African nations' borrowing costs are high, but reforms offer a fix: IMF

Why must sub-Saharan African governments pay so much to borrow money on capital markets? And are these costs justified? A group of International Monetary Fund economists decided to get to the bottom of these questions so that governments will have the tools to more effectively raise the money they need to fund infrastructure, health systems, and job creation. They found tangible concerns around risks in the region that explain why investors demand higher rates of return, and argue that reforms would go a long way toward lowering costs. Some African governments have at times claimed they are treated unfairly and that their actual risk is lower than the level perceived by credit rating agencies. The IMF staff study’s timing is critical. Ajay Banga, the new World Bank president, said he wants to attract more private money to low-income countries. Removing the obstacles driving high borrowing costs can help his agenda, making development more affordable and attractive to investors. “We decided we needed to look at the facts. What does the data tell us?” Yirbehogre Modeste Some, an IMF economist, told Devex. The team ran the numbers on more than 1,500 bonds. The first conclusion they reached is that sub-Saharan nations “are certainly paying more than other countries,” he said. Their study shows the difference in borrowing costs is substantial. The premium paid by sub-Saharan African, or SSA, countries on the primary market was 66% higher than the average in other regions and is the highest among all emerging and frontier markets. On average, SSA countries paid 2.1 percentage points more than peers. From there, the economists dove deeper to understand the drivers of this difference between bonds from different regions, investigating issues affecting political risk and economic stability. Specifically, they poked around on budget transparency, the extent of the informal economy, the level of financial development, and quality of public institutions. Their empirical analysis showed that investors considering putting their money to work in Africa “probably are worried about these factors and might then require the additional premium,” he said. This means it’s not a geographical bias — a suggestion at times made by activists and even governments on the continent, and which helped prompt the research — but one based on a tangible risk assessment, Some explained. “The combination of these factors are reinforcing each other,” Some noted, leaving African countries at the mercy of high rates demanded by bond buyers. In the somewhat formal language of economists: “We found that the high premium estimated for SSA countries fades [away] when these structural factors are accounted for.” The study was published as the world faces interest rates at highs not seen in decades, as central banks around tighten policy to fight inflation. African costs of borrowing are spiking, coming on the back of historically higher rates even when the global environment was far more accommodating. The good news is that governments can implement reforms that will lower their borrowing costs, according to the IMF economists. The study found that “countries with (a) high level of fiscal transparency tend to have lower sovereign bond spreads.” Similarly, countries with lots of economic activity in the informal sector will have higher interest rates. “If they can improve transparency in the budget process, and make more finance data public, that would help,” Some told Devex. Fixing issues around the informal sector is more “tricky,” he admitted, but cautioned governments that this is an area that investors have their eye on. “And developing domestic financial markets would help lower the risk premium they are facing on the international market,” he added. The new IMF study means that reforms — such as those noted by Some, along with improving the quality of public institutions — are needed, or borrowing costs will weigh on African governments for years to come. However, major creditors could still offer relief to distressed African nations, through programs such as suspension of debt repayments. This could help tide countries over — and creditors could do so in a way that boosts ongoing reforms, making Africa more investable.