Bond Markets in Africa
  • 1 0000000404811396https://isni.org/isni/0000000404811396International Monetary Fund

Contributor Notes

African bond markets have been steadily growing in recent years, but nonetheless remain undeveloped. African countries would benefit from greater access to financing and deeper financial markets. This paper compiles a unique set of data on corporate bond markets in Africa. It then applies an econometric model to analyze the key determinants of African government securities market and corporate bond market capitalization. Government securities market capitalization is directly related to better institutions and interest rate volatility, and inversely related to the fiscal balance, higher interest rate spreads, exchange rate volatility, and current and capital account openness. Corporate bond market capitalization is directly linked to economic size, the level of development of the economy and financial markets, better institutions, and interest rate volatility, and inversely related to higher interest rate spreads and current account openness. Policy implications follow.

Abstract

African bond markets have been steadily growing in recent years, but nonetheless remain undeveloped. African countries would benefit from greater access to financing and deeper financial markets. This paper compiles a unique set of data on corporate bond markets in Africa. It then applies an econometric model to analyze the key determinants of African government securities market and corporate bond market capitalization. Government securities market capitalization is directly related to better institutions and interest rate volatility, and inversely related to the fiscal balance, higher interest rate spreads, exchange rate volatility, and current and capital account openness. Corporate bond market capitalization is directly linked to economic size, the level of development of the economy and financial markets, better institutions, and interest rate volatility, and inversely related to higher interest rate spreads and current account openness. Policy implications follow.

I. Introduction

The African Development Bank recently announced that it plans to launch a new bond program for infrastructure to raise up to US$40 billion for investments in projects such as ports and airports, highlighting the growing role for bond markets in financing development in sub-Saharan Africa. 2 Yet bond markets in these countries are at a nascent stage of development and there is a strong need to promote their development.

First, sub-Saharan Africa has been heavily dependent on external grants and concessional loans for funding capital spending and government deficits. Only a small number of countries have limited access to global capital markets. 3 Additionally, western donors are now facing substantial fiscal challenges and consequently donor flows to sub-Saharan Africa may be scaled back significantly. Without access to alternative sources of finance, including bond markets, many African countries could find it difficult to finance critical needs.

Second, well-functioning bond markets help sustain economic stability. The Asian experience supports this point. Since the 1997 Asian financial crisis, many Asian economies have made significant progress in strengthening bond market development. This has in turn helped these Asian economies weather the recent global financial crisis because deeper financial markets generated valuable funding sources for these countries to finance fiscal stimulus packages.

Third, the development of bond markets in sub-Saharan Africa can improve the intermediation of savings. Although Africa needs money, Africa is a net capital exporter to the rest of the world (IMF, 2012). This is mainly because there is a lack of effective intermediate channels to absorb this capital. Bond markets are an effective way to intermediate capital savers with capital users.

Fourth, promoting bond market development in sub-Saharan Africa can improve the structure of the African financial system. The African financial sector is dominated by banks. The non-banking sector and bond markets, both public and private, are still in their infancy. Bond markets and bank finance are complementary rather than incompatible. While banks tend to be more adept at providing short-term (working) capital, bond markets enjoy a comparative advantage in financing government deficits and infrastructure investment, and providing longer-term capital to companies for growth.

Fifth, deeper bond markets will enable central banks in sub-Saharan Africa to conduct monetary policy more effectively. At present, many banks have few domestic fixed-income instruments to use for sterilization other than short-term government debt. Deeper bond markets would provide a wider, more effective range of instruments for monetary policy implementation.

This paper investigates empirically the determinants of local currency bond markets in sub-Saharan Africa. 4 Although a number of countries have issued sovereign bonds in foreign currencies, we focus on local currency bond markets because of the importance of the local currency markets compared to international sovereign bonds and because of the need to focus on African countries’ ability to overcome what is referred to in the literature as “original sin,” that is, the inability to issue debt in local currency. 5

We use data for local currency government securities market capitalization for 36 countries, over the years 1980–2010, along with a newly developed database for corporate bond market capitalization. This sample makes the study the largest of its kind in terms of both number of countries included and number of years covered. To investigate the determinants of bond markets, we draw upon an econometric approach used in Eichengreen and Luengnaruemitchai (2004), Claessens, Klingebiel, and Schmukler (2007), and Adelegan and Radzewicz-Bak (2009), among others. We use generalized method of moments estimation, in view of possible endogeneity among variables relevant to bond market development.

