Research Briefing

Emerging markets

October 7, 2013
Authors
Oliver Masetti
+49 69 910-41643
oliver.masetti@db.com
Aila Mihr
Editor
Maria Laura Lanzeni
Deutsche Bank AG
DB Research
Frankfurt am Main
Germany
E-mail: marketing.dbr@db.com
Fax: +49 69 910-31877
www.dbresearch.com
DB Research Management
Ralf Hoffmann
Capital markets in
Sub-Saharan Africa
Growth and improved macroeconomic stability lead to substantial private capital
inflows. Strong growth prospects, improved macroeconomic management,
increased political stability, as well as robust global commodity demand have
led to sizeable capital inflows into Sub-Saharan Africa (SSA).
Capital markets lack size and liquidity, but have attracted investor interest.
Portfolio investment in equity and debt markets in Sub-Saharan Africa is small
mainly due to the low depth and liquidity of local markets. Recently, however,
high yields and improvements in capital market access have started to attract
foreign investors searching for higher yields given record-low interest rates in
developed markets and meagre returns in more established emerging markets.
Surging Eurobond issuance. The increase in financial inflows has enabled Sub-
Saharan African countries to diversify their investor base and to access inter-
national bond markets at favourable conditions. There is growing activity in the
SSA Eurobond market, with several debut issues planned.
EM sell-off raises borrowing costs, but demand remains. Expectations of a
reduction in central bank liquidity in the US led to increasing yields on SSA
bonds recently. SSA countries will likely have to cope with tighter borrowing
conditions and increased scrutiny from investors in the medium term, but
demand for SSA assets has held up reasonably well so far.

Private capital inflows to Sub-Saharan Africa 1

Net Inflows, USD bn

80 7
70 6
60
5
50
40 4
30 3
20
2
10
0 1
-10 0
2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

FDI inflows Portfolio equity inflows

Bond inflows Bank lending
Short-term debt flows Total, % of SSA GDP (right)

Sources: World Bank, IMF, DB Research

Capital markets in Sub-Saharan Africa

Capital flows to Sub-Saharan Africa on the rise...

Strong growth performance 2 Sub-Saharan Africas strong growth performance (see chart 2), improvements in
Real GDP, % yoy
the business environment, ongoing economic reforms as well as robust
commodity demand have drawn global investor attention to the continent.
12 Combined with easy conditions in the global financial markets record low
10 interest rates in developed markets and ample liquidity this has led to
8
increasing private capital inflows to Sub-Saharan Africa over the last ten years.
6
4
Private capital inflows, i.e. foreign direct investment and portfolio investment, to
2 SSA increased sharply and nearly quadrupled from USD 13.2 bn in 2003 to
0 USD 48.3 bn in 2012 (see chart 1). Foreign direct investment (FDI) continues to
-2 be the main conduit for private investment. In 2012 FDI inflows accounted for
-4 two-thirds of total private capital inflows. The nature of these FDI inflows,
-6
2006 2008 2010 2012E 2014F however, is changing. FDI is no longer directed exclusively towards extractive
industries, but increasingly targets the rising African consumer market. Some of
Asia (ex Japan)
the most active sectors over the last few years have been consumer-oriented
1
Latin America manufacturing, infrastructure and services.
Central & Eastern Europe

Middle East/North Africa

... but vulnerable to external developments
Sub-Saharan Africa

Advanced countries Despite the strong overall growth, private capital inflows to SSA have been
Sources: IMF, DB Research highly vulnerable to external developments. The financial crisis of 2008/2009
and the spike in the euro area crisis in 2012 significantly slowed capital inflows
(see chart 1). It is thus also likely that the recent sell-off of EM assets, sparked
by fears about a reduction in the US Federal Reserves bond-buying pro-
gramme, will have negatively affected investment flows to SSA. South Africa,
the only country for which recent data on portfolio flows are available,
experienced a reversal of non-resident portfolio inflows in May and June 2013.
Especially bond purchases by non-residents turned negative. Net outflows of
about USD 632 m in June are, however, relatively modest compared to net
outflows of USD 4.9 bn in October 2008 after the collapse of Lehman Brothers,
or USD 3.1 bn in September 2011.

