Local debt markets could shield Africa as funding sources shrink, Moody's says

According to Moody's, African nations should prioritize developing liquid local debt markets to mitigate global volatility, as countries like Benin and Ivory Coast with strong local funding are outperforming those reliant on foreign investment. Moody's notes that while credit ratings are improving for some African countries, reduced access to diverse financing sources, including declining flows from China and falling oil prices, necessitate a shift towards domestic funding; the median interest rate on local currency debt in Africa is roughly 12%, presenting potential cost savings compared to Latin America and Asian emerging markets.

Analysis

Moody's global head of sovereign risk, Marie Diron, advocates for African nations to develop liquid local currency debt markets as a crucial defense against global volatility and reliance on unpredictable foreign capital, citing Benin and Ivory Coast as examples of countries faring better due to robust local funding. While some African sovereign credit ratings are improving post-pandemic, significant headwinds persist, including global trade tensions and geopolitical risks. South Africa's deep domestic debt market, for instance, has reportedly helped insulate its rating and borrowing costs. Key factors supporting creditworthiness include efficient revenue utilization, reduced foreign currency debt exposure, and extended debt maturities. African sovereigns could realize substantial cost savings by developing these markets, as the median interest rate on local currency debt in Africa is approximately 12%, significantly higher than the 8% in Latin America and 5.5% in Asian emerging markets. Compounding these challenges, traditional diverse financing sources are diminishing; aid from wealthy nations is being cut, concessional finance is shrinking, and net financial flows from China are turning negative as repayments outpace new lending. Furthermore, declining oil prices, with Moody's forecasting Brent futures near $65 per barrel (a $10 reduction from previous forecasts), are squeezing revenues for oil exporters like Angola. While multilateral development banks are attempting to bridge the financing gap, their contributions are insufficient to cover the estimated $400 billion annual requirement, and potential U.S. funding cuts to these institutions pose an additional risk to their lending capacity amidst rising borrowing needs.

Key Decisions for Investors

• Investors should scrutinize African sovereign exposures, favoring countries with established and liquid domestic debt markets which offer greater resilience to external financial shocks and currency volatility.
• Monitor key indicators such as the ratio of local to foreign currency debt, average debt maturity profiles, and progress in deepening local capital markets when assessing sovereign credit risk in the region.
• Exercise caution regarding African sovereigns heavily reliant on external financing, given the diminishing traditional funding sources, negative net flows from China, and the potential impact of reduced multilateral development bank lending capacity.
• Re-evaluate exposure to African oil-exporting nations in light of Moody's revised lower oil price forecast, which could pressure fiscal balances and debt servicing capabilities.