Commodity-indexed bonds and Africa’s search for innovative financing

Africa needs about $ 1.3 trillion per year to meet the goals of the 2030 Agenda for Sustainable Development. These needs include, for example, about $ 93 billion to $ 170 billion per year in investments for Africa. the promotion of adequate infrastructure, which does not include the financing necessary to deal with the increasingly devastating effects of climate change. Yet despite efforts to improve domestic revenue mobilization, Africa faces a huge funding gap to support its development agenda.

In addition, the devastation caused by the COVID-19 pandemic has highlighted today more than ever the need for an adequate, predictable, sustainable and integrated funding mechanism to build back better. However, Africa does not have fiscal space as countries’ debt levels have reached unsustainable levels in the wake of the pandemic as countries have had to borrow more to take mitigation measures against the virus. . Indeed, many experts recommend that over-indebted countries restructure their debt. However, given the uncertainty and economic costs associated with debt restructuring, African countries may seek alternative resource mobilization strategies.

Government-subordinated debt securities

Most African countries, because they are major commodity exporters and have limited capacities to effectively mitigate risks when commodity prices fall and interest rates rise sharply, are vulnerable to major financial risks associated with risks related to commodity prices. Such conditions lead heavily indebted countries to face the challenges of increased indebtedness and debt service difficulties. These difficulties also lead to the deterioration of the balance of payments of the countries with the fall in export earnings and, consequently, the depreciation of the value of their currencies. The forms of financing present in the financial markets of industrialized countries and offering considerable risk management potential for African countries are conditional debt instruments to the government (SCDI), which could facilitate faster and less expensive restructuring of debt as payments from restructured debt contracts could be linked to future results. SCDIs are contractual debt instruments where payments are tied to a predefined state variable such as GDP, exports, or commodity prices.

Commodity-related obligations

In particular, Commodity Bonds (CLBs) – a type of SCDI – represent an important vehicle that Africa could use to mobilize resources for its development given the vast mineral deposits on the continent. There are a number of positive economic implications for Africa regarding the issuance of CLBs.

First, the CLBs could potentially stabilize a country’s debt. A country’s debt-to-GDP ratio is affected by two fundamental shocks: i) shocks to public spending, resulting from shocks to the structural primary balance and interest payments; and ii) growth shocks, which arise from GDP growth. Because CLBs indemnify creditors with yields that vary based on the face value of the debtor country’s commodities and, by extension, nominal GDP, CLBs can reduce the risks a country faces due to shocks from the debtor. growth. Therefore, commodity bonds provide a form of insurance against recession to the issuing country and reduce the risk that growth shocks will cause a sovereign state to default.

Second, CLBs, compared to conventional debt, can increase a country’s ability to maintain higher debt levels without being under market pressure. Indeed, the probability of default of a country increases with the increase in the level of indebtedness or the need for debt restructuring and consequently the yield demanded by creditors to hold sovereign debt increases. The size of this credit gap will depend on the magnitude of the potential shocks to the debt-to-GDP ratio. In other words, the spread will depend on the probability that the shock could push the country into default. In addition, the debt-to-GDP ratio is much less volatile for countries with commodity-linked obligations than conventional debt. Therefore, at any level of indebtedness, the probability that a government exceeds its debt limit is lower for commodity-linked bonds than for conventional bonds, implying a lower credit spread. for a given level of debt. Therefore, commodity bonds have the effect of raising the debt ceiling and providing fiscal space for policymakers.

Third, African countries could, by issuing bonds linked to their main export, guard against fluctuations in their export earnings. Notably, the debt crises that African countries have faced in the past have been due to declining export earnings coupled with the simultaneous rise in global interest rates and debt service payments. If African countries’ debt had been issued in the form of CLBs, then their debt service payments would have declined along with export prices (or export earnings), thus relieving their indebtedness. .

Fourth, by issuing CLBs, African governments in need of investment funds could share the appreciation of the market value of the underlying commodities with bondholders in exchange for a lower coupon rate. CLBs offer African commodity-producing issuers and international commodity organizations the opportunity to borrow at lower than market interest rates. Through this process, countries could place themselves in an advantageous position by being linked to international markets, such as the US commodity markets and the Eurobond markets.

In conclusion, the issuance of commodity bonds would offer African commodity producing countries the opportunity to tie their borrowing needs to an endowed resource. By issuing bonds indexed to their main export product, African countries could hedge against fluctuations in their export earnings and at the same time reduce the likelihood of defaulting on their external debt.

For more on this issue, see my article, “Commodity Bonds as an Innovative Financing Instrument for African Countries to Build Back Better.” “

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