Small and illiquid equity markets in SSA
Stock market capitalisation as of 2012
Sources: World Bank, regional stock exchanges, DB Research
3 Equity markets lack size and liquidity
Portfolio equity investment in SSA is focused on the most active and liquid stock
markets: South Africa, Nigeria, Kenya, Mauritius and Zimbabwe (see chart 3).
The Johannesburg Stock Exchange (JSE) continues to dominate the region,
representing 38% of all listed companies and 83% of total market capitalisation
2
in SSA in 2012. 68 of Sub-Saharan Africas 100 largest companies in terms of
market capitalisation are listed on the JSE, including the 5 largest companies in
3
Africa. Most of the major companies listed on the JSE are, however, large
multinational companies that are listed on several stock exchanges world-wide.
Apart from being the most advanced stock exchange in SSA, the JSE is also
among the global top 20 of exchanges in terms of market capitalisation and
turnover. There are over 400 firms listed and full electronic trading, clearing and
settlement is operated. With a market capitalisation of 159% of GDP in 2012,
South Africa also has one of the largest equity markets relative to the size of its
economy in the world. After South Africa, Nigeria has the second largest equity
market in Sub-Saharan Africa. The Nigeria Stock Exchange accounted for 7.7%
of total market capitalisation in SSA in 2012. 15 Nigerian companies are among
the 100 largest in SSA and two Nigerian firms already rank among the top 25:

1
For further information see Schaffnit-Chaterjee (2013): Sub-Saharan Africa: A bright spot in
spite of key challenges. DB Research Current Issues Emerging Markets.
2
World Bank (2013b).
3
African Business Magazine (2013).

2 | October 7, 2013 Research Briefing

Capital markets in Sub-Saharan Africa
4
.... but high equity returns 4 Dangote Cement and Nigerian Breweries. Excluding South Africa and Nigeria,
stock market capitalisation in the region remains low at only around 10% of GDP
Regional stock indices, % yoy, 2012
and is only a fraction of that in other emerging markets.
Uganda
Beside a lack of size, Sub-Saharan African stock markets, with the exception of
Kenya
South Africa, are also characterized by a high degree of illiquidity. Shares are
Nigeria
Ghana
rarely traded and turnover ratios are low by international standards. Activity is
South Africa impeded by outdated trading, clearing and settlement systems, which can take
MSCI EM months to complete a single transaction. Trading is often limited to a few stocks
5
Tanzania which represent the majority of market capitalisation. The 10 largest companies
S&P 500 accounted for 48.9% of total value traded in aggregate SSA stock markets in
Zimbabwe 6
2011, and in Mauritius the figure was as high as 85.7%. Many exchanges still
Mauritius
operate manual systems which are not equipped to handle sizeable capital
-10 10 30 50
inflows. This lack of efficiency severely reduces the attractiveness of SSA stock
Sources: Bloomberg, DB Research markets for equity investors.
Although SSA equity markets remain a challenging investment environment and
corporate governance is still an issue, equity returns have been high. Driven by
a returning global risk appetite after the financial crisis and excess liquidity in the
market, many SSA stock markets have rallied, outperforming benchmark indices
such as the S&P 500 or the MSCI Emerging Market Index in 2012 (see chart 4).

Mining sector dominates equity markets 5 Extractive industries lead stock listings
Market capitalisation per sector, % of market
capitalisation of SSA top 100 companies in 2013 Looking at the sector level, the extractive sector still dominates stock listings in
Sub-Saharan Africa. Mining and metal companies account for 23% of the
market capitalisation of the largest 100 companies. But also consumer-oriented
22% 23% industries and financial services have a significant and increasing share among
Africas top 100 companies, illustrating the regions growing focus on an
increasingly active middle class requiring consumer goods and access to
5%
finance. After resource companies, consumer goods constitute the second
5% 17% largest sector by market capitalisation, followed by banks and financial
5% institutions, telecom, retail and insurance industries (see chart 5).
7%
16%

Mining and metals

Government bonds dominate domestic debt markets
Consumer goods/food
Banks and financial services Rising investor demand and a broader investor base enabled many Sub-
Telecom Saharan African countries to extend borrowing in their own currencies. The
Retail and general trading amount of local currency debt securities issued increased from USD 11 bn in
7
Insurance 2005 to USD 31 bn in 2012. Nevertheless, compared to other emerging
Oil and gas countries, domestic debt markets in SSA remain shallow. Turnover is generally
Other low and secondary market trading is not very active as most investors adopt a
buy-and-hold strategy. Dealing is mostly limited to over-the-counter
Sources: Africa Business Magazine, Bloomberg,
DB Research transactions. The only deep and liquid domestic debt market in the region is the
Bond Exchange of South Africa, which boasts a market capitalisation of USD
182 bn or 47% of GDP (see chart 6).
Domestic debt markets in Sub-Saharan Africa are dominated by government
securities. Government bonds account for over 75% of total bond market
capitalisation in the region. Maturities vary from country to country and range up
to 26 years in South Africa. However, except for South Africa and Nigeria, the
majority of government securities are short-term which creates higher roll-over
risks due to frequent debt refinancing. The lack of long-term maturities also

4
African Business Magazine (2013).
5
Andrianaivo and Yartey (2009).
6
World Bank (2013b).
7
Only government securities issued. Source: African Financial Market Initiative.

