This past month it was announced that Chad was seeking to reschedule payments on a $1.5 billion oil-backed loan. The money was borrowed in 2014 from a consortium led by Glencore, the giant Swiss-based commodities trader, to finance Chad’s acquisition of Chevron assets in the country. The request to reschedule comes in the wake of the fall in global oil prices since repayments on the loan were linked to revenues from future oil exports. The price of oil has fallen rather steeply (by about 46%) since the financing deal was announced in the middle of 2014 (see chart). According to Bloomberg, rescheduling of payments on the loan will give the government some fiscal space given the sheer size of the loan relative to the country’s gross domestic product which currently stands at $13.5 billion.
Many African countries are increasingly looking to borrow from international private lenders to finance their recurrent and capital expenditure needs. Previously, financing largely came from official creditors such as governments or multilateral entities like the World Bank and IMF. And most of this borrowing took place under what were widely regarded as harsh conditions. The writing off of debt under the Heavily Indebted Poor Countries (HIPC) and Multilateral Debt Relief Initiative (MDRI) initiatives in the last decade, which improved the financial standing of most countries, has ironically led to an accumulation of new debt, this time from private creditors.
Many African countries have since 2006 issued dollar denominated bonds, a first for sub-Saharan Africa. In 2006, the Seychelles was the sole issuer of a $200 million bond. By 2013, the cumulative total of sovereign bonds issued on the continent had grown to at least $10 billion (see chart). In addition, foreign private banks have also joined the lending fray. For example, Russia’s VTB Bank issued a $1.5 billion loan to the Angolan government in 2014.
Much of the dollar denominated credit to African governments is implicitly backed by commodities, a straight forward consequence of the continent’s reliance on primary commodity exports. So when the prices of commodities fall, as so often happens, the consequences can be quite dire. And the outlook is not encouraging for commodity-reliant economies that borrowed heavily during the recent borrowing boom. Zambia, which issued two sovereign bonds in a space of two years (2012 and 2014), is already considering the possibility of refinancing or rescheduling its debt given the poor performance of copper, its biggest foreign exchange earner. The price of copper has fallen by about 20% over the last two years. Ghana, which issued its first sovereign bond to much fanfare in 2007 and went on to issue two more, was forced this past April to obtain a $1 billion loan from the IMF to meet budgetary and debt service obligations. Since the World Bank is forecasting weak commodity markets, this scenario is expected to play out over and over again for many African countries in the near future.
The problem with debt
And this is precisely the fundamental problem with debt contracts, particularly the commodity-backed ones favoured by creditors to African governments. With such loans, a lender (whether it’s an international bank or an investor in a sovereign bond) faces limited risks whereas the bulk of the risks are carried by the borrower.
If the price of a major commodity falls, the principal amount of the loan remains largely unaffected and the borrower is expected to pay back the loan in full. The borrower can at best request for a rescheduling of payments or seek refinancing options. In the worst case scenario, the borrower can default on the debt. But default is highly unlikely: the IMF and other multilateral entities usually put together “rescue” packages (not free, of course) for countries that find themselves in a debt crisis.
So all things considered, the creditor comes out largely unscathed whereas the borrower is left to pick up the pieces. And a debt crisis can be disastrous for social spending in a poor country: this study finds that the share of the national budget allocated to education and health can decline by as much as one-third in response to an increase in the debt burden.
There is an urgent need to rethink how commodity-backed loans to African governments are structured.
The advantage of equity
One option would be to structure the contracts so that they are more like equity. This way, both the lender and borrower share in the upside (a rise in commodity prices) and in the downside (a fall in commodity prices). Sharing in the upside might involve increasing the interest rate payable on the loan whereas sharing in the downside might involve a downward adjustment in the value of the loan.
This is how the stock market works: when a company does well, the share price rises and the company declares a dividend. When the company underperforms, the share price declines and no dividends are paid out.
Structuring debt to be more equity-like has two immediate advantages:
(1) Lenders are more careful when extending credit (they might extend smaller loans or closely monitor how loans are used)
(2) countries burdened with debt can largely continue funding social services even when the prices of key commodities plummet. The economists Atif Mian and Amir Sufi have proposed this type of debt contract, which they are calling “Shared Responsibility Mortgages”, in the context of the housing market in the US.
Robert Shiller, the Nobel Laureate economist, has been advocating for bonds linked to a country’s GDP: if a country goes into a recession, then the bond value or interest payments would likewise be adjusted (think how the “Greek tragedy” would have played out if Greece’s bonds were GDP-linked). But equity-like commodity-backed loans would be directly linked to the one thing that most African countries depend on. And such loans would be an easier sell because, unlike GDP statistics that can be manipulated, the prices of commodities are determined via an open and transparent system.
Perhaps Chad’s situation would not be so dire if its outstanding loans to Glencore were simply adjusted to reflect new realities in the oil market.