When you think about entrepreneurs, most would think of stocks and successful initial public offerings (IPOs). However when building and growing companies, access to debt finance is even more important.
Historically, most African economies have relied on bank financing, and to a lesser extent, on the equity markets, to fund investments. Except for countries like South Africa and Nigeria, corporate bonds are almost unheard of in the region.
But bonds and bond markets are as important, if not more so, than stock markets, for the efficient allocation of a nation’s resources. In major economies, it is not uncommon for bond markets to be substantially larger than equity markets. But that’s not always the case in Africa.
Today, about half of sub-Saharan African governments have recognized credit ratings.
The bad news is that many African governments borrow little from outside sources. This, in turn, means a limited amount of government debt is available for trading on secondary markets. Don’t go looking for a deep and liquid secondary market for African debt. For businesses trying to issue bonds, this is a problem because a government-bond market is such that it sets interest rate benchmarks for corporate bonds. This is why some countries issue sovereign bonds to replace maturing ones—even when the funds aren’t needed—to maintain benchmarks across the yield curve.
Yet, to have a corporate bond market, companies need to issue bonds. In many African countries, companies have traditionally relied on bank loan financing; international donor financing and in recent years financing from the Chinese.
It will take some persuasion to change that. Today, even if a corporate bond option existed, African companies would still head for the bank or ask its friends in Beijing for money.
Why? In short: cheap money. Companies can borrow at low, government-determined interest rates, irrespective of the risk of the loans. The risk is assumed by the government, which must periodically bail out banks by taking over their non-performing loans. Companies are further encouraged to seek bank financing as state-controlled banks almost always automatically roll over maturing loans at low rates. This is of course a classic case of moral hazard. Costs and risks are absorbed by state-owned banks, which ultimately pass them on to the government.
All of the above makes a convincing argument for the development of an African corporate bond market. Such a market would serve several functions: first, it would enable companies to raise funds even if they are not favored customers of the banks. Africa has some of the world’s most entrepreneurial economies but entrepreneurs aren’t usually well-connected. So, even as new companies are constantly being established, and many have succeeded and created jobs, they tend to be, and stay, small because they lack access to funding for further growth. A corporate bond market could remove this constraint and enable Africa to create more world-class companies and, even more importantly, jobs for tens of millions of people.
Secondly, it allows for fewer systemic risks. Typically, bank loans are of short to medium-term, and therefore need to be rolled over to cover the life of the project funded. This lends an air of uncertainty to business planning. Worse still, loans can be called in before schedule, leaving companies in dire financial predicaments.
Recourse to bond financing would eliminate any mismatch between the lifetime of assets and the duration of liabilities.
Thirdly, as the number of African pension funds, social security funds and insurance funds proliferate, bond markets are key to ensuring that these funds can match their future payment obligations with assured future income. Without a long-term bond market, such funds, increasingly important to Africa, will be at risk.
A well-regulated corporate bond market open to private companies can fund the jobs Africa needs for social stability. Together, government and corporate bond markets can stabilize Africa’s financial landscape by properly matching assets to liabilities and at the same time provide risk capital to entrepreneurs who build businesses, employ people and create economic growth.
Developing African bond markets will unlock Africa’s huge medium-term growth potential.