Nurturing Domestic Capital Markets: Over the Past Few Years, an Increasing Number of African Countries Have Joined the Trend of Issuing National Bonds Which Are Globally Marketable. This Is a Vital Addition to Africa's Capital Markets, but More Needs to Be Done If the Full Benefits Are to Be Reaped

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The Basle-based Bank for International Settlement (BIS), the banker to the world's central banks, writes that over the past decade, "the conscious nurturing of local currency debt markets became a major objective of financial policy in many countries".

However, apart from the highly developed financial system in South Africa, bond markets in several countries are still largely shallow, illiquid and inefficient, thus unable to provide access to longer-term savings or venture capital. Vibrant capital markets and investable assets are vital components of robust economic growth in the region.

Yet the lack of capital for the private sector is a major developmental challenge. In terms of the composition of finance, most African countries depend less on the domestic bond market than on the banking sector.

The stock market is prominent in South Africa, Nigeria, Kenya and Mauritius. Of the three funding sources (fixed-income, equities and banking), the last remains the number-one channel in almost all African economies.

Bond markets in sub-Saharan Africa developed much later than in other emerging regions. Until the global financial crisis, many countries had relatively open access to loans and grants from foreign OECD donors (in hard currency) or from multilateral bodies--mainly the International Development Association (IDA), the soft lending arm of World Bank Group. Moreover, the commercial banking system often provided cheap loans to governments, reducing incentives for developing fixed-income markets. The issuance of treasury bills or central bank paper was not a regular practice.

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In the wake of the 2009 financial turmoil, the mobilisation of domestic resources as an alternative source of funding became pivotal to Africa, with governments keen to reduce their heavy dependency on external capital.

With the donor nations still mired in fiscal retrenchment and tighter credit conditions, funds are becoming scarcer and more expensive. The IMF cautions: "The financial sector of many African countries is vulnerable to swings in global market sentiment and foreign investors' risk aversion." That highlights the need for efficient and liquid domestic and regional bond markets to protect against the on-off access to external finance.

More reliable channels

National bond markets improve capital allocation by directing savings towards productive assets with higher returns, provide medium- or long-term funds and facilitate risk management by sharing risk among diverse groups of investors. More importantly, such markets can spur private-sector-led growth through increasing access to low-cost finance for larger firms. As in the banking sector, bond pricing depends on the issuers' creditworthiness, transaction size and types of projects being financed. The presence of pension, mutual funds and insurance firms is key to debt-market development, given their far-sighted investment strategies. They require fixed-income assets to match longterm liabilities or payments to current and future policyholders. Thus if bond markets are developed, institutional investors can hold long-term securities that match the liability side of their balance sheets. In order to meet the growing demand for longer-dated papers, many countries have raised the maturities of their government bonds up to 10 and 15 years.

However, if government debt surges, it can 'crowd out' (i.e. restrict) much-needed funds to private businesses. That would harm the real economy through lower private investment. Government paper--generally the safest asset in any economy--provides a benchmark return for the issuance of other securitised debt, such as corporate bonds. Even in developed economies, pension and mutual funds hold the majority of their portfolios in treasury bills or bonds.

Greater efficiency gains

Well-run debt markets support structured financing and stimulates healthy competition among different investors. …