This research aims to achieve three purposes. First, it outlines the current situation of local currency bond markets including both government securities and corporate bond markets in sub-Saharan African countries. Second, it discusses and estimates key determinants of bond market development in sub-Saharan Africa. Finally, it offers policy advice for enhancing bond market development in sub-Saharan Africa.

The structure of this paper is as follows. Section II reviews the relevant literature. Section III provides an overview of the government securities and corporate bond markets in sub-Saharan Africa. Section IV sets out the analytical framework and discusses the econometric methodology underpinning the empirical analysis. Section V presents and discusses the results from the estimation. Section VI draws out the policy implications of the findings from the previous section and concludes.

II. Literature Review

The research on African financial sector development is growing. Most of the literature has so far focused on financial development of the banking sector and stock markets (e.g., Detragiache et al., 2005; McDonald and Schumacher, 2007; Yartey and Adjasi, 2007; Andrianaivo and Yartey, 2009; Anayiotos and Toroyan, 2009; Kablan, 2010; and Beck et al., 2011). Relatively little attention has focused on development of public and private bond markets. 6

Several studies have examined the determinants of bond markets in more developed economies. Eichengreen and Luengnaruemitchai (2004) consider a broad set of determinants of bond market development, using panel data from 1990 to 2001, for a sample of 41 developing and developed countries, with a focus on emerging Asia. They regress several measures of domestic currency bond market capitalization on various explanatory variables, and estimate these equations using generalized least squares, with heteroskedasticity and panel-specific autocorrelation correction. For determinants of the stock of public bonds, they find that GDP at purchasing power parity, exports, English origin, distance from the equator, a positive investment profile, and an open capital account are positive and significant while GDP per capita at purchasing power parity, banking sector concentration, bureaucracy quality, the interest rate spread, exchange rate volatility, and the fiscal balance are negative and significant (Table 6, column 7 of their paper). For private bonds, they find that GDP at purchasing power parity, exports, Asia dummy, distance from the equator, corruption, accounting standards, domestic credit, and bureaucracy quality are positive and significant while English origin, the interest rate spread, and exchange rate volatility are negative and significant (Table 6, column 4 of their paper). They conclude that market size matters; poor accounting standards hinder development of private debt markets, along with corruption and low bureaucratic quality. Well-capitalized bank systems promote bond markets. Stability of exchange rates encourages bond market development, and an absence of need for public financing discourages public bond markets. Capital controls also discourage bond market development.

Table 1.

Countries in the Sample, Definition of Variables and Sources

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Table 2.

Sub-Saharan Africa Corporate Bond Market Database, 1980–2010

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Source: IMF staff compilations.

BVMAC is the Bourse Régionale des Valeurs Mobilières d’Afrique Centrale.

CAR is the Central African Republic.

BRVM is the Bourse Régionale des Valeurs Mobilières.

Table 3.

Descriptive Statistics, 1980–20101

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Sources: IMF staff compilations based on data from IMF IFS, WEO and World Bank, ADI; and national sources for corporate bond market capitalization as set out in Table 2.

This is based on the full 36 country sample as in Table 1.

Higher values for bureaucracy, comprisk, corruption, invprofile, and laworder provide a more favorable indication for institutional quality than lower values.

Table 4.

Bond Market Capitalization Comparison, 2010

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Sources: IMF staff compilations based on data from IMF IFS, WEO and World Bank, ADI; BIS; and national sources for corporate bond market capitalization as set out in Table 2.
Table 5.

Sub-Saharan Africa Bond Market Capitalization, 2006–10

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Sources: IMF staff compilations based on data from IMF IFS, WEO and World Bank, ADI; and national sources for corporate bond market capitalization as set out in Table 2.
Table 6.

