African Capital Markets Development Workshop
By
Oduetse A Motshidisi
Deputy Governor, Bank of Botswana
October 27-29, 2003
Introduction
March 2003 marked an important step in the development of Botswana's capital market when the Government of Botswana launched its first ever bond issue - a five-year bond. This initial 5-year bond was followed by a 12-year bond issued in April and a 2-year bond issued in May, all of which were oversubscribed. In many respects these bond issues were a truly momentous event as the objective of the bond issue was not primarily driven by a need to raise revenue or funding but to develop the domestic capital market. Botswana has the highest credit rating of any African country and has run budgetary surpluses for most of the past twenty years while deficits which arose on a few occasions have always been small. Also, Botswana's reserves, relative to other countries are high, giving an import cover of around 30 months.
Background
My presentation will go over the key steps the Botswana Government took and mainly the steps that we, at the Bank of Botswana, were involved in, in order to assist the Government in its issuance process.
Two years ago, the Government of Botswana had no publicly traded debt and only residuals of concessionary loans dating from previous periods. On the asset side of "the balance sheet", the reserves accumulated over the years were worth close to USD6 billion and the fiscal balance was expected to be mainly positive over the next few years.
Why then borrow? The often quoted benefits of increased market discipline imposed by publicly traded debt did not apply in Botswana's case since there was effectively no debt, private or public on the balance sheet.
The answer lay with a common objective of both the Central Bank and the Ministry of Finance and Development Planning (MFDP): the development of the domestic market.
Two years ago, Botswana's capital markets were characterised by limited alternatives for investments. On the one side, the Central Bank had just streamlined the Bank of Botswana Certificates, commonly called BoBCs, into a regular programme of weekly issues with a fixed 3 months maturity. There was no fiscal requirement to issue BoBCs; rather BoBCs' play a major role in the mopping up of excess liquidity. With regard to long-term investment asset classes, the only fixed income investments available to the market were a handful of bonds issued by parastatals but totaling less than the equivalent of USD40 million. Most of these bonds were purchased by local investors on a buy and hold basis, which as expected could not generate secondary market activity.
For Botswana the impetus for capital market development was driven by two key factors. Firstly, it is widely accepted that a vibrant capital market is a catalyst for economic development and the creation of a risk free yield curve is the first step of such an evolution. Secondly, the imminent funding of the Public Officers Pension Fund was a further incentive to issue. Up to a few years ago, the Public Pension Fund was a Defined Benefit Plan, in that the Pension Fund was an un-funded liability of the Government. Government, being the largest employer in Botswana, decided to fully fund the Pension Fund liabilities which represented a major injection of funds into the financial markets; at the time it was estimated to be worth around P10 billion or approximately USD2 billion. Thus the decision to fund this liability significantly increased the need for domestic long-term investable assets given the requirement that fund managers which were entrusted with managing the funds had to invest at least 30 percent of the funds locally. In this light, the issuance of long-term Government securities was considered desirable to avoid the build-up of a bubble in the values of local assets, i.e. equity and real estate and thereby reduce the financial risk on the pension fund and other investors.
Once it was agreed to issue Government bonds domestically, the implementation of the issuance programme required many steps to be followed.
One of the first decisions was to define the structures and roles of those involved in the bond issuance programme of the Government of Botswana.
Process
From the beginning, and as laid down by statute, the Bank of Botswana's role was to advise the Government on the process. Accordingly, a Senior Steering Group (SSG) consisting of senior officials of the Bank of Botswana and MFDP and chaired by the Bank was established to act as a coordinating advisory body. While the Bank side gave advise on the process, the final decision making with regard to the strategy and the bond specifics such as term, size and other bond characteristics stayed with the Government.
The creation of a debt-issuing agency was also considered, but taking into account the size of the borrowing programme, it was felt that was not necessary at this early stage. However, in the long term, the Bank and the Ministry recognise the need to build debt management capacity within Government.
An important decision was made between the Bank of Botswana and the Government, (as the issuer), to seek specialist institutions in order to ensure success of the programme. Over 10 international financial institutions were invited to submit proposals on their strategies for a bond issuance programme. These were carefully evaluated by the SSG which ended up selecting a team composed of FirstRand Bank of South Africa and First National Bank of Botswana. A key consideration in the selection of an advisor was the ability to advise and tailor the programme to a small underdeveloped capital market such as Botswana, especially from a regional perspective. Second, big league advisors do not come cheap. The choice of RMB/FNBB was an exceedingly good value for money - they exceeded expectations and continue to play a major role in the market.
Another key decision was to evaluate the size of the overall bond issue. As mentioned earlier, the Government has no requirement for funding. However, in order to achieve liquidity and support market development, the issue amount had to be large enough relative to investors' needs, otherwise the bonds would be bought and held to maturity. Furthermore, the existing legal framework imposed a ceiling on how much the Government could borrow annually. Taking those two factors into account, the Minister chose to aim for a programme totaling between P2 and P2.5 billion (or between USD 0.4 and 0.5 billion) for the current year.
