Ghana issues US$3 billion Eurobonds in tricky circumstances

Last week Ghana made another foray into the international capital market and came away with US$3 billion in Eurobond proceeds.

Under the trying circumstances in which the issuance was done government was justified to claim that the issuance illustrated that international bond investors still have strong confidence in Ghana’s economic prospects despite its public debt to Gross Domestic Product having climbed to 76.1 percent which is significantly higher than the generally accepted debt sustainability ratio of 70 percent.

After all Investors last week offered to buy up US$6 billion in Eurobonds on offer by government and the Ministry of Finance asserts that this means the issuance was two times oversubscribed.

Actually, this is not quite true – the subscription offered by investors was twice what government actually accepted, but only 20 percent higher than what was offered; the Finance Ministry’s claim in actual fact could be seen as an attempt to assuage justified worries that international bond investors are beginning to replace enthusiasm with caution over lending government more money.

Indeed, while US$6 billion in offered subscriptions is impressive by any standards and more-so being only the second offer put on the international capital market by a sub-Saharan African country since COVID-19 erupted across the globe more than a year ago this strong demand came at a price – in terms of coupon rates demanded – which government considered too steep.

Consequently, it decided to sell just US$3 billion worth of bonds. This suggests that investors are getting worried about Ghana’s public debt trajectory and therefore are demanding a higher risk premium than hitherto, an assertion which government’s critics, particularly its political opponents have been keen to jump onto.

Conversely, though government officials are arguing that the demand for higher coupon rates is the result of rising United States federal fund rates over the past fortnight and suspicions that the Federal Reserve may decide to begin pulling back from monetary easing by the next year or two, thus discouraging many bond investors from locking into current historically low-interest rates.

This too is true; yields on 10 year US bonds are currently at their highest levels since the Federal Reserve Bank employed intense monetary easing to boost economic activity in response to the effects of COVID-19 and the requisite public policy responses by both the federal and various state governments.

Now the Fed is openly considering monetary tightening as the US economy has begun growing strongly but the fiscal deficit is reaching new highs, propelled by two ,multi-trillion economic stimulus packages implemented by the federal government over the past year.

Instructively both the World Bank and the International Monetary Fund, after actively supporting such stimulus packages all around the world last year are becoming alarmed by the speed and depth with which fiscal deficits are expanding and consequently have begun recommending that relief spending be rolled back.

Although there is little chance of significant rate hikes by the US Fed this year, investors now see higher interest rates looming over the horizon and have begun reacting by pushing bond yields upwards on secondary markets.

Therefore it is only to be expected that such sentiments will spread to new issues with medium to long term tenors, especially those issued by emerging market countries.

Instructively this had started telling on Ghana’s already issued Eurobonds several days before the latest issuance. Yields on Ghana’s $1 billion of 2030 bonds climbed eight basis points to 6.82% at 3:35 p.m. in New York a fortnight ago – that is the week before the latest issuance – to the highest since November, after rising 29 basis points during the previous week.

Ghana’s bond issuance comes after a series of fixed-income virtual meetings held locally across three (3) days with Investors from the United States, United Kingdom, Europe, Middle East and Asia.

The transaction comprised US$525 million 4-Year Zero Coupon, US$1 billion 7-year Weighted Average Life (WAL), US$1 billion 12-year WAL and US$500 million 20-year WAL. The traditional Eurobonds priced at 7.75%, 8.625% and 8.875%, respectively.

The 20 Year Tranche, which priced at 8.875% is also expected to fill a gap in Ghana’s yield curve, ensuring that Ghana now has a well-defined yield curve with issuances across the curve from 4 years to 41 years.

Part of the proceeds shall be used for domestic liability management. “For example, using US$400m of the zero-coupon bond to refinance domestic debt with an average interest rate of 19% will net Ghana savings of some $200 million over the four years,” Finance Minister Ken. Ofori-Atta has explained.

The proceeds will, alongside conducting liability management, also support the budget deficit by funding growth-oriented expenditures. Besides using zero coupon bonds – the first time an African country has done so on the international capital market – allows government to borrow without having to worry about interest payments during the duration of the bonds, which is crucially beneficial for a country whose debt servicing costs this year will consume 49.5 percent of its tax revenues. The accruable interest has been deducted from the proceeds Ghana receives from the issuance, which will pay off the full principal upon maturity.

However the zero-coupon bonds are the most controversial tranche of the lot – with a tenor of four years it will leave the next administration with a US$525 million debt to immediately it assumes office.

The government’s critics see the timeline as cynical, since the incumbent administration will enjoy the benefits of the issuance but will leave its successors to pay for it immediately after assuming office

However government’s decision to only issue US$3 billion rather than the US$5 billion it was aiming for is prudent considering the increase in coupon rates demanded by investors since last year’s US$3 billion issuance.

Economist Dr Lord Mensah points out that the latest issuance is relatively very expensive. Dr. Mensah told Joy Business the success of the bond doesn’t mean the country’s investment climate is the best, but rather because the government is desperate for money to finance the budget.

“If you look at the composition of the mixture [debt instrument] from the $3.0 billion bonds, you’ll realize that obviously because of COVID-19 and the risk involved – as far as the investor funds are concerned – you are not going to get the same coupon rate as we did last year.”

“Last year, we raised a 7-year bond which was worth about 6.37% for the coupon rate, but then this time if you look at the mixture, 7-year bond is going for 7.75%; and I mean it signals were we are”, Dr. Mensah said.

