Liquid illusions: Who really benefits from the Liquidity and Sustainability Facility?
During the past year, the United Nations Economic Commission for Africa, in partnership with the US asset management firm PIMCO, has advocated for the establishment of a Liquidity and Sustainability Facility (LSF). The LSF has been presented as a mechanism to support countries in Africa in the aftermath of the Covid-19 pandemic. But which countries and investors really stand to benefit?
During the past year, the United Nations Economic Commission for Africa (UNECA), in partnership with the US asset management firm PIMCO, has advocated for the establishment of a Liquidity and Sustainability Facility (LSF). The LSF has been presented as a mechanism to support countries in Africa in the aftermath of the Covid-19 pandemic. It aims to reduce the borrowing costs of countries in the region through the establishment of a repo facility. Funding for this initiative would be provided by either official development assistance (ODA), multilateral development banks and/or by the central banks of members of the Organisation for Economic Co-operation and Development (OECD). The facility would allow international investors to borrow using eligible sovereign bonds as collateral. Provision of “competitive funding” to investors would, in theory, improve the liquidity of sovereign bond markets in Africa.
However, there are concerns about whether the LSF can actually accomplish its stated goals. These include the pro-cyclical nature of repo arrangements, institutional risks linked to potential conflicts of interest and questions about the real beneficiaries of a development model shaped under what professor Daniela Gabor terms the Wall Street Consensus. Under this paradigm, development interventions are structured around partnerships with global finance with questionable benefits to developing countries. In addition to these concerns, there is uncertainty regarding the beneficiaries of the facility: which countries and investors stand to benefit from the LSF? This blog post focuses on these last questions.
A set of working assumptions
Official details on the LSF are scant. It's unclear which countries and borrowing instruments would be eligible to participate in the facility. This uncertainty provides the scheme with an illusion-like nature where observers can project their own preferences. A more concrete analysis of its merits and potential beneficiaries requires the introduction of a basic set of assumptions:
- All countries in Africa with outstanding sovereign bonds would be eligible, regardless of income levels.
- The LSF would only accept as collateral sovereign bonds from countries with low or moderate risk of debt distress. While apparently simple, this criteria poses a problem as the International Monetary Fund (IMF) uses a separate set of methodologies to assess the risk of debt distress in low- and middle-income countries. Instead this analysis uses a simple rule of thumb based on a good predictor of debt distress: the share of government revenues allocated to external public debt service. Countries that use more than 20 per cent of revenues for debt service would be excluded from the LSF.
- The LSF would only accept bonds from eligible countries issued in a G7 market under foreign currency and governing law.
Which countries would be eligible for the LSF?
Using data from Eurodad’s “Sleep now in the fire” report, it is possible to identify 19 countries with outstanding sovereign bonds issued in a G7 market under foreign currency and governing law in Africa. This group includes three low-income countries (Ethiopia, Mozambique and Rwanda), 13 lower-middle income countries (Angola, Benin, Cameroon, Republic of the Congo, Côte d'Ivoire, Egypt, Ghana, Kenya, Morocco, Nigeria, Senegal, Tunisia and Zambia) and three middle-income countries (Gabon, Namibia and South Africa). Taken together, these countries had a total of US$ 130.6 billion in outstanding bonds as of January 2021.
Excluding countries with a ratio of external public debt service to government revenues above 20 per cent limits LSF eligibility to a mere eight countries: Benin, Côte d'Ivoire, Egypt, Kenya, Morocco, Nigeria, Rwanda and South Africa (see Figure 1 below). These countries have a total of US$ 91.6 billion in outstanding bonds between them. The distribution of these instruments is highly concentrated in just three countries. Egypt, South Africa and Nigeria account for 75 per cent of the bonds that would be eligible as collateral for the LSF (see Figure 2 below).
Who are the investors that stand to benefit from the LSF?
An analysis of the bond holdings of the eight LSF-eligible countries reveals two relevant facts. First, the identity of most investors remains hidden. It is only possible to identify creditors with bond holdings worth US$ 29.1 billion (31.8 per cent of the total). Second, there is a high degree of concentration among the largest identified creditors. The top five asset managers, which include AllianceBernstein (US), Blackrock (US), Amundi (FR), PIMCO (US) and JP Morgan (US), have bond holdings worth US$ 10.2 billion, equivalent to a third of identified investors (see Figure 3 below).
Limited eligibility, high costs and conflicts of interest
This simple analysis paints a problematic picture of the LSF.
First, the structure of sovereign bond markets in Africa and the sharp increase in debt vulnerabilities caused by the pandemic reduces to a trifle the number of countries that can participate in the LSF. In fact, most countries in the region don't have a liquidity problem, which the LSF aims to address, but rather are facing substantial solvency challenges. Additional borrowing without measures to address large and growing debt service requirements will exacerbate the problem posed by net negative transfers on public debt.
Second, countries in the region face substantial financing constraints to overcome the pandemic. In addition to taking measures to address their debt burdens, these are in need of concessional support to finance a recovery from the crisis. Financing the LSF would tie down a large amount of these scarce resources. A group of six African countries recently set a price tag of as much as US$ 30 billion to be sourced from Special Drawing Rights (SDRs) lent by developed economies. To place this figure in context, this is roughly equal to the share of the US$ 650 billion special allocation of SDRs of all countries in Africa or to the costs of vaccinating the entire continent. Given the urgent and widespread needs facing the region, it is ill-advised to commit such a huge amount of public funds to the LSF when only a handful of countries would be able to access it.
Last but not least, the involvement of PIMCO in the LSF presents a clear conflict of interest. On the one hand, PIMCO is a partner of UNECA in the process of establishing the LSF. On the other hand, the US-based asset manager stands to profit directly from the facility at the expense of public resources provided. If the LSF works as intended, the arrival of new investors in the region would increase the price of eligible bonds. A 1 per cent increase in the price of these instruments would translate into an increase in the value of bond holdings of PIMCO of US$ 15 million. At a time when countries in the region are in desperate need of vaccines to stop further waves of Covid-19, it is unacceptable that donor resources should be used to subsidise PIMCO’s profits under a scheme specifically designed by it.
More importantly, the troublesome nature of the LSF is the unavoidable result of a development paradigm designed to respond to the financial illusions of investors in New York, London and Frankfurt rather than to the pressing needs of the people in Lusaka, Dakar or Luanda. This highlights the urgent need for a more transparent and inclusive debate on how public resources from developed economies are being used to ensure an equitable and sustainable recovery from the pandemic.