GOVERNMENT OF MOZAMBIQUEIN COLLABORATION WITH WORLD BANK AND IMF WORKSHOP

Expanding Access to Local Currency Non Government Bond Markets and their Role in Economic Development: The African Experience

Hotel Xisaka - Namaacha, Mozambique

24 March 2010

Presented by: Evans Osano, Program Manager, ESMID, IFC/World Bank

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•Importance of Non-Government Bond Markets

•Status of the Bond Markets in Africa

•ESMID’s role Reforming Local Currency Bond Markets in Africa

•Case Studies – Kenya, Nigeria

•Conclusion

Agenda

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• Estimated Financing needsAnnual spending needs: ~US$ 100 billion (15% of GDP)

• Current sources of financing cover only half of this needBudget and off-budget spending: ~US$ 45 billion

• Funding shortfall is substantialWithout efficiency gains, annual funding shortfall: ~US$ 55 billion

-Africa’s Infrastructure: A Time for Transformation, The World Bank 2010

Key recommendation for closing the infrastructure funding gap:

……most of this finance takes the form of relatively short-maturity commercial bank lending, often not the best suited for infrastructure projects. A need exists to further develop corporate bond markets and to create regulatory conditions for greater participation by institutional investors in funding infrastructure investments.

-Africa’s Infrastructure: A Time for Transformation, The World Bank 2010

Infrastructure Financing Needs in Africa are large

The potential for Bond financing is also largeLocally sourced infrastructure financing by financial instrument Amount outstanding at end-2006 or most recent available

Country (US$ million) Bank loans1 Government

Bonds2 Corporate

Bonds Equity Issues Benin 124 70% 0 0% 52 30% 0 0% Burkina Faso 85 68% 0 0% 39 32% 0 0% Cape Verde 108 100% — — 0 0% 0 0% Congo, Dem. Rep. 6 100% 0 0% 0 0% 0 0% Côte d'Ivoire 335 72% 0 0% 0 0% 133 28% Ethiopia 248 100% 0 0% 0 0% 0 0% Ghana 178 100% 0 0% 0 0% 0 0% Kenya 575 14% 0 0% 65 2% 3,408 84% Lesotho 21 100% 0 0% 0 0% 0 0% Madagascar 68 100% 0 0% 0 0% 0 0% Malawi 17 100% 0 0% 0 0% 0 0% Mozambique 61 82% 0 0% 13 18% 0 0% Namibia 117 28% 0 0% 298 72% 0 0% Niger 67 100% 0 0% 0 0% 0 0% Nigeria 2,444 98% 47 2% 0 0% 0 0% Rwanda 26 100% 0 0% 0 0% 0 0% Senegal 286 13% 93 4% 67 3% 1,827 80% South Africa 6,275 10% 763 1% 6,841 11% 48,149 78% Sudan 5 0% — — — — 2,302 100% Tanzania 93 100% 0 0% 0 0% 0 0% Uganda 75 91% 0 0% 7 9% 0 0% Zambia 73 91% 0 0% 7 9% 0 0%

Source: Local sources of financing for infrastructure in Africa, The World Bank March 2009

Majority of infrastructure financing in SS Africa from local sources is through bank loans.

However, in 2006 20 percent of outstanding corporate bonds in South Africa were issued by infrastructure providers.

And in Chile, on average US$ 1 billion of infrastructure bonds a year were issued between 1996 and 2003, equivalent to 50 percent of all issues.

Financing Sources for the Housing Sector

Brazil

ChileChina

Colombia

Czech Rep

ublic

Hungary India

Korea, R

ep. o

f

Malaysi

a

Mexico

Poland

South

Africa

Thail

and

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

Emerging Market Mortgage Funding

OtherMBSBondsDeposits

Note: ‘Other’ include Housing Provident FundsSource: Housing Finance Policy in Emerging Markets, Edited by Loic Chiquier and Michael Lea, The World Bank 2009

In SSA the use of bonds markets to support the housing finance needs has been negligible

However, countries such as Chile, the Czech Republic and Hungary meet over half of their mortgage funding needs through simple debt instruments such as covered bonds.

In 2007, 17% of mortgages in Europe were funded by covered mortgage bonds (CMBs)

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• Non-government bonds definition:

– The term “non-government” is used to encompass bonds and asset-backed securities issued by entities other than the federal government, including corporations, municipalities, as well as project finance companies created for specific infrastructure projects.

• Benefits of local currency bonds

– ability to minimize or avoid exchange rate risks

– ability to provide long maturities suitable for long-term infrastructure or projects

– potentially lower cost of funding

– ability to attract and mobilize savings directly from long-term institutional investors, who are best suited for bond investments.

