The good ship “Paris Club” riding at anchor

In the mid- to late 1980s Western banks lost colossal amounts of money on the export credit loans in Western currencies that they had lent into public sector borrowers and projects in the Third World, where the loans were insured or counter-guaranteed by government agencies such as ECGD (UK), Coface (France), SACE (Italy), Hermes (Germany), and NCM (Netherlands).

Western banks enjoyed credit insurance from these agencies of between 90-100% of their main loans into the projects (which amounted in turn to 85% of the project cost). The focus of competition became the willingness to lend the remaining 15% of the project cost and on the pricing applied both to that tranche and to whatever percentage of the main loan was not insured.

Either way, the entire loan could be classified as “sovereign risk” e.g. insured by the Dutch government for 80.75% of the total financing (95% of the 85% main loan) with the remaining 19.25% being risk on the Nigerian government (5% of the 85% main loan and the entire 15% downpayment loan).

These were the percentages in the case of a financing for dry docks in Lagos and Port Harcourt lead managed by Lloyds Bank International (Amsterdam branch) in 1983, and insured with the Dutch NCM credit insurance agency.

With that quality of risk, we filled our boots, because sovereigns don’t default, do they?

However large the losses of the commercial banks, they were dwarfed by the losses of the government agencies providing the credit insurance. The losses fell back on the hapless taxpayers of the respective Western country, and the agencies worked through a pre-existing organisation called the Paris Club to reschedule the loans over many years and to try and mitigate the losses.

An aggravating factor in the 1980s was that these loans were in foreign currencies as far as the borrowers were concerned. In fact the loans were largely funded by the deposits made by Arab countries into the same Western banks of the proceeds of oil sales, so the money was being recycled into the same countries who had bought the oil in the first place.

“Those who forget the past are doomed to repeat it”. Who said that? Karl Marx? Groucho Marx? Well he knew a thing or two whoever he was, because recent dialogue involving main decision-makers in the field points to a new approach that may delight borrowers but dismay taxpayers in Western countries – when they find out, which will be once the losses have been made.

Vera Songwe, UN under secretary-general and executive secretary of the UN Economic Commission for Africa, wrote in the Financial Times on 25th November 2018 that banks should be making credit available to African countries in the borrower’s currency, and not a foreign or Western currency. Her rationale is primarily the issue of currency devaluation, which magnifies the borrower’s debt in their home currency: “The Ghanaian cedi and the Nigerian naira, for example, have been depreciating against the US dollar since 2008. This means that the current nominal values of the eurobonds issued by both countries have increased significantly. In the case of Ghana, the nominal value of its $750m 2007 eurobond was $3.4bn in 2017. A similar trend is discernible in the case of Nigeria, which issued $500m-worth of eurobonds in 2011. By 2017, their nominal value had risen to $966m”.

What that means is that it required 3.4 billion Ghanaian cedi, at 4.53 to the USD earlier this year (it is 4.86 now), to raise the USD750 million repayment of Ghana’s 2007 10-year 8.5% bond, whereas the exchange rate in 2007 was 0.95 to the USD and the issue proceeds would have yielded only 713 million cedi.

It is obviously lunacy in principle to borrow in a hard currency and convert it into a weak one, when one has no natural hedge such as a flow of revenues in hard currency.

In practicality, though, there is not such a pool of lenders available as to sustain a condition that they lend in the borrower’s currency and not in the ones they have readily at their disposal. The willingness of Western financiers to take on the Country Risk of the respective country as well as the Credit Risk of a particular borrower in that country cannot be taken as a willingness also to extend credit – cross-border – in the home currency of that country.

It is a different matter if the financier has an in-country lending platform – i.e. a locally-accredited institution with a credit licence, be it a subsidiary or a branch. The local platform might have a deposit base in local currency that it would be willing to lend out, although foreign banks tend not to have retail deposit bases of any size, and are dependent upon local money markets (assuming such exist) to raise the funds with which to make loans.

These obvious situational limitations seem lost on Ms Songwe, however. Her solution is that “international financial institutions should come up with ways of hedging their exchange risks as they lend in local currency”. This is a comical statement when the currency involved may well be non-convertible, or subject to strict exchange controls, or have a very limited offshore market for these international financial institutions to deal in.

In such circumstances the tools for the creation of hedging instruments lie entirely onshore – within the control of the monetary authorities of the country concerned. The offshore market cannot create hedging instruments without their being strongly underpinned to onshore cash instruments. If that is not the case – and the means to achieve lie with local monetary authorities – the prices of the offshore hedging instruments will fail to track the prices of the onshore cash instruments, and then you do not have a hedge at all.

More worrying than this element of ignorance about financial markets from the UN was the contribution to the debate of a Mr Louis Taylor, the CEO of UK Export Finance. UK Export Finance is the operating name of the Export Credits Guarantee Department, the United Kingdom’s export credit agency, or ECGD, the self-same institution that took such a bath for the UK taxpayer last time around.

Mr Taylor confidently stated that “at UKEF we offer guarantees in more than 60 currencies, including the Ghanaian cedi, Nigerian naira, and 13 other African countries’ currencies. We can also guarantee capital market structures, further diversifying the sources of finance available. This means that overseas buyers can access both UK quality and expertise, and flexible UK Government-backed finance in their currency of choice – “buying British, paying local.” By helping UK suppliers offer international customers attractive financing terms, we are helping to make the UK offer as a whole more competitive and sustainable”.

Back to the future, then: another bath in prospect for the UK taxpayer, but this time without the help of the Paris Club to fall back on.

ECGD will be stuck with long-term receivables in depreciating foreign currencies but which have not defaulted, disqualifying them from rescheduling through the Paris Club.

ECGD will have enabled the exporter, by way of example, to get paid at an equivalent of 6.15 Ghanaian cedi to the £ now under a £20 million contract, out of a loan at 7% p.a. in cedi with annual coupons and bullet repayment. If the cedi falls by 5% per annum against the £, the proceeds of those payments, when converted, will fall short of producing a 7% coupon in £ and full repayment of principal by £8.96 million over the life. ECGD will have had no effective hedge in place since, as Ms Songwe has told us, there is no hedging market. So ECGD has no-one to claim against for the £8.96 million loss, through the Paris Club or otherwise, and just has to write it off to the UK taxpayer. That’s very sustainable but for whom?