How States Can Raise Money by Issuing Euro Bonds

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Introduction

According to the IMF, over 20% of the 48 Sub-Saharan nations have issued Euro bonds. African governments view Euro bonds as a source of financial diversification and a technique to help them avoid traditional foreign aid, which usually comes with strings attached.

What Are Euro bonds?

These are bonds or debt instruments issued offshore by governments or corporates and are denominated in a currency other than that of the issuer’s country. Euro bonds are typically long-term debt instruments denominated in US Dollars, Euros, Japanese Yen, Swiss Francs and other currencies.

Since Euro bonds are typically issued in external currencies, they are sometimes called external bonds. Euro bonds are vital because they help governments and companies to raise capital while having the flexibility to issue them in a foreign currency.

The issuance of Euro bonds is typically handled by an international establishment of financial institutions on the borrower’s behalf where one financial centre may underwrite the bond, thus affirming the purchase of the whole issue.

The popularity of Eurobonds as a financing tool reflects their high degree of flexibility since they offer issuers the capacity to choose the country of issuance based on the regulatory landscape, interest rates, and market depth. Eurobonds are attractive to investors because they usually have small face values providing a low-cost investment. Eurobonds also possess high liquidity, meaning that they can be easily sold and bought.

What’s the Primary Reason for Issuing Eurobonds?

The leading reason for Euro bonds issuance is the necessityfor currency capital coming from another country. Since these bonds are fixed return securities, they typically give a fixed interest rate to investors. The issuers of euro bonds pay fixed rates of interest to the Euro bond holders. The fixed rate of return that investors receive on investment is called the coupon.

What’s a Coupon Payment?

It’s the annual interest rate paid on a bond expressed as a percentage of the euro bond’s face value and it’s paid from issuance date until maturity. The reason it’s called a coupon rate is that before electronic investing, each bond was issued with pieces of paper called coupons.

Types of Euro bonds

Straight Euro bonds. These bonds have fixed maturities and carry a fixed interest rate. Straight Euro bonds are paid by repayment plans or in one payment at the date of maturity. Straight euro bonds are regarded as unsecured bonds because nearly all of them aren’t secured by any particular property of the borrower. Because of this, the euro bond holders become general creditors if the borrower defaults payment.

The lenders usually analyze the nature of the borrowers’ assets, their earning power, and their general credit strength.

Convertible Euro bonds. These bonds can be converted in to parent common stock and have become increasingly popular since the market for straight euro bonds has declined. Convertible euro bonds avail investors with a steady income and an opportunity to participate in rising stock prices. International investors are inflation-sensitive as they choose convertible euro bonds, which hold the buying power of their money.

Bond with warrants. Some euro bonds are issued with warrants. A warrant is an option to buy a particular number of common shares at a stated price during a specific period. Warrants don’t have dividends, voting rights, and they become pointless at expiration except ifthe price of the common stock surpasses the exercise price.

Floating rate bonds. These bonds are frequently called Floating-Rate Notes. The rate of return on these notes is changed at regular intervals, usually every six months to reflect changes in short-term market rates.

Currency Basket Bonds or Currency Cocktail. Currency basket bonds were formulated to balance the buying strength of the coupon. This is realized by combining a variety of currencies as per weighting process. The amount of every currency in the basket typically remains stable but the basket’s value changes as some of the currencies depreciate or appreciate corresponding to each other.

Investor Interest in Sub-Saharan Africa’s (SSA) Euro bonds

Investor interest mainly from the USA and Europe to take up these SSA Euro bonds is high to the extent that almost all of these issues have been oversubscribed. During the first half of 2021, Africa’s demand for Euro bonds continued where Benin, Ivory Coast, Ghana, and Kenya raised USD 6.1 bn, translating to a 3.8x subscription rate.

This high subscription rate is caused by increased investor confidence in the region following the positive perspective in the SSA’s economic recovery and increased appetite for higher-yielding investments. The increased fondness for Euro bonds by African countries keeps on to be credited to the following;

•​Financing of maturing account payable obligations.

•​The need to finance massive deployment infrastructure projects.

•​Reduced financial aid to African states by western donor nations.

•​The need to bridge the widening fiscal budget deficits.

•​The need to retrieve the African economies, which have been negatively affected by the COVID 19 pandemic.

Background of Euro bonds issued in sub-Saharan Africa

Collectively, H1’ 2021 witnessed four countries located in the Sub-Saharan territory take up USD 6.1 billion through Euro bond issues. The new instruments enticed massive interest as evidenced by the oversubscription in all the issues, with the Kenyan issue recording the highest oversubscription of 5.0x. This emphasizes the demand by premium investors to hold riskier assets, partly due to comparison, African sovereign debt provides the highest yields to global investors.

Some of the countries that issued Eurobonds in H1’ 2021 include Ivory Coast, Benin, Ghana, and Kenya as explained below;

•​Ghana. Ghana became the first Sub Saharan African nation to issue Euro bonds in US Dollars since the onset of the COVID 19 pandemic. The country raised USD 3.0 bn using a four tranche Euro bond issued on 7th April 2021 that comprised of a 4-year Zero Coupon bond, a 7-year bond, a 12-year bond and a 20-year bond with coupons of 7.8%, 8.6%, and 8.9% respectively.

The tranche received offers of USD 6.0 billion translating to an oversubscription of 2.0x, a strong signal of the investor’s confidence in the country’s plan for debt sustainability, economic recovery, and growth. The proceeds from the Euro bond supported the budget deficit by funding growth-oriented expenditures and conducting liability management on external and domestic bonds.

