Monday, December 1, 2014

Ethiopia’s bond plan will test hunt for yield

Ethiopia is sounding out investors about a plan to issue a debut dollar bond. The demand for such frontier-market debt will be a good gauge of just how adventurous asset managers have become in their quest for yield.

The Horn of Africa nation may be unfamiliar to many fixed-income investors but it meets some of their key requirements. Its economy has grown rapidly, by about 9 per cent or more per annum in the last decade, at least a couple of percentage points faster than sub-Saharan Africa as a whole, according to the International Monetary Fund. It has also outperformed the bloc of emerging market and developing economies. Debt and deficit levels are currently manageable, while inflation is under control.

IFR reports the issue will have a maturity of 10 years and be around $1-billion (U.S.), making inclusion in emerging market bond indexes a distinct possibility. That should further help drum up demand. Investors might also view Ethiopian bonds as a useful way of diversifying risk given frontier market debt typically has a low correlation with major bond markets. While it’s too early to pin down pricing, one asset manager reckoned the issue could yield 75 to 100 basis points more than the 5.8 per cent currently offered on a comparable Kenyan bond.


These seem heady returns in a world where 10-year German bonds yield 0.7 per cent, and Spanish and Italian debt only about 2 per cent. Still, caution is warranted.

Ethiopia’s debt outlook is not as bright as it seems. The IMF said in September the risk of debt distress was “low,” but on the cusp of making the transition up to “moderate.” Ghana offers a salutary lesson on how quickly public finances can deteriorate. A poster child for frontier markets in 2007, when its debut dollar bond was issued, the West African country is now in talks with the IMF about a financial aid program.

This year has taught investors how shockingly fast market liquidity can dry up. Even bonds that are frequently traded have proved hard to sell when too many tried to exit at the same time, as in October. Asset managers will have to weigh carefully whether they are being adequately compensated for venturing into a less-than-liquid market at the best of times.
http://www.theglobeandmail.com