Morality and politics are touchy subjects. Buying up bad debt in emerging markets such as sub-Saharan Africa effectively stands in the crossing where those two heavily emotive rivers collide.
The story of American bank Goldman Sachs buying $2.8 billion worth of Venezuela government bonds back in May stirred a, perhaps unwarranted, backlash from the morality police.
Nomura, a Japanese investment bank, also joined the fun – albeit hiding in the shadows of Goldman – by buying $100 million worth of similar bonds. The economic story-line of these transactions, which many observers speculate, may include one or two more banks, is mixed with lessons on history, finance, government and pure self-confidence.
The Venezuelan Treasury owned some of the bonds initially issued in 2014 by Petroleos de Venezuela, the Venezuelan state-run oil and gas company. They sold those bonds to Goldman Sachs and Nomura at significant discount to face value, reportedly at 31 cents on the dollar. The deal netted the struggling Nicolas Maduro-regime a quick $865 million windfall.
First, for history buffs and socialism enthusiasts, the capitalistic purchase of bonds, by the capitalists Maduro despises, from a socialist regime is a stamp of certification on the partial or entire failure of socialism.
Secondly, morality is not straightforward. Yes, the Venezuelan economy is a catastrophe, with 70 percent of the population living on less than three meals a day, no medicine in hospitals (in other words, infant mortality rate is up), and inflation expected to approach 2,500 percent this year.
That does not mean banks shouldn’t provide liquidity to a struggling government…or what would the morality play for an investment bank be?
The Maduro regime does have the ability to borrow more debt but is simply choosing not to. Thus buying debt at a fire sale wasn’t the last lifeline to Venezuela.
Third, the country has oil and can pay in the long run. Fourth, the bold (and self-confident) take the risks, and not too many individuals (capitalists or socialists) are willing to buy that debt.
Fifth, Goldman has already sold some of the bonds to hedge funds in London and New York for about 32.5 cents on the dollar to create liquidity on the bonds while establishing a trading market.
With that in mind, we offer Goldman a few candidates in Africa to put on their radar:
Three things make the Nigerian bond market attractive….
First, it has a lot of oil (and a lot of gas). Not surprisingly, low prices have been a problem for Nigeria. But, regardless of prices, the Nigerian National Petroleum Corporation, the state run oil company, will continue to push production as the tax revenue and export revenue is vital to maintaining, at a minimum, the status quo and combating the currency crisis and the budget deficit. Crude oil sales account for two-thirds of government revenue and 85-90 percent of foreign exchange earnings.
Second, the Nigerian economy is teetering out of recession (with a budget shortfall). It shrank 1.7 percent in 2016, according to the International Monetary Fund, falling below the larger sub-Saharan African growth rate of 1.5 percent and nowhere near the neighboring star in Cote d’Ivoire, which grew above 8 percent in the same period.
Foreign investment slowed in 2016 and remains quite stagnant in 2017, as asset prices are high and cross-border limitations on currency movement discourage the risk. The country began the year with the government indicating a need to borrow $3.5 billion to fund its budget.
Third, Nigeria has low debt levels which means the country can (and, based on the numbers, will) borrow more in future. This has many leaders feeling comfortable and relaxed. But any shock could bid trouble and distress. For example, an OPEC cut in output (assuming that Nigeria would be brought into that equation and comply) would hurt government revenue. Or any security threat (again) in the Niger Delta would hurt daily oil production. Militant attacks in the third quarter of 2016 effectively curtailed production to 1.63 million barrels per day, compared to the projected 2.2 million barrels per day in 2017.
If distress arises in government finances (as it already has in the Nigerian corporate bond market), some investors will pounce on an opportunistic investment.
The Ghanaian political process is well respected for its peaceful transitions. But it has been questioned for the spending associated with it. Former president John Mahama was starkly criticized for overspending toward the end of his term by opening new schools, roads and bridges.
Ghana’s current president, Nana Akufo-Addo assumed power with ambitious spending plans to jumpstart economic growth, yet encountered an unexpected $1.6 billion budget gap and deficit double that of what was predicted before the December 2016 election. Such a discovery has confronted the last three presidents in their transition. Voters will give the new administration time to prove itself. Yet it will be a major mistake to underestimate this vibrant democracy, as a president, because voters have proven a capability to punish the incumbent. That pressure aside, it is still unknown if the current president can provide the necessary ‘umpf’ to the economy.
The IMF is already slow-walking its way to any extension on funding or restructuring. The Akufo-Addo-regime requires an influx of cash over the next few years to maintain election promises, which include strengthening private sector growth (through either more infrastructure spending or tax changes) and providing free secondary education. Ghana cannot rely on oil revenue as low prices are hurting British company Tullow and its Jubilee oil field. And, with the deficit around 9 percent, the country is well above the IMF’s target of 5.25 percent for 2016.
Many foreign investors are being patient with the country. But there are investors already taking a position in cedi-dominated bonds. A sell recommendation on Ghanaian bonds or any downgrade would create an opportunity for crafty traders.
The gas-rich country is struggling through 2017. The hidden debts that came to light in 2016 continue to plague the economics of the Mozambican government. The $1.1 billion hidden debt includes loans from Credit Suisse and VTB of Russia to the companies, Mozambique Asset Management and Proindicus. A third loan to Ematum, the Mozambican Tuna Company, was not secret because it was a Eurobond issue, which was later converted into Mozambican government bonds. The companies involved in the three combined loans are running in the negative, with most analysts suggesting the companies will not turn a profit in the near term.
The previous administration, under President Armando Guebuza, remain under scrutiny because it guaranteed the three loans, both breaking budget laws in 2013 and 2014 and violating an article in the Mozambican constitution requiring country’s parliament to approve the debts. Parliament remains hesitant to approve any new debt, with some local groups calling for the country not to pay the ‘hidden’ debts. Such a scenario would raise major concerns in the bond markets.
Opportunistic investors are already lurking around the capital Maputo with increasing interest in the secondary market for the debt. Local officials already openly talk about worries that some hedge funds in the bond space will call for full repayment in the next 12 months.
Mozambique will likely balk, but some funds are betting they may go to the bond market for new debt for relief on old debt as a bridge to full liquefied natural gas production. As one U.S. investor described it, this is as close as it gets to Venezuela in the near term in Africa…“buying cheap discounted debt today and pushing for repayment right when leaders can see the metaphorical gas light at the end of the tunnel would guarantee a nice return on investment.”
Finance minister Felix Mutati dropped a bomb last month by announcing that Zambia’s external debt had increased to $7.2 billion. Three things combined with that statistic is further raising eyebrows. First, revenues underperformed by 10 percent compared to budget, described by the minister as a result of low tax compliance and behind schedule installation of electronic devices to improve value-added tax (VAT) collection.
Secondly, there is a limit to how much the government can borrow from local commercial banks. Some local investors argue that foreign investors are showing concern for the country’s finances, but with an interest in discounted debt purchases. Third, the government is partially limited in opportunities with restructuring its budget, and if so, the government will face some increased financial distress, which will intrigue active bond traders.
Kurt Davis Jr. is an investment banker focusing on the natural resources and energy sectors, with private equity experience in emerging economies. He earned a law degree in tax and commercial law at the University of Virginia’s School of Law and a master’s of business administration in finance, entrepreneurship and operations from the University of Chicago. He can be reached at kurt.davis.jr@gmail.com.