3 | October 7, 2013 Research Briefing

Capital markets in Sub-Saharan Africa

Only South Africa has a deep domestic impairs investment by foreign institutional investors and pension funds. Thus,
bond market 6 although foreign investors are increasingly active in SSA, domestic commercial
Domestic bond market capitalisation, USD bn banks, pension funds and insurance companies remain the main holders of
200
domestic debt instruments. The development of a reliable sovereign yield curve
47%*
could also improve foreign market participation and facilitate pricing of corporate
150 financing instruments.
100 Corporate bond markets outside South Africa and Nigeria are either non-
27%
existent or at a nascent stage (see chart 6). Corporate bonds are primarily
50 issued by financial institutions, insurance and industrial companies. Although
29% 25% 21% 10% 21% the market remains small in size, growth has been strong over the past years
0
ZAF NGA KEN GHA MUS TZA UGA and corporate bonds might become an important source of funding for SSA
8
Government bonds Corporate bonds companies in the coming years.
* % of GDP

Sources: Bloomberg, DB Research Accessing international debt markets: Eurobonds

As an alternative to high debt servicing costs for local-currency denominated

Sovereign credit ratings 7 debt, SSA countries have also tapped international debt markets over the past
Highest sov. rating assigned by Fitch, S&P or years to expand their investor base. The growing activity in international bond
Moodys
issuance is also the result of improved availability of credit information. The
number of countries in the region rated by either Moodys, Fitch or Standard &
Poors increased to 21 from only 10 in 2003 (see chart 7). Eurobonds (except for
South Africa) are a comparatively new and unexplored funding source in SSA.
13 SSA countries have issued Eurobonds so far: South Africa, Seychelles,
Republic of Congo, Cte dIvoire, Ghana, Gabon, Senegal, Nigeria, Namibia,
Zambia, Tanzania, Rwanda and Mozambique (see chart 8). The proceeds were
either used for debt restructuring (Cte dIvoire, Seychelles, Republic of Congo,
Gabon) or infrastructure funding. Apart from South Africa, which has Eurobonds
in several currencies, all Eurobonds have been issued in USD with maturities
mostly around 10 years and most are listed at the London Stock Exchange.
Comparing foreign- and local-currency-denominated debt, Eurobonds represent
only a small share of the total outstanding debt in most countries. Exceptions
are countries which issued Eurobonds for debt-restructuring reasons such as
Sources: Bloomberg, DB Research
Cte dIvoire, Seychelles and Gabon.
Due to lower interest costs, Eurobonds provide a good alternative for SSA
countries to raise affordable long-term financing instead of expensive local-
Surging Eurobond issuance 8
currency debt. Additionally, Eurobonds help to diversify the lender base, and
USD bn, excl. South Africa international issuance can also facilitate improved transparency, market reforms
9 and fiscal management due to enhanced scrutiny and information standards by
8 international investors. Eurobonds can also provide a benchmark for pricing
7 corporate bonds in international markets, enhancing global access for SSA
6 9
companies. However, international debt issues incur costs such as underwriting
5
and credit-rating costs. The preparation period can be long (usually more than 1
4
3
year), requiring considerable resources for global advertising and road shows.
2 Repayment costs might also rise if the currency depreciates. International bonds
1 with a bullet repayment structure can lead to phases of soaring debt servicing
0 obligations and demand competent public debt management which is not yet in
2007 2008 2009 2010 2011 2012 2013 10
place in many SSA countries.
Ghana Gabon Senegal
Nigeria Zambia Angola Eurobond sales by SSA countries generally met with high investor demand in
Congo Cte d'Ivoire Seychelles the past. The bonds sold at relatively low yields and were heavily oversub-
Namibia Rwanda Tanzania scribed (e.g. Zambia 15 times, Rwanda 7.5 times, Namibia 5 times and
Kenya Uganda Mozambique Tanzania 4 times). Investor demand was particularly high for bonds with a clear
Sources: IMF, Bloomberg plan for financing infrastructure projects. Sub-Saharan African countries
8
Mu, Phelps and Stotsky (2013).
9
IMF (2013).
10
IMF (2013).

