BLOG — Nov 09, 2021
Assessing UNECA’s new liquidity facility for African sovereign debt
By Brian Lawson and Chris Suckling
On 3 November, at the United Nations Climate Change Conference (COP26), the UN's Economic Commission for Africa (UNECA) announced it had launched its Liquidity and Sustainability Facility (LSF) to improve the liquidity of sovereign debt issued internationally by African borrowers. The initiative was initially announced on 23 March 2021 to incentivize sustainable development initiatives, particularly the issuance of Green and marine-focused Blue bonds by sovereign issuers in the region.
Key Points
- While the announcement claimed the new facility would raise USD3 billion from on-lending of SDR allocations, no specific detail is yet available on such commitments.
- UNECA has targeted a USD30 billion size for the LSF.
- Although risk-positive for the region, the annual benefits claimed by UNECA are relatively modest, crudely equating to under 40 basis points in annual savings on the end-2020 regional debt stock.
- These benefits could be largely offset by the future impacts of US tapering and eventual monetary tightening.
- Despite ambitious claims by UNECA, transformational relief for the region is likely to need wider debt forgiveness and additional aid.
Special Drawing Rights (SDR) reallocation to give liquidity to the facility as yet undefined, with private-sector support also initially unclear
UNECA stated that the facility initially would raise USD3 billion of liquidity to fund the program by seeking on-lending of SDRs recently allocated to developed countries within the IMF's general allocation of SDRs (worth some USD650 billion). Such funds would enable African Export Import Bank (Afreximbank) to provide liquid funds to holders of government debt willing to lend their holdings out temporarily through sale and repurchase or "repo" agreements, a widely used feature in the trading of government bonds in developed economies. However, it did not specify any country which has specifically committed to such provision.
In an article in the New African magazine on 14 October, Hippolyte Fofack, Afreximbank's Chief Economist and Head of Research noted that only USD33 billion or 5% of the IMF distribution had been allocated to "the whole of Africa - where it is most needed", while 60% (65% including mainland China) had been delivered to developed countries, with the EU alone receiving USD119 billion. IHS Markit calculations are slightly different: we calculate Africa's share at 5.25% of the total, for USD35.6 billion equivalent in SDRs. By contrast, the G20 received just under a 58% share of the total allocation, for USD437.5 billion equivalent in SDRs.
The mechanism for on-lending appears already in place: the IMF lists an ample group of developed countries which have signed agreements for voluntary trading arrangements in SDRs. These include the United States, European Union, European Central Bank, large EU member states, and mainland China and Australia, among others. Given that the LSF has been under preparation since March and the SDR allocation undertaken in late August, we assess that the lack of specific backing is an adverse indicator for initial momentum with the LSF, but one that could be swiftly rectified by significant commitments in the next few months. More positively it claims that it also has "received interest" from a number of "large asset managers", with Amundi participating in a pilot transaction: Citigroup also is actively involved as a structuring agent.
UNECA is targeting USD30 billion facility size
Despite the above early uncertainties over exact sources of funding, UNECA suggested that the LCF could reach USD30 billion in size, with the goal of "providing African governments with a liquidity structure on a par with international standards", while looking to "dramatically increase" the volume of Green and Blue (marine sustainability-focused) bonds issued within the region and facilitate their provision at more affordable rates. An initial USD200 million transaction, funded by Afreximbank, is currently being prepared.
UNECA claims important, transformational benefits: our assessment is that these are important but unlikely to have a dramatic overall impact
UNECA presents the new LSF as an important development, claiming it will "lower the borrowing cost for African sovereigns", with the development of a repo market in their debt potentially transforming "African sovereign bonds into liquid assets", while encouraging Environmental, Social, and Governance (ESG) issuance and "enhancing…debt sustainability". It specified that "thanks to the LSF", the region could save USD11 billion during the next five years through lower borrowing costs.
IHS Markit assesses that the potential reduction in borrowing costs is clearly risk positive for debt sustainability, while also reducing contract-related risks and the need for increased taxation in beneficiary countries. However, we are less convinced about the "transformational" nature of the development.
Using World Bank data, total external debt in SSA reached USD702 billion in 2020, having risen from USD492 billion in 2016. Excluding middle-income countries, it rose over the same period from USD411 billion to USD588 billion. In approximate terms, to save some USD2.2 billion annually is important in absolute terms but if spread evenly equates to 31 basis points per year in potential interest cost savings using the 2020 stock as the base, if spread over the full region, or 37 basis points if applied only to the lower-income group.
The USD3 billion funding base for the facility also is modest, even if used on a leveraged basis. As a comparison, the stock of German Bunds is EUR5.75 trillion, while that of the UK Gilt market is GBP 2 trillion. The ECB reports that daily average secured borrowing turnover was EUR402 billion, looking at the largest 47 banks in the Eurosystem.
Benefits could be offset by tapering, higher rates, and greater risk aversion - other policy measures appear potentially more beneficial for regional debt sustainability
Overall, we assess that the LSF is at a very early stage of development. If it achieves the cost savings suggested, this is clearly a positive development for the region, but not an indicator of fundamental change in its debt sustainability. A 30-40 basis points annual saving - if realized - could be offset relatively quickly by the impact of US tapering and an eventual move towards tighter policy rates in major developed economies. Even this hypothetical benefit is untested, and we would caution that African debt markets remain fundamentally smaller than those in developed European markets, so will have materially less liquidity even after the benefits of this facility are made effective. Overall, we continue to view wider and more sizeable initiatives to offer debt relief covering private-sector as well as official bilateral borrowings (an area that has proved sticky to date) and expanded provision of grants to help the region's countries fund climate transition as likely to have a potentially greater impact on the region's fiscal position and debt sustainability.
Nevertheless, existing debt relief initiatives (DSSI) also have proved relatively modest so far. They do not cover private-sector debt: participation by private-sector creditors is entirely voluntary and to date, none have participated. It also excludes multilateral lenders, notably the World Bank, and is instead limited to official bilateral creditors (i.e., those of the Paris Club). China is not a Paris Club member and has participated separately on an ad-hoc basis, so the DSSI is still missing Africa's (by far) largest creditor.
A significant positive initiative for the region is the Resiliency and Sustainability Trust, which aims to raise USD100 billion equivalent in SDRs recycled from wealthy economies. The trust would finance projects related to climate mitigation and vaccine rollout. If this is prioritized, given the political urgency for COVID-19 vaccination and climate transition initiatives, this focus might reduce the volume of SDR allocations supporting the LSF.
In summary, we view the new LSF as welcome and risk-positive. However, we are concerned by the initial absence of specific pledges of resources to finance the facility, given that work has been undertaken on it for over six months, although this could be rectified quickly if major governments of developed countries - and large private institutions - become actively involved. On balance, we assess that the LSF will make the region's debt marginally more attractive and provide at least some welcome cost savings but view it as less likely to transform the trading liquidity of the region's debt. Ultimately, liquidity is a function both of the stock of an outstanding debt instrument - far larger in highly developed markets like the USA, EU, and UK - and the depth of the investor base for such securities, which is highly sensitive to their credit quality, an obvious constraint for the depth of the market in African debt.