Liquidity as impact? and rural electrification in Africa
Liquidity for impact: lowering costs for African sovereign debt
A seemingly innocuous announcement came out of London Climate Week, about liquidity for ‘sustainable development’:
“The Liquidity and Sustainability Facility (LSF) is pleased to announce its collaboration with S&P Dow Jones Indices (S&P DJI) on the development and launch of the iBoxx LSF USD African Sovereigns Index. The index tracks the performance of the universe of African Sovereign Eurobonds that the LSF accepts as collateral in the framework of repo transactions. ….
“Deepening capital markets, by building infrastructure that facilitates the inclusion of developing economies in capital market instruments is crucial to mobilize cheaper and longer-term resources” said Vera Songwe, Founder and Chairwoman of the LSF. “Inclusion in indices is an important step towards increased profile and access to a wider range of investors for African Sovereign issuers and we hope for many other emerging markets as we expand.” ...
[David Escoffier, CEO of the LSF Secretariat:] “We need instruments such as indices that bring additional transparency and liquidity to the market in order to crowd in more investors and effectively mobilise private capital to support the sustainable development of Africa.”
How exactly does bond liquidity support sustainable development?
When a company or a country raises finance (a “primary” investment), an investor gives them money in exchange for a claim – shares in their business, a promise to repay debt with interest, or some more exotic instrument like sharing government savings if they reduce criminal re-offending. The default option is then to sit and wait until your investments pay off.
As an investor, your pay-off could take a very long time, for example if it is an equity investment in a privately held company that is re-investing profits as it grows, or a bond with a 30-year duration. Your circumstances may change and you might need the money from the investment sooner rather than later. To achieve this, you need “liquidity”.
“Liquidity” is the ability to convert the value of your investment into a more fluid medium of exchange like cash. Selling to another party (a “secondary sale”) allows the investor to receive their money back before the investment has run its course, perhaps with a discount or profit. Even if a sale is possible, it may only be in demand by a handful of potential buyers, reducing the ability to convert it into cash at its fair value. If you are not able to stomach the possibility of having an illiquid investment, you might allocate less of your capital to it in the first place.
While completing a secondary sale does not generate any additional funds for the original issuer, the ability to do so means that the investment will appeal to more investors. This helps the issuer through more investor competition, driving down their interest costs or increasing the potential valuation of their company.
Bill Gross, “The Bond King”, made his billions by valuing and trading bonds before their expiry dates at a time when this was uncommon, generating liquidity for those investors. Today, many bonds are publicly traded. Yet in Africa, these bonds trade at a premium to reflect higher perceived risks.
According to S&P’s African Sovereign Bond Index, their portfolio of 13 African countries[1] traded with a yield to maturity of 12.16% as of June 28th 2024. That is, if you bought these bonds at their fair value today, you could expect to make 12.16% annualized returns if you held onto them until they mature, versus the stated 9.46% interest rate at their original face value (‘par’). This return is ~770 bps above 10-year US Treasury yields[2].
An index like the S&P’s creates demand for African sovereign debt, which would eventually lower its yields. If an ETF is launched using it, investors can make a smaller, diversified investment, instead of investing individually in each country’s bonds, which often requires a minimum spend.
The LSF reckons 22 African countries have access to capital markets, out of 54 countries on the continent. Even within these 22, bonds from smaller or higher risk countries may be more thinly traded. This reduces liquidity and can increase the bid/ask spread - a higher bid/ask spread means you are not able to buy or sell your asset as close to its fair value, because your broker is pricing in the risk of matching your trade up with someone else.
LSF’s announcement of this new index could further increase demand for an African Sovereign Debt, including from adding new countries like Angola, Senegal, Côte D’Ivoire and Gabon. This could eventually reduce government borrowing costs or increase the amount they could borrow. Proceeds could then be channeled into national investments, for example in sustainable infrastructure.
While this is not as grand as announcing millions or trillions of dollars for climate projects, it does help to grease the wheels for funding to be channeled to African nations more cheaply and in greater quantities. This seems like a great outcome for Africa from London Climate Week and seems like a necessary condition for cost-effective economic growth, even if it may not be a sufficient one.
[1] Botswana, Egypt, Ghana, Kenya, Mauritius, Morocco, Namibia, Nigeria, South Africa, Tanzania, Tunisia, Uganda, Zambia
[2] The index has a weighted average 8.8 year maturity, hence selecting 10-year Treasuries as the benchmark. Yield was 4.45% according to Bloomberg at time of writing.
Donors need to do more to fund rural electrification in Africa
As published in this week’s Economist.
The depressing thing about your article on private firms driving a revolution in solar power in Africa is that it could have been written ten years ago (“The light continent”, June 22nd). The number of people without electricity in sub-Saharan Africa has not moved since 2014, when off-grid solar was still often cheaper than grid extension and South Africans were already battling power outages.
Then, as now, we are not doing enough to fund electricity infrastructure in countries that need it. The West heavily subsidised electricity grids when they were first built out; rural customers are still subsidised today. Yet we expect off-grid electricity to be profitable in Africa.
The World Bank and other donors pledged around $2bn to off-grid solar from 2012 to mid-2020, often with great fanfare. Just 13% of that money was disbursed over that time, even though private companies were poised and ready to build. We will be in the same place in 2034 if donors continue making grand promises that don’t materialise. We can’t rely on the private sector in Africa to shoulder the cost of connecting rural customers when they are the least profitable. Our aid institutions must put their money where their mouths are if we are to build solar infrastructure in Africa.