4 | October 7, 2013 Research Briefing

Capital markets in Sub-Saharan Africa

announced plans to issue up to USD 8 bn of international debt in 2013 (see

SSA equity markets resilient to sell-off... 9
chart 8). Potential debut issuers include Kenya (USD 1.5 bn), Angola (USD
Equity returns, 02.05.2013=100, last observation 1 bn) and Uganda (USD 0.5 bn). Reoccurring issuance by Senegal (USD
28/08/2013
120 0.5 bn) and Tanzania (USD 1 bn) has been announced as well.
115
110
EM sell-off increases yields, but demand for SSA has held up
105
reasonably well
100
95
Emerging market currencies, stocks and bonds have suffered a fierce sell-off
90
since mid-May on rising investor concerns that the US Federal Reserve might
85 reduce its bond-buying programme. Whereas SSA equity markets have been
May 13 Jun 13 Jul 13 Aug 13
fairly resilient relative to other emerging markets (see chart 9), yields on SSA
South Africa Nigeria
bonds have soared. Yields on SSA Eurobonds rose by more than 100 basis
Kenya Mauritius
points between May and the end of August 2013 (see chart 10). Nigeria had to
MSCI EM
pay a yield of 6.625% for its second Eurobond placement in July. This is much
Sources: Bloomberg, DB Research more than what it would have had to pay if it had tapped markets in early 2013
when yields on its existing Eurobond stood at 3.6%. Also Ghana had to pay a
yield of 8% for its recent Eurobond, nearly twice the yield its bond had in
... but bond yields hit hard 10 January. Nevertheless, both placements were oversubscribed, indicating that
Change in yields between 01/05/2013 and there is still foreign investor demand for SSA assets. If the financing
29/08/2013, bps environment deteriorates further, once Fed tapering actually starts, some of the
Honduras (B) planned Eurobond issuance might be delayed (as has happened with Kenya,
Senegal (B+) Tanzania and Uganda in the past) or issuance volumes reduced.
Sri Lanka (B+)
Zambia (B+) Although the times of high oversubscription and yields at record lows might be
Ukraine (B) over, raising international debt is likely to remain an attractive option for most
Nigeria (BB-) SSA countries due to their need for external financing diversification and
Gabon (BB-)
infrastructure funding. Furthermore, although yields might have been rising, they
Namibia (BBB-)
Ghana (B)
are still below their historical peaks (see chart 11). A sound economic frame-
Lebanon (B) work and familiarity to investors will become even more important for future
0 100 200 300
issuance. Adequate advertising measures and global road shows will be a key
factor for successful placements, especially for debut issuers. Higher borrowing
Sovereign rating by S&P, Namibia by Fitch costs are not necessarily bad, if they induce governments to come up with
Sources: Bloomberg, DB Research specific plans prior to the issue on how to use the proceeds more effectively and
thereby reduce uncertainty for investors. Moreover, higher yields can discourage
excessive borrowing and the build-up of financial imbalances in these fragile
Eurobond yields still below historical capital markets.
peaks 11
Oliver Masetti (+49 69 910-41643, oliver.masetti@db.com)
Yield on 10-year Eurobonds in % (maturity) Aila Mihr
18

15

12

0
09 10 11 12 13
Ghana (2017)

Gabon (2017)

Senegal (2021)

Nigeria (2021)

Namibia (2021)

Zambia (2022)

Sources: Bloomberg, DB Research

5 | October 7, 2013 Research Briefing

Capital markets in Sub-Saharan Africa

References

African Development Bank, OECD, UNDP, ECA (2013). African Economic

Outlook 2013.
African Business Magazine (2013). African Business Top 250 rankings.
Andrianaivo and Amo Yartey (2009). Understanding the Growth of African
Financial Markets. IMF Working Paper 09/182.
International Monetary Fund (2013). Regional Economic Outlook Sub-Saharan
Africa: Building Momentum in a Multi-Speed World. May 2013.
Mu, Phelps and Stotsky (2013). Bond Markets in Africa. IMF Working Paper
13/12.
Schaffnit-Chatterjee (2013). Sub-Saharan Africa: A bright spot in spite of key
challenges. Deutsche Bank Research. Current Issues / Emerging Markets.
World Bank (2013a). Global Economic Prospects: Less volatile, but slower
growth. Volume 7, June 2013.
World Bank (2013b). World Development Indicators.
World Bank (2011). Global Economic Prospects: Navigating strong
currents.Volume 2, January 2011.
UNCTAD (2013). World Investment Report 2013 Global Value Chains:
Investment and Trade for Development.

6 | October 7, 2013 Research Briefing

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