Sub-Saharan African Bond Market Capitalization, 1990–2000 and 2001–101

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Sources: IMF staff compilations based on data from IMF IFS, WEO and World Bank, ADI; and national sources for corporate bond market capitalization as set out in Table 2.

This table excludes certain countries for which bond market capitalization data are not available over either 1990–2000 or 2001–10.

Eichengreen, Panizza, and Borensztein (2008) extend this analysis, using panel data on a range of developing and developed countries, with a focus on Latin America. They construct separate measures of the dependent variable for government bonds, private bonds (corporate plus financial), corporate bonds, and financial bonds. Their results (Table 9, columns 1–4 of their paper) confirm many of those of Eichengreen and Luengnaruemithai (2004). They find that country size is positive and significant, with a concave relationship. GDP per capita is also positive and concave and trade openness is positive and significant. The domestic interest rate is negative and significant only for government bonds. Interest rate volatility is positively correlated with the private bond market and negatively with the government bond market. Domestic credit is positively and concavely related to financial bonds. The interest rate spread is positively correlated with the corporate but not public bond market. The opposite is found for financial bonds. Stricter capital controls are correlated with large public bond markets, but do not influence private bond markets. Larger public debt is linked to large public bond markets but is not significant with regard to private bond market determinants.

Table 7a.

Correlation Matrix1

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Source: IMF staff estimates.

Government securities sample.

Table 7b.

Correlation Matrix1

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Source: IMF staff estimates.

Corporate bond sample.

Table 8a.

Determinants of Government Securities Markets

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Source: IMF staff estimates.*,**,*** indicates significance at 10%, 5% and 1% respectively. Results based on heteroskedasticity robust standard errors.

The specific effects row in the table indicates whether country and time effects are included in the estimation. Since there are no specific effects in the pooled least squares model, a ‘NO’ is indicated, whereas a ‘YES” is indicated for the two-way random and fixed effects models due to the inclusion of specific effects. The outcomes of the Breusch Pagan and F tests for random and fixed effects respectively are presented.

The random effects vs. fixed effects row presents the outcome of a Hausman test for the correct specific effects model (see Hausman, 1978). If the fixed effects model is preferred, then fixed effects is indicated, along with the statistical significance of the test statistic, otherwise random effects is reported.

Table 8b.

Determinants of Government Securities Markets

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Source: IMF staff estimates.*,**,*** indicates significance at 10%, 5% and 1% respectively.

GMM (A1, A2, A3) consider fiscal endogeneity; GMM (B1, B2, B3) consider fiscal, intvol, and spread endogeneity.

Hansen test for validity of instruments (see Hansen, 1982).

Arellano-Bond AR test for estimation consistency (see Arellano and Bond, 1991).

Hausman test for differences in GMM and preferred fixed effects coefficients reported in Table 8a (see Hausman, 1978).

Table 9a.

Determinants of Corporate Bond Markets

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Source: IMF staff estimates.*,**,*** indicates significance at 10%, 5% and 1% respectively. Results based on heteroskedasticity robust standard errors.

The specific effects row in the table indicates whether country and time effects are included in the estimation. Since there are no specific effects in the pooled least squares model, a ‘NO’ is indicated, whereas a ‘YES” is indicated for the two-way random and fixed effects models due to the inclusion of specific effects. The outcomes of the Breusch-Pagan and F tests for random and fixed effects respectively are presented.

The random effects vs. fixed effects row presents the outcome of a Hausman test for the correct specific effects model (see Hausman, 1978). If the fixed effects model is preferred, then fixed effects is indicated, along with the statistical significance of the test statistic, otherwise random effects is reported.

Table 9b.

Determinants of Corporate Bond Markets

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Source: IMF staff estimates.*,**,*** indicates significance at 10%, 5% and 1% respectively.

GMM (A1, A2, A3) consider fiscal endogeneity; GMM (B1, B2, B3) consider fiscal, intvol, and spread endogeneity.

Hansen test for validity of instruments (see Hansen, 1982).

Arellano-Bond AR test for estimation consistency (see Arellano and Bond, 1991).

Hausman test for differences in GMM and preferred random effects coefficients reported in Table 9a (see Hausman, 1978).