•​Kenya. Kenya issued a USD 1.0 billion 12-year Euro bond with a coupon rate of 6.3% on 17th June 2021, which was 5.0x oversubscribed. The issue was the first Euro bond sale in two years and the 4th cardinal debt to be experienced by the country since 2014. The Euro bond, listed on the London Stock Exchange, got offers of USD 5.4 billion and a final pricing outcome, which was better than the initial market expectations pointing toward strong global investor confidence in the country’s economy and medium-term economic prospects.

The Euro bond will be reimbursed in two equal tranches in January 2033 and January 2034 to sooth repayment burdens. The Euro bond will immense the public debt, which is estimated at 69.6% of GDP as of December 2020. On the flip side, the issue will assist in financing the anticipated 7.7% budget deficit for the Fiscal year 2021/22 and aid in responding to the COVID 19 crisis.

•​Ivory Coast. Ivory Coast re-opened a dual-tranche Euro bond on 9th February 2021 consisting of 11.0 year and 27.0-year instruments, with 4.8% and 6.8% coupon rates, respectively that erected USD 850 million. The issue earned bids worth USD 2.9 billion translating to a 3.4 x rate of subscription. The bond was allocated for financing Ivory Coast’s budget. The extreme subscription was a mirror of Fitch Rating declaring Cote d’Ivoire’s Long-term Foreign Currency Issuer Default Rating (IDR) at ‘B+’ with a Positive anticipation in December 2020.

The declaration was championed by high-powered economic growth possibilities, comparatively reduced fiscal and foreign deficits and debt proportions of 41.7 percent as at the climax of 2020 in spite of bearing political hazards, low development indications, and fairly high commodity enslavement.

•​Benin. Benin became the 1st African nation to issue a Euro-classified Euro bond by issuing a dual-tranche paper in February 2021, raising an equivalent total of USD 1.2 billion. The issue had tenors of 11 years and 31 years, with coupon rates of 4.9% and 6.9%, respectively. The issue got bids worth USD 3.6 billion interpreting to a 3.0x rate of subscription. This is linked to the amendment of Benin’s Long-term Foreign-Currency Issuer Default Rating (IDR) outlook to Positive from Steady, asserting the Issuer Default Rating at B with a positive outlook, in February 2021.

Consequently, the positive outlook was reflected in the existing Benin Euro bond, which declined by 1.0 percent in H1’ 2021 pointing towards enriched investor affection on Benin. The bond will allow the early remuneration of 65% of the nominal cost of the country’s 2026 Euro bond and also assist in financing the 2021 budget on flagship Government Action Program Projects.

Yields on Sub Saharan Africa Euro bonds Issued in h1’ 2021

Bond yields are the annualized returns that an investor earns by holding a bond until its date of maturity. They are a component of the euro bond price. If the price of the bond changes, so does the yield. The lower the bond price, the higher the yield rises and the higher the bond price, the lower the yield. A negative yield is when investors are getting less money than they originally paid.

Yields on African Euro bonds recorded mixed performance in H1’2021, with most yields readjusting upwards as investors linked a higher risk premium on the regions affected by the new COVID 19 variant which is anticipated to curtail their economic expansion.

Yields on the Zambian and the Kenyan Euro bonds declined in H1’2021 by 3.4% and 0.6% points to 16.8% and 3.3% from 20.2% and 3.9%, respectively, recorded at the climax of December 2020. The yields on the Zambia Euro bond however remained relatively high, owing to the high risk attached to the country as it failed to honour its service obligations of a USD 42.5 million Euro bond coupon in November 2020 and struggled with high debt levels which stood at 104.0% of the GDP in 2020.

On the other hand, yields on the Senegal Euro bond increased by 0.7% points to 3.9% from the 3.2% registered at the climax of December 2020. This was attributed to the economic decline because of the COVID 19 pandemic with the tourism and transport sectors being some of the hardest hit sectors.

Yields on most of the Sub-Saharan Euro bonds increased in H1’ 2021 because of the high demand for regional issues coupled with low supply of issuances.

Zambia registered the highest drop in Eurobond yields indicating increased investor morale, with the 2014 ten-year and 2015 12-year instruments both declining by 2.8% points, to 16.8% and 9.4%, from 19.6% and 12.2% respectively.

Zambia’s 10-year Euro bond was the worst performer, with the yields increasing by 20.3% points to 41.8% from 21.5% following the growing concerns of a growing fiscal deficit and the deteriorating credit worthiness after Zambia missed a USD 42.5 million coupon payment on its 2024 note. But, the Zambian government has put more efforts on debt sustainability which has helped in regaining some of its investors’ confidence.

Outlook on Sub Saharan Africa Euro Bonds Explained

From the above analysis, it’s obvious that most Euro bond yields in the region increased in H1’2021, because of the emergence of subsequent waves of COVID 19, which saw investors attach a higher risk premium on the affected regions because of the anticipation of slower economic rehabilitation and a sluggish vaccination rate. Notably, debt in most African countries has been on the rise mainly because of the surge in government financing needs as a result of COVID 19 costs, increasing depreciation in exchange rates, rising interest payments, and widened primary deficits. To reduce the fiscal deficit rift, most countries have been compelled to re-enter the International fixed income market to raise funds to fund their budget deficits and refinance existing debt obligations.

More African countries are most likely going back to the Euro bond market in an attempt to seek more funding. But, Euro bond issuance is expected to remain lower than in previous years partly because of the availability of the low-priced concessional and multilateral debt bonded with the need for higher premiums by the international market on the records of developing countries.

Conclusion

Euro bonds must be different from the currency of the country that issues them. Euro bonds provide a high profit investment opportunity for foreign currency investors. SSA countries love issuing euro bonds because they have high liquidity and can be converted in to cash within one fiscal year. Contact Financely today to learn more about how SSA countries can raise money by issuing euro bonds.