Unsustainable sovereign debt has been a disorder of the emerging economies and developed world.  Whereas nations like the US, Canada, Denmark, Belgium, Malaysia, Mauritius, New Zealand, England maintain a clean record, Portugal, Greece, Spain, Russia and Argentina have maintained a very bad record. Indeed, Portugal has defaulted four times since the late 1800s whereas Greece and Spain have defaulted five and six times respectively.

Despite the underlying risks, issuing of bonds is irresistible; and there will always be takers.  The excellent returns from bonds have always dwarfed those of giant economies like the US. According to Morningstar, a research firm, the average return for a mutual fund investing in emerging market debt which mainly means government bonds has returned 10.4% per annum since 1998 as opposed to emerging markets stock funds which have yielded 8.2%

Recently, Greece posted a 74% loss in investments for its sovereign debt investors. The case was not any different for Argentina’s 2005 and 2010 exchange offers. That’s the futility of investing in sovereign bonds, even amid the near guaranteed returns. 

While the medium term outlook for Africa remains rosy, I am most worried about the long term forecast. I believe that African nations are foolishly borrowing and the spree could translate to massive defaults in years to come.

According to Standard and Poors (S&P), the 19 African countries it rates will borrow an equivalent of US$ 61 billion from long term domestic or global commercial sources this year alone.  Out of this amount, US$16 billion or 26% will be used to refinance maturing long term debt.  Overall, the total commercial and concessional debt for the African nations is projected to increase by 14.6 percent to US$ 392 billion by the end of the year.

This is both good and bad for the African economies. It is good because the ambitions to build infrastructure which has been limiting growth will come to fruition. On the flipside, it is bad because it waters down the sweet growth story that has been a fresh chapter in the minds of many a business people seeking alpha.  Africa has had a good growth decade so much so that it has remained the second growing continent in the world, second to South Asia. 

Africa’s growth rate stood at 4.7% in 2013 and is forecasted to grow at 5.2% in 2014 at the backdrop of increased investment in natural resources and infrastructure. This growth story could however be watered down by the increasing borrowing if not contained.  According to Christine Legarde, IMF Managing Director, African nations risk ‘spoiling’ the Africa rising narrative. Governments should guard against overloading their countries with too much debt.

South Africa has been issuing debt for many years. Ghana and Gabon issued US$ 750 million and US$ 1billion respectively in 2007 followed by Senegal in 2009 (US$. 500 million) and Nigeria in 2011 with a similar amount. In 2012, Zambia issued US$ 750 million while Angola issued US$ 1billion.

Closer home, Rwanda issued its Debut bond in 2013 (US$ 400 million) while during the same period, Ghana reissued US$ 1 billion and Nigeria reissued US$ 1 billion. The two nations have had the highest rollover rates for both short and long term borrowings reaching 28 % and 26% respectively. In the same year, Namibia issued US$ 500 million while Tanzania issued US$ 600 million.

Recently, Kenya closed its US$ 2 billion offering amidst concerns that conditions were likely to be less favorable owing to US Federal Reserve tapering.  The issue was oversubscribed like most of other offerings across Africa. 

Now that Africa has the funds, does it mean that its business on to the next level? There are underlying dangers depending on the circumstances at hand, especially if the funds are diverted from the designated use to fund more recurrent expenditure or the government does not generate enough revenues (‘original sin’) to service the repayments.

Is the wave of default experienced in the Euro area likely to hit Africa in a decade to come? The probability is high. But why do nations default in the first place?

Default, is as old as civilization. The first default occurred in 377 BC in Ancient Greece.  Arguably, because of uncertainties and default penalties, governments most often face two trade-offs: between foreign repayment and default and between domestic default and repayment through distortionary taxation. The government decides each period whether to transfer resources away from the economy as repayment of debt to foreign investors or keep resources at home and suffer default penalties. When output is low ceteris paribus, it is more costly for a risk averse borrower to respect the contract.

The second trade-off is new and drives domestic debt and default policies. This trade-off is drawn along different lines, as both repayment and default on domestic debt is a transfer of resources within the economy. In the case of default on domestic debt, government suffers default penalties similar to foreign default penalties. When it decides to repay however, it needs to finance this repayment with costly tax collection. This trade-off draws distinction between tax-financed and debt-financed expenditure policies.

Empirical evidence proves that domestic debt plays an important role in build-up to sovereign default. Worse still, the government has the full discretion to allocate the resources appropriately. 

Africa is almost fully out of the donor aid dependency days.Its competitiveness on the global space is making it increasingly visible as witnessed by the growing and favorable ratings by Ratings Agencies. Presidents continuously become democratically elected and formulate forward thinking policies and agendas. FDI flows too continue to have an impact on key projects and bottom-line growth projections.  

But even with these good prospects, most African nations are grappling with problems of balancing between spending on long term projects while meeting short term obligations.In actual sense, African nations could be borrowing for short term gains with the belief that they will kick the pain down the road.  A case in point is Kenya that is fighting a huge wage bill amidst billions worth of infrastructure projects. None of the African nations are an exception. That withstanding, corruption still remains rife within the continent.

African nations can and will default: it is unstoppable.While this wakeup call is coming, it may not be too soon. The effects of this could however be contained if governance is kept a core priority while balancing growth on core areas like healthcare and education. Failure to generate revenues to repay debt will be spectacularly sinful.

By Michael Musau
michaelmusau@hmail.com