yields on these sovereign bonds, as a proxy for the borrowing costs for select

SSA economies, with some implications for macroeconomic development.

Between 2006 and 2014, 14 first-time SSA national borrowers issued over US$15

billion in foreign currency-denominated bonds. However, commodity price volatility

on global markets may have a significant impact on global investors’ perceptions of

country risk and subsequently countries’ continued ability to borrow at competitive

rates, particularly as post-crisis liquidity dries up. Related and urgent is the problem

of financial soundness and macroeconomic sustainability. Critically, foreign investor

exposure and SSA debt sustainability have not yet been addressed adequately in

the academic literature. This paper aims to fill some of the gap in the literature to

date.

The main thrust of the empirical analysis in this study is on nine SSA countries

that are first-time sovereign bond issuers and have a characteristic dependence on

primary commodities in their industrial and export structure: C^

ote d’Ivoire, the

*Gevorkyan (Corresponding author): St John’s University, 8000 Utopia Parkway, Queens, NY, 11439,

USA. E-mail: gevorkya@stjohns.edu. Kvangraven: New School for Social Research, New York, NY,

10011, USA. The authors thank participants at the Southern Economic Association’s 2014 annual

meeting in Atlanta, GA, for comments on an earlier draft. The views expressed in the paper are solely

those of the authors and do not represent the views of the institutions with which they are affiliated.

Review of Development Economics, 20(4), 721–738, 2016

DOI:10.1111/rode.12195

©2016 John Wiley & Sons Ltd

Republic of Congo, Gabon, Ghana, Namibia, Nigeria, Rwanda, Senegal and

Zambia. This paper is not an exhaustive study of problems affecting these

countries. Rather, given space constraints, it is an insightful sketch of key factors

affecting sovereign bond yields. The hope is to spur further research in the subject

area.

Following this introduction, section 2 reviews the relevant literature and gives an

overview of the macroeconomic situation of the SSA bond issuers. Econometric

methodology and data are discussed in section 3. Thereafter, sect ion 4 analyzes the

empirical results before the paper concludes with a summary analysis.

2. Background

External Debt and Economic Development

While some economists claim that poor domestic policy that leads to balance of

payment deficits is the main driver of unsustainable debt (e.g. Krueger, 1987), others

point to reliance on the exportation of primary commodities as a central issue

affecting countries’ vulnerability to external debt crises (Gavin et al., 1995). Countries

that export primary goods are in a particularly vulnerable position owing to the

volatility of commodity prices, which lies outside their control (Cashin et al., 2000).

In development economics, Prebisch (1950) and Singer (1950) were early writers

on deterioration in the terms of trade as a result of declines in the price of primary

commodities. Elsewhere, Gevorkyan and Gevorkyan (2012a) consider

overdependence on exports of primary commodities and volatility in derivative

prices as destabilizing factors that exacerbate already fragile macroeconomic

conditions in emerging markets. Separately, Kondratieff (1935) analyzed commodity

cycles early on, in his explanation of economic crises—this idea is developed in a

more contemporary context in Bernard et al. (2014). Moreover, Pettis (2001)

argues that the flow of international loans since the 1820s has been driven

primarily by external events and not by domestic politics. In that analysis, the flows

of capital between rich and poor countries are generally determined by domestic

conditions in rich countries, rather than the quality of investment opportunities in

poor ones.

A related concept is a currency mismatch, which arises if a country’s assets are

denominated in its domestic currency, while external debt obligations are

denominated in a foreign currency (Burger and Warnock, 2006). If there is no

currency mismatch, a negative shock that causes investors to sell the country’s

assets will, in theory, correct itself. As the country’s currency plummets,

depreciation has an expansionary effect, causing the country’s products to become

more competitive and foreign goods more expensive, thereby improving the

country’s balance sheet. If a country borrows heavily in foreign currency-

denominated debt, however, the depreciation immediately and severely worsens

government and private balance sheets and greatly increases debt repayments.

In fact, Eichengreen et al. (2005) find that the extent to which debt is

denominated in foreign currency is a key determinant of output stability, volatility

in capital flows and exchange rate management. They find that output fluctuations

are wider in countries with a larger share of foreign currency-denominated debt and

that capital flows are more volatile. The “original sin”—a country’s inability to

borrow abroad in its own currency—has been used to explain the Latin American

debt crisis in the 1980s.

722 Aleksandr V. Gevorkyan and Ingrid Harvold Kvangraven

©2016 John Wiley & Sons Ltd