Benefits of Non-Government Bond Markets

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Importance of Securities Markets for Development

Improved risk management

Financial sector diversification

Decreased vulnerability to external shocks

Increased access to infrastructure and housing

Increased production of goods and services Job creation Growth in domestic savings for further investment

Improved ability to cope with financial crises

GROWTH AND POVERTY REDUCTION

Productive Usesof Funds

DomesticSourcesof Funds

Securities Markets

Productive Usesof Funds

DomesticSourcesof Funds

Securities Markets

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Benefits of Well Functioning Local Bond Markets

Expanded housing and infrastructure finance

Better risk management for borrowers:

• Lower interest rates • Reduced foreign currency risks• Reduced refinancing risks

Improved yields for institutional investors

Improved ability to deal with financial crises

Financial sector diversification

Accelerated private sector development

This generates growth and reduces poverty

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Ingredients for a Vibrant Bond Market

Enabling Environment

Macro EconomicEnvironment

Tax Regimes

Market Place

Trading, Clearing, Settlement, Depository

Pre-trade and post-trade transparency

Bond Market Structure

Capacity

Bankable Projects & Sponsors

Informed Intermediaries

Informed Investors

Difference between Equities and Bonds

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Government Bonds Non Government Bonds Equities

Heterogeneity One clear issuer with clear risk/return

Many issuers with diverting risk/returnMany different types of bonds per issuer

One form of equity per issuer

Fungibility Benchmark bonds fungible.

New issues not fungible with previous issues: different amount, coupon, maturity, and (possibly) credit rating.

New issues fungible with outstanding shares

Issuance Very Frequent Frequent Less frequent

Price Discovery Price movements mostly respond to macroeconomic developments.

Trades carry some firm-specific info. Price movements mostly respond to macroeconomic developments.

Trades carry significant info about firms’ prospects

Maturity Finite Finite. Most < 20years Infinite

Liquidity Highly liquid Similar pattern across bonds: high post issuance (two weeks), but eventually buy-and-hold and illiquid

Depends on stock type

Type of Investor Institutional investors Institutional investors Diversified – includes retail

Market Model OTC OTC or Hybrid Exchange Traded

Status of Bond Markets in Africa

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Status of Bond Markets in AfricaType of Fixed Income Instrument Number of Countries

IssuingNo of issuers as % of total

Treasury Bills 39 74

Government Bonds 26 49

Municipal Bonds 3 6

Corporate/Parastal 21 40

Source: African Development Bank, May 2007

Bond Markets at nascent stage – Only half the countries have government bond markets

Corporate bonds underdeveloped compared to bank loans and government bond markets

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Size of Equity and Bond Markets in Selected SSA Countries, 2006

Equity Bonds2

Equity Market Cap to GDP (%)

Number of public

companies

Govt Bonds Outstanding (USD Million)

Govt Bonds to GDP (%)

Non-Govt Bonds Outstanding

(USD Million)3

Non-Govt Bonds to GDP (%)

South Africa 280 401 66,029 26 30,588 12

Mauritius 57 42 998 16 0

Kenya 50 54 3,301 14 117 1

Botswana 36 18 300 3 349 3

Ghana 25 32 0.12 0 25 0

Cote d'Ivoire 24 36 326 2 61 0

Nigeria 22 289 8,218 6 258 0

Senegal 19 1 86 1 105 1

Togo 13 1 69 3 13 1

Zambia 11 14 645 6 8 0

Namibia 8 8 984 15 112 2

Swaziland 7 6 7 0 13 0

Tanzania 4 6 885 6 69 0

Mozambique 1 1 205 3 744 11

Uganda 1 5 493 5 37 0

3. Non-government bonds outs tanding may not include a l l private placement issues .

Source: African Development Bank, and Estimates

Significant differences in the level of development in the countries and regions

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• Better macroeconomic management

• Lower Inflation

• Lower interest rates

• More stable exchange rates

• More sustainable budget deficits

• Development in government bond markets

• Tenor extension

• Yields flattening in some countries

…However, environment is becoming more favorable for debt capital markets in Africa

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 20100

5

10

15

20

25

30

35

GhanaKenyaMozambiqueNigeriaTanzaniaZambia

Inflation Rates in Selected African Countries

2000 2001 2002 2003 2004 2005 2006 2007 2008 20090

5

10

15

20

25

30

35

40Ghana

Kenya

Mozambique

Nigeria

Tanzania

Zambia

Short Term (91-day) Interest Rates in Selected African Countries

Role of ESMID in Reforming Non-Government Bond Markets

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ESMID Africa ESMID:

• Efficient • Securities • Markets • Institutional• Development

A partnership between:

• Swedish International Development Cooperation

Agency (Sida)

• World Bank• International Finance Corporation (IFC)

Aims to foster development of well functioning securities markets to:• Broaden availability of local-currency investment instruments• Enable private sector development• Improve financing for housing & infrastructure• Create jobs and improve livelihoods

ESMID Africa – Current Operations

ESMID Africa largely works with clusters of countries where changes have the potential to reverberate across several nations, i.e. East Africa

• Kenya• Uganda• Tanzania• Rwanda

• Nigeria

East Africa

(Regional Approach)

Country Approach

ESMID Comprehensive Approach

Assistance to Regulators

Strengthening the Marketplace

Capacity Building

Transaction Support

Enabling Environment

Programs draw on full range of WB/IFC tools:• Global product expertise + in-country knowledge/presence • Public and private engagements • Enabling environment plus transaction support

Regionalization

ESMID-Africa

Regulatory Assistance

• Improve approval process • Market structure• Framework for new products

Capacity Building

• Certification/Licensing program

• Securities Training modules• Develop regional provider

Strengthening Market Infrastructure

• Market Structure • Clearing , Settlement &

Depository• Transparency & Information

Dissemination

Regionalization

• Broadening & deepening markets

• Minimum common standards• Consolidated infrastructure• Cross border issues &

investors

A comprehensive and integrated approach to developing local bond markets

Transactions Support

• Active support to issuers and intermediaries for demonstration transactions

• Introduce new & innovative products

Case StudiesKenya

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• 1997 - First floating rate T-bond issued

• 2001 - Lengthening of domestic debt maturity gains momentum

• Significant change in domestic debt profile in 7 years

• Share of T-bonds rise from 28% in 2001 to 72% in 2008

• Maximum tenor extended from 6 years in 2002 to 20 years

• Composition of domestic debt rise from 33% in 2001 to nearly 50% in 2008

…Restructuring of Domestic Debt in Kenya

2000 2001 2002 2003 2004 2005 2006 2007 20080

2

4

6

8

10

12

14

Kenya Public Debt 2000 -2008 (USD Billions)

DomesticExternal

2003 2004 2005 2006 2007 2008 20090

100

200

300

400

500

600

Kenya Composition of Domestic Debt

T-billsT - Bonds

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Treasury Yield Curves Kenya

91 Day

182 Day

1 Year

2 Years

3 Years

4 Years

5 Years

6 Years

7 Years

8 Years

9 Years

10 Years

11 Years

12 Years

13 Years

14 Years

15 Years

16 Years

17 Years

18 Years

19 Years

20 Years

0

2

4

6

8

10

12

14

16

20062009

Kenya Government Treasuries Yield Curve 2002-2009

Yields have flattened

• Treasury yield curve lengthened to 20 years

• Yields flattened due to improved investor confidence

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Corporate Bond Issues - KenyaKenya Industry Ksh (M) Gurantee Year of Issue Tenor Coupon

East African Development Bank (EADB) DFI 800 None 2004 7 7.5% Fixed

Faulu Kenya Microfinance 500 AFD 2005 5 91 day T-bill + 0.5%

PTA Bank DFI 800 None 2005 7 7.80% Fixed

Athi River Mining Cement 800 None 2005 5 91 day T-bill + 1.75%

Shelter Afrique Housing DFI 200 None 2005 7 91 day T-bill + 1.0%

CFC Stanbic Bank (Private Placement) Banking 600 None 2005 7 182 day T-bill + 1.5%

PTA Bank DFI 1,000 None 2007 7 182 day T-bill + 1.0%

Barclays Bank of Kenya Banking 1,206 None 2007 7 91 day T-bill + 0.6%

Barclays Bank of Kenya Banking 740 None 2007 7 182 day T-bill + 1.0%

Sasini Tea & Coffee Agriculture 600 None 2007 5 11.75% Fixed

Mabati Rolling Mills Manufacturing 1,200 None 2008 8 182 day T-bill + 1.75%

Mabati Rolling Mills Manufacturing 800 None 2008 8 13.00% Fixed

I & M Bank (Private Placement) Banking 600 None 2008 7 91 day T-bill + 2.5%

Zain Kenya (Private Placement) Telcom 5,700 Parent Co 2008 3 182 day T-bill + 1.75%

CFC Stanbic Bank Banking 98 None 2009 7 182 day T-bill + 1.75%

CFC Stanbic Bank Banking 2,402 None 2009 7 12.50% Fixed

Shelter Afrique Housing DFI 1,000 None 2009 311.00% Fixed, Floating (182 day T-bill +1.50%)

