Debt Capital Markets – Part of the solution to accessing long-term funding
One of the sessions at the World Economic Forum on Africa in Cape Town is titled “Where next for Africa’s capital markets?” The delegates discussed a number of issues regarding the development of capital markets in Africa, stretching across both equity and debt capital markets.
The inclusion of debt capital markets in the discussion is encouraging, as the development of local debt capital markets is critical to increasing the availability of long-term funding to corporates on the continent. Key requirements highlighted by the delegates for the development of capital markets included increased domestic savings rates and sound macroeconomic policies.
Well-developed debt capital markets provide a number of benefits to an economy including:
• An alternative source of funding to corporates, which may result in continued access to finance during times when banks are less inclined to lend.
• Access to funding with tenors longer than banks are willing to provide.
• Development of a yield curve, which provides a benchmark for more transparent pricing of bank loans and corporate bonds across the risk spectrum.
• Competition to bank lending, which reduces the cost of funding to corporates.
Debt capital markets in Africa are dominated by government bonds often issued at high interest rates. Governments are deemed as lower credit risk, therefore corporates will issue bonds at higher interest rates. The high interest rates result in bonds often being expensive and inefficient sources of funding for corporates.
The impact of high interest rates on domestic banking sectors in Africa is twofold. Firstly, domestic banks are unable to raise long-term funding at competitive rates, resulting in banks relying on short-term funding. Banks are hesitant to utilise short-term funding to provide long-term loans to corporates, due to the mismatch in maturities. Secondly, the high interest rates banks earn on investing in government bonds provide little incentive for banks to extend loans to corporates which are viewed as higher risk.
The ability of corporates to raise long-term, local currency funding is limited by the high cost of bonds and lack of long-term funding available from domestic banks. Corporates therefore rely on regional and international commercial banks, along with development finance institutions for long-term funding. These loans are often denominated in hard currency and the tenor is shorter than the cash flow profile of the projects being developed. These factors introduce additional risks to the corporates which may experience difficulties in repaying the debt should the local currency weaken, or the project experience construction delays.
Lack of long-term credit hampers economic growth, employment and fixed investment. Developing strong debt capital markets is critical to improving the overall financial systems on the continent. Developed debt capital markets will enable banks to extend bank loan maturities and corporates to match debt maturities to investment projects being undertaken. The true test remains to be seen whether the discussions held at the World Economic Forum for Africa will contribute to the development of debt capital markets in Africa.