He emphasized that it’s not only about raising the money, but it is about the cost of the debt which you [government] will pay a higher interest later.

The reduction in the amount taken will not affect the financing of the 2021 budget deficit (targeted at 9.5 percent of GDP) however.

This is because only US$1.5 billion out of the issuance is meant for budgetary support. This means that only US$1.5 billion will now go into refinancing relatively expensive existing debt rather than the US$3.5 billion originally envisaged, since at the rates obtained there would no interest rate advantage in substituting existing debt with the US$2 billion now foregone.

Ghana successfully raised US$2 billion in 2018, US$3 billion in 2019 and US$3 Billion in 2020. Monday, 29th March’s successful bond issuance should boost business confidence as the Government looks to stimulate the economy and increase revenue through what it calls “burden-sharing” for “enhanced profit sharing.”

The Joint Lead Managers for the transaction were Bank of America Securities, Citibank, Rand Merchant Bank (RMB), Standard Bank and Standard Chartered Bank. They were supported by local financial institutions, CalBank PLC, Databank, Fidelity Bank, IC Securities and Temple Investments as Co-Managers.

The latest Eurobond issuance falls within the wider Medium Term Debt Strategy devised by government to cover the period 2021 to 2024.

2021-2024 MTDS

The Medium Term Debt Strategy (MTDS) is based on the debt management objectives as stated in Section 58 of the Act 921 and it concerns the following: ensuring that the financing needs of Government for the medium term are met on a timely basis; borrowing costs are as low as possible and consistent with a prudent degree of risk; promotion of the debt market and pursuing any action considered to impact positively on public debt.

As part of the measures to reduce risk, Government will pursue liability management of the debt portfolio based on non-distressed debt transactions. This could indirectly affect cash flows from government fiscal operations when the timing of Liability management coincides with negative carry on idle cash.

This MTDS covers the period 2021 to 2024. The strategy considers the costs and risks embedded in the current debt portfolio; future borrowing requirements for the medium term, the 2021 macroeconomic framework, the prevailing market conditions and other factors necessary to develop the strategy. This is in fulfilment of the statutory requirements in Section 59 of Act 921.

The macroeconomic framework of Ghana for 2020 was on a favourable path with macroeconomic stability restored and fiscal consolidation gaining root and consistent with a monetary policy stance that had supported a strong external sector development.

In addition to this, the financing conditions for the Government was favourable, which supported growth (even with the COVID-19 pandemic) and inflation within the targeted corridor.

Investor sentiments were high and their interest was once again heightened for Ghana’s Eurobond issuance in February 2020 resulting in a size of US$ 3.0 billion.

The COVID-19 pandemic hit Ghana around March 2020 and this adversely affected the economy’s positive economic performance. Consequently, the original MTDS had to be recalibrated to ensure the financing gap of government is met.

This included the IMF Rapid Credit Facility of GH¢ 5.6 billion (1.45% of GDP); African Development Bank Funding of GH¢ 389.7 million (0.1% of GDP), European Union of GH¢ 504 million (0.13 % of GDP); the Bank of Ghana Asset Purchase Programme of GH¢ 10 billion (2.61% of GDP); and the World Bank funding of GHS 1.1 billion (4.6% of GDP).

How zero coupons’ bonds will work for Ghana

Assuming Ghana issues US$500 million in zero-coupon bonds at a discounted rate of 20 percent (US$100 million) Ghana will receive US$400 million in cash today but will pay back US$500 million when the bonds mature in four years’ time.

In the interim however Ghana will not pay any interest over the four years. This means government can save the money it would have used to pay interest over the next four years for something else. In this case the Government of Ghana says it will refinance its more expensive debt on which it is paying an average of 19 percent interest per annum.

Ghana’s existing domestic debt attracts an average of 19 percent (for ease of analysis put this at 20 percent). So here Ghana issues 20 percent discounted zero coupon bonds of US$500 million and receives US$400 million.

If this is converted into cedis at an average exchange rate of six to one this would amount to GH¢2.4 billion. This can be used to retire domestic bonds attracting interest of 20 percent which comes to GH¢480 billion in savings a year (i.e. 20 percent times GH¢2.4 billion).

Multiplying the GH¢480 million a year by four years gives GH¢1.92 billion (equivalent to US$320 million) in savings over the four years. If we deduct the US$100 million deducted upfront on the zero coupon bonds from the US$320 billion we get net savings of US$220 million.

This is an approximation meant to allow easy explanation. Based on the precise rates involved in Ghana’s zero bond issuance the savings are actually about US$200 million.

It can be argued that foregoing all the monies that would have been paid as annual or semi-annual interest in one go at the start of the transaction is not favourable because in actual fact this amounts to paying all the interest up front.

However this structure allows for a lower effective interest rate to be negotiated. In the case of Ghana a 20 percent discount for a four year bond issuance amounts to an effective interest cost of five percent per annum which is considerably lower than the rates Ghana has obtained on all the other tranches of conventional bonds being issued.

However, with the interest being deducted upfront, the time value of money means that Ghana’s savings are actually lower than what is computed in the analysis above. Nevertheless, the savings are significant and real.

But the real downside is the necessary short tenor of the zero-coupon bonds which will give the administration that succeeds this one refinancing or repayment challenges immediately it enters office.

This means it behooves on the incumbent government to arrange either the refinancing or the retirement of these bonds before it leaves office at the start of 2025.