KenGen Infrastructure 25,000 None 2009 10 Fixed 12.5%

Safaricom Infrastructure 7,500 None 2009 5Fixed 12.25%, Floating 182-day T-bill +1.85%

51,546

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East Africa Cumulative New Corporate Bond Issues (US$M)

2004 2005 2006 2007 2008 2009 -

100.0

200.0

300.0

400.0

500.0

600.0

700.0

Kenya

Uganda

Tanzania

Global Credit Crisis

Kenya has had record issuance of US$500 million in 2009, over 90% infrastructure

related KenGen (US$330

million) and Safaricom (US$100 million)

“The results clearly show that we can raise most of the funds needed to realise the goals of Vision 2030 through our own capital markets,” Kenya’s Prime Minister Mr Raila Odinga on the issue of KenGen bond.

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…Role of Pension & Insurance Sectors in Kenya

Pension reforms effected in 2001 – significant growth in assets under management to date

Pension & Insurance funds accounted for 55% of Investments in Corporate bonds and 42% Treasury

Bond holdings in 2009

50%

36%

5%5% 4%

Kenya: Corporate Bond Holding by Investor Class Jun 2009

Pension Funds

Banks

Investment Companies

Insurance Companies

Individuals

Pensions Industry

Insurance Industry

Unit Trusts0

50

100

150

200

250

300

Estimated Institutional Investor Assets (Ksh.Billion)

Assets estimated at 20% of GDP

Case StudiesNigeria

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• 2003 – Restructuring of external and domestic debt

• 2003 – First FGN Bond issued

• 2005 – Regular monthly issuance of FGN bonds

• 2008 - Tenor extended to 20 years

– Reduces roll over and refinancing risks

– Reduces interest rate volatility in the money market

– Ensures better asset/liability match

• 2010 – Renewed priority for corporate bond market development

…Restructuring of Domestic Debt in Nigeria

Up to 2 yrs63%

2-5 years7%

5-10 years6%

Over 10 Years24%

Nigeria Profile of Domestic Debt 2003

Up to 2 yrs33%

2-5 years38%

5-10 years12%

Over 10 Years18%

Nigeria Profile of Domestic Debt 2007

Source: Central Bank of Nigeria

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…Corporate Bond Issues in NigeriaIssuer Amount (N’bn)

Access Bank* 13.5

Access Bank 200.0

Crusader* 4.0

Federal Mortgage Bank of Nigeria* 27.0

Guaranty Trust Bank* 200.0

C & I Leasing 2.2

Diamond Bank 200.0

FCMB 100.0

Fidelity Bank 200.0

First Bank 500.0

NAHCO 5.0

Oando 200.0

Thomas Wyatt 2.0

UBA 500.0

UPDC 30.0

Zenith Bank 200.0

TOTAL 2,383.5

In 2009, 3 state governments raised N85.5 billion (USD 0.5bn) from the local bond markets to

fund infrastructure development

Pipeline of corporate bond issues in 2-3 years

estimated at N2.4 trillion (US$ 16bn)

Many of the issues (including banking sector)

to fund infrastructure

* Issued fully or in tranches Source: AFRINVEST West Africa

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• 2004 - Pension reforms in Nigeria

• Assets under management have grown rapidly (average 30% p.a.) to US$10 billion in 2009

• Assets forecast to triple to US$30 billion in next five years - increased compliance (coverage ratio still low)

• Pension funds becoming important investors in the bond market. Share of the market rose from 6% in 2008 to 22% in 2009.

• Pension Assets expected to fund infrastructure and other corporate issues.

…Role of Pension Fund Reforms in Nigeria

Deposit Money Banks

39%

Discount Houses

10%

Pensions Funds22%

NBFI's19%

Other Insti-tutional In-

vestors2%

Foreign Investors

8% Individuals0%

Nigeria Bond Market Investor Profile 2009

Deposit Money Banks72%

Discount Houses

7%

Pensions Funds6%

NBFI's10%

Foreign Investors

5%

Individuals0%

Nigeria Bond market investor Profile 2008

Source: AFRINVEST West Africa

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Conclusions• Africa’s housing & infrastructure financing needs are enormous

• Bulk of infrastructure undertaken by public sector using foreign currency loans

• Private sector can help bridge the financing gap

• Capital Markets can raise long-term local currency financing for priority sectors such as infrastructure and housing

• Equally important to develop government securities markets and the institutional investor base – e.g. through pension reforms

Thank YouEvans Osano

eosano@ifc.org

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