The Temptation of Frontier Markets

Barry Eichengreen

Barry Eichengreen, Professor of Economics and Political Science at the University of California, Berkeley, is the author, most recently, of In Defense of Public Debt (Oxford University Press, 2021).

BERKELEY – Frontier markets are back. Several African countries have recently returned to global financial markets, placing foreign-currency bonds with international investors. The question is whether they are back for good, or whether someone or something – namely, the US Federal Reserve – will throw a wrench in the works.

Let’s start with the facts. In January and early February, Côte d’Ivoire and Benin were able to place $3.35 billion of bonds with international investors. Côte d’Ivoire’s issue was more than three times oversubscribed, and Benin’s more than six times. Kenya followed with a $1.5 billion Eurobond that attracted more than $5 billion in orders. This activity marked the end of a two-year dry spell when African borrowers were locked out of international capital markets.

In several cases, the revenue raised will be used to buy back debt maturing this year or next. The fact that investors are willing to participate suggests that they are confident in governments’ ability to service their debts. They are not seeking to exit once their holdings mature.

Several factors account for this sudden success. First, macroeconomic performance across Africa is improving. The African Development Bank forecasts that the continent’s GDP will grow by 3.8% in 2024 and 4.2% in 2025, faster than last year. Eleven African countries are projected to expand by at least 6% in 2024. Not coincidentally, this group includes Côte d’Ivoire and Benin, with Kenya just behind at 5%. More growth means more debt-servicing capacity. Credit-rating agencies expect more upgrades than downgrades for the first time in years.

Second, the International Monetary Fund has been unusually supportive, providing more than $50 billion to the region between 2020 and 2022. This is more than twice the amount extended in any ten-year period since the 1990s. Investors may be anticipating that the IMF will bail them out if things show signs of going wrong.

Third, press reports suggest that the United States and China are eyeing a new initiative to lighten the debt load on low-income countries, with an eye toward presenting a proposal to G20 leaders later this year. This could entail adding to debt contracts a provision allowing troubled countries to extend loan maturities, and increasing grant financing from the World Bank and other multilateral institutions.

Given the failure of existing G20 debt schemes such as the Common Framework for Debt Treatments, a new initiative is welcome. Averting defaults in troubled countries is a necessary condition for enabling governments to refinance their maturing debts. Given the prevalence of contagion in global bond markets, averting defaults would avoid demoralizing investors and interrupting market access where it has been regained.

Fourth, investors are betting that yields on US Treasuries and other advanced-economy bonds will come down once the Fed and the European Central Bank declare victory in their fight against inflation. If yields on ten-year US Treasuries fall from their current level, slightly above 4%, a Benin dollar bond yielding 8.5% or a Kenyan dollar bond yielding 10% will be more attractive still.

But not everyone agrees that the recent episode of inflation is definitively over. If hopes for interest-rate cuts are disappointed, or, worse, if the Fed and the ECB see signs of resurgent inflation and feel compelled to raise rates, Kenya’s February bond placement could be the last. And with ten-year US yields up 50 basis points over the first two months of 2024, someone is evidently betting on the possibility of rate hikes.

This points to another danger, namely the dollar cycle. Typically, when the Fed raises rates, the dollar strengthens, making it harder for developing countries to service their dollar debts. Much has been made of the supposed end of “original sin” – the name given to the fact that emerging markets have long been able to place only dollar bonds with international investors. Now, it is said, they are also able to sell bonds denominated in their own currencies.

In fact, however, redemption from original sin has been highly selective. Any newfound ability to sell local-currency bonds to international investors has in practice been limited to a handful of relatively large middle-income countries, leaving frontier markets exposed to currency risk.

As everyone knows, there are two sides to dollar exchange rates. Local currencies can weaken against the greenback, aggravating debt-servicing problems, not just because the Fed raises rates but also owing to domestic economic and political problems.

Ghana, for example, experienced mass protests late last year over the austerity required in order for it to restructure its debts and begin repairing relations with its foreign creditors. Reflecting this turmoil, the Ghanaian cedi has been weakening, which further complicates the country’s debt problem. Politics, and therefore exchange-rate fluctuations, happen. African countries contemplating a return to the Eurodollar market should take this risk to heart.