Rising global interest rates create more challenges for Africa’s sovereign debt issuers

As global interest rates rise, sovereign debt issuers in emerging markets, particularly those in Africa, are facing challenges in raising debt.

The rising interest rates available in the United States are making it difficult for these countries to attract the investments they need to grow their economies and improve their infrastructure.

The issue stems from the fact that the largest pool of liquidity for issuance in the world is in US dollars. The change in interest rates in the United States has a ripple effect on every piece of dollar-denominated debt worldwide, impacting the cost of funds for emerging-market countries.

Investors have the opportunity and expertise to invest anywhere in the world, so as the recent tightening of developed markets’ monetary policy has made instruments like US treasury bonds and UK gilts more appealing to investors, they are increasingly questioning the value of investing anywhere else. These US bonds are considered risk-free, with the 10-year US Treasury bond recently testing the 4% level – a notable psychological level for most global investors. This makes it very difficult for emerging-market sovereign debt issuers to compete for investments, particularly since some investors are less familiar with issuers on the continent and are hesitant to invest in longer-tenor financial instruments based in jurisdictions that they perceive to be higher risk.

In addition to the challenge of rising yields, sovereign debt issuers in Africa also face the problem of currency risk. The biggest liquidity pool for any debt raise remains US dollars. When African sovereigns raise debt in US dollars, the risk premium reflects the fact that they are priced at US Treasury yields plus a spread. While this spread compensates investors for a lack of liquidity relative to the US Treasury issuances, it also reflects the foreign exchange risk for investors looking at a non-dollar issuer borrowing in dollars. Moreover, many African countries experience difficulties accessing US currency, making it even more difficult to manage currency risk effectively.

Having many investment options available to them has allowed global investors to be discerning about where they place their money. While there are still-growing emerging-market investment mandates in place, investors now tend to scrutinise their options in this regard far more closely.

To compete effectively in this environment, emerging-market sovereign issuers need to focus more intently than ever on doing the right things in the eyes of prospective investors. This includes ensuring that they have accommodative fiscal and monetary policies in place while still positioning themselves strongly as credible issuers.

Ultimately, competing effectively for the same pot of global investor money requires a measured approach. Timing the market correctly and issuing debt instruments at the most opportune moment is critical. So too is choosing the correct tenor point in the issuer’s yield curve and avoiding over-structuring to the point of losing liquidity.

Leveraging ESG wherever possible is also an invaluable way of positioning yourself as an attractive source of sovereign debt. Even if issuers cannot make a compelling argument for all three components of ESG, they can, and should, capitalise on those areas where they can show strength. The importance and value of ESG- and sustainability-linked instruments in this environment should not be underestimated. They provide sovereign borrowers with an opportunity to demonstrate their commitment to sustainability and responsible fiscal practices and can also help to lower borrowing costs if structured to do so. They also present opportunities for borrowers to access new sources of funding that might not have been available to them through traditional financing mechanisms. Lenders can benefit by aligning their lending practices with their sustainability goals and reducing their exposure to sustainability-related risks.

Finally, given the many complexities and nuances of the sovereign debt environment, the importance of partnerships with financial institutions that have market and investor knowledge, and demonstrable experience with successful sovereign issuance cannot be overstated. Such partnerships are not only vital to help issuers navigate the complex financial landscape, but also stand to massively enhance their chances of successfully securing the investments they need from global investors.