The next decision was the resolution to auction the bonds directly through the Bank of Botswana using the BoBCs auction framework. The alternative would have been to access the market through syndication. In Botswana's case, it was felt that the expertise gained through many years of BoBCs auctions, the small size of the programme, the objective of market development and competition and the absence of a real need for funding all did not warrant the cost of syndication.
As a consequence and at the same time recognising the important role which the major financial institutions play in the development of the Botswana financial markets, it was decided to grant Primary Dealer status (we call them Primary Counterparties) to selected financial institutions which are directly supervised by the Bank of Botswana. The selection was based on capitalisation, significant operating presence in Botswana, commitment to adequate participation in the primary and secondary market and in the development of the financial market as a whole. This exercise resulted in the selection of six Primary Counterparties and each counterparty was required to sign a Memorandum of Understanding which set out their rights/privileges and obligations.
The next question which was addressed was the number of issues to be made to create the yield curve. While we were aware that the information available to the market is proportional to the number of issues on the yield curve, it was important to also take note of the small issue size that would result from multiple issues. Accordingly, a compromise was reached, based on market feedback, to issue in 3 terms of 2, 5 and 12 years. Because of the segmentation of the investor base, it was felt that the pension fund requirements would be adequately addressed by the 12 years issue, the commercial banking sector with the 2 years issue and the 5 years issue would provide an intermediate point on the curve.
Having chosen to go for a trio of issues, the next question was about the timing and the relative desirability of a big bang approach against a gradual issuance programme. While it was recognised that issuing the three bonds simultaneously could increase the impact of the programme, it was felt more important to let the market get acquainted gradually with this new feature of the Botswana financial markets. In doing so, the winner's curse would be reduced and each bond auction and the related secondary market activity would be useful in providing valuable information for subsequent primary issues. Accordingly, the Government issued the 5, 12 and 2-year bonds in March, April and May respectively.
From the outset the Government intended to list bonds on the Botswana Stock Exchange. However, there were some regulatory and institutional systems which needed to be addressed. In that regard, most of the issues have been resolved and the listing of the bonds on the Exchange is imminent.
In relation to the necessary infrastructure for settlement, registration and transfer, it was decided, as a temporary measure, to strengthen the systems in the Central Bank, thus the Bank effectively serves as a central depository, a function that will transfer to the Exchange in due course.
The final major decision was on what role, if any, the Central Bank should play in the secondary market. Being an agent of the Government for its issuance programme, it was deemed inappropriate for the Bank to simultaneously occupy a major or central position in the secondary market. However, this does not mean the Bank of Botswana is totally absent from the market. In order to assist the Primary Counterparties to deal with short-term shortages of bonds, the Central Bank decided to participate on an ad-hoc basis and in a small way in the primary market in order to be able to lend securities to Primary Counterparties who could be temporarily short a specific bond at a later stage.
Many other decisions were taken and processes defined as the bond programme developed. However, the above factors represent the main questions we had to address.
This paragraph recapitulates the different bonds that were issued and the results of each auction. As can be seen, each auction was oversubscribed. The rates obtained provided Botswana with an inverted yield curve consistent with the current overnight interbank rate of 13.75 percent and the expectations of lower inflation rates to come.
Following the completion of the first stage of the programme, the Government recently announced the reopening of the 5-year and 12-year bonds. The 5-year auction will be held on October 29, 2003 for P400 million while the 12-year will reopen at end November 2003. The decision to reopen was taken in order to increase the liquidity of the current bonds. These two auctions will finalise the current year issuance of between P2 and P2.5 billion.
A task not yet completed is the formalisation of the bond calendar process. In the next few months, the Bank and MFDP will finalise the establishment of the bond issuance process and migrate from the current ad-hoc basis into a recurrent yearly programme. This in turn will increase the predictability of issuance from the market's point of view.
Looking forward, increasing the secondary market activity remains a challenge and the Bank of Botswana and MFDP will look into ways to encourage Primary Counterparties' participation in the market.
Finally, the Minister has recently announced Botswana's intentions to consider issuing a bond internationally when conditions are appropriate. However, no decisions have been made yet. If it becomes necessary, the experience gained issuing the bonds domestically should provide valuable lessons.
Conclusion
We believe that the Bank and the Government have created favourable conditions for the development of the capital market in Botswana. It is expected that other issuers will take advantage of this enabling environment to raise funds by issuing bonds thus contributing to the development of the market.
Central banks can facilitate the process by issuing and maintaining process by issuing and maintaining clear legal and institutional framework that is transparent to investors, including taxes and other costs associated with the issuer.