While the mere fact that western outlets are openly pontificating in advance on the possibility of an African, or more pointedly, a ‘Nigerian spring’ distinguishes the current fuel subsidy row from the MENA wide, spontaneous surge ignited last year by a Tunisian street vendor’s self-immolation, there is a fil conducteur of sorts–namely an “ever simmering, north-south regional and religious bifurcation” per my macro commentary from last week’s Alterio Research report. It would be a mistake, however, to simply equate various cultural tensions given at a minimum their inherent contextual and historical differences. And it would be equally erroneous to expect markets to do so. Nigerian ’21 yields actually narrowed despite mentions of an industry wide shutdown as the subsidy removal is deemed essential to its credit status per S&P and long term positive for the state’s creditors. Left unanswered, however, is how the government can simultaneously meet its stated goal of reducing its fiscal deficit to less than 3% of GDP–a key tenet per its central bank in stabilizing the exchange rate and interest rates–while under increasing pressure by the aforementioned social divisions to maintain security and also address myriad and ever-mounting grievances.
Excerpted from this week’s Alterio Research report:
Given in particular the success of Namibia’s USD500mn maiden Eurobond last fall which saw an over-subscription of roughly 5.5x—largely a function, per pundits, of its perception as a proxy on SSA commodity wealth with a similar [Fitch] credit rating (BBB-) to South Africa (BBB+) but an approximate 200bp added spread—most observers expect Zambia’s impending offering in 2012 to be similarly received against a supportive macro backdrop defined chiefly by copper’s potential and relative price resiliency (in the face of developed market aggregate demand contraction) as well as accommodative monetary policy unconstrained by overly zealous inflationary pressures.
To the first point much like the supply side dynamic for crude whereby prices are likely to be supported going forward by limited spare capacity and inventory cover (irrespective of events stemming from China, Europe or even Iran), global mine output for copper—bluntly described by one analyst as ‘disastrous and getting worse’—was on track in late November to contract annually for the first time since 2002 while physical indicators in China (i.e. wire and cable demand and scrap shortages) now pose upside risks given deep discounts already ascribed to the effects of a credit-induced market crash there. Such price stickiness would not only be welcome to Zambia, where the potential pace of Copperbelt output expansion over the next several years stand to make it the fifth-largest producer in the world, but somewhat imperative to post-election fiscal ambitions and thus of utmost interest to its creditors who will monitor the continued health of a current account balance now slightly in surplus (the 2012 budget, for example, is characterized by increases in social spending and farming subsidies as overall spending is slated to rise to 26.5 percent of gross domestic output from 21 percent). To this end President Michael Sata’s decision to double mining royalties but withhold a much-ballyhooed windfall tax was not only prudent but in fact obligatory in our view given the unfortunate reality of infrastructural bottlenecks (i.e. transport and power supply related) and skilled-labor shortages that for the appreciable future will relegate Zambia to being a comparatively inefficient, high cost producer (though admittedly bond proceeds would theoretically begin to erode at least some of these concerns).
As to central bank easing, strategists suggest that Sata’s election in fact signaled a monetary policy paradigm shift towards cheaper funding costs. Indeed within one week of former President Rupiah Banda’s defeat then-central bank Governor Caleb Fundanga, credited by some with helping to temper inflation into single digits for the first time in three decades, was removed. Since then a 300bp reduction of the reserve ratio for both local and foreign currency deposits as well as the core liquid assets ratio, coupled with a general reduction of base lending rates (for now Zambia lacks an official benchmark rate per se) augmented liquidity while headline inflation fell sharply over the last three months of the year (7.2 percent y/y in December from 8.1 percent in November and 8.7 percent in October). Taken together, and alongside a fairly resilient currency (due in part to central bank support) real yields remain attractive going forward as investors embrace a new political and perhaps monetary landscape in the new year.
Buffeted by an “unparalleled infrastructure, flexibility in production volumes and policy machinery”, all of which make it per Barclays “the key player at the margin of the oil market” Saudi Arabia remains relatively insulated contra developed market-derived contagion–more so than any other GCC economy. Increasing non-hydrocarbon imports, for instance, are a proxy for improving and resilient domestic demand driven chiefly by expanding private sector credit (9.8% y/y in October, compared with 8.7% in September) within a domestic banking system comparatively unconstrained by the high loan-to-deposit ratios (inversely correlated with liquidity) observed in UAE, Qatar and Oman, or the significant reliance on funding from European banks (and hence external funding base exposure to that sector’s ongoing deleveraging) seen in the UAE and Qatar (on the contrary funding remains largely based on customer deposits in Saudi Arabia at ~70% of total assets in 2011h1 versus 57.9 GCC avg). To that end we remain intrigued (see our original thesis from last March) by the Saudi banking sector heading in 2012, home to nearly one-third of Global Finance’s recent “Safest Emerging Markets Banks” Top 20 rankings. This doesn’t necessarily come as a surprise given capital adequacy (CAR) and non-performing loan (NPL) dynamics matched only by Qatar in terms of dual attractiveness while liquid asset ratios—i.e. cash, central bank certificates of deposit, interbank deposits and high-grade fixed income securities—are over 50% for certain Saudi banks (2x those seen by other GCC institutions). And while one weakness of the sector in our view remains its credit/funding concentration (i.e. a predominantly corporate profile), banks such as Banque Saudi Fransi are targeting a larger retail base and the lower cost deposits and higher interest margins which come with it.
Admittedly the conservative asset growth and high risk aversion within the Saudi banking sector is largely a function of environment; aside from timeless speculation surrounding succession the Kingdom’s macro viability, for instance, remains intrinsically wedded to its swing-production power within OPEC and the ensuing, relative size and stability of its energy receipts which tie neatly in with the comparative, aforementioned liquidity of its banks’ funding base (the government remains a major and/or majority shareholder of banks such as Samba Financial Group). Indeed recent oil production cuts (from a peak of 9.9mb/d in August) during oil’s near-convergence earlier this year to the estimated fiscal breakeven oil price are symptomatic of an increasingly pragmatic state that, against an Arab Spring/Euro Malaise backdrop remains keen on fiscal expansion (25% y/y in 2011 and, despite official rhetoric of easing next year most analysts still envision spending momentum to continue with the overall effect being the state’s budget surplus will remain static if not increase slightly in 2012) and thus as ardent as ever in supporting a defacto price floor in crude (though citing non-OECD demand trends in particular, many energy analysts argue a reprise of oil’s post-Lehman price crash would be quite remote anyway) which should help translate into ‘backwardated’ markets for the appreciable future and thus even larger coffers for the Kingdom to tap.
I’ll be providing macroeconomic analysis going forward through Alterio Research, an independent research firm founded last year by Fabrice Yanou.
Last week I focused on Nigeria and this week’s concentration shifted to Kenya, where a number of dynamics have been in play since the summer, testing central bankers and causing a currency flux. My hope going forward is to continue to evolve the sophistication of commentary while offering institutional and retail investors alike a top-down view of the primary economic catalysts inherent to a given Sub-Saharan sovereign, a shifting paradigm and backdrop against which equity valuations are continuously refined. Last week’s macro report follows:
Against the backdrop of rising developed market equity correlation and volatility, in conjunction with ongoing liquidity contraction (i.e. what the IMF deems the absence of “financial lubrication”[1]) stemming not only from the post-Lehman deleveraging paradigm but also from the (best case) renovation or (worst case) deterioration and ultimate destruction of the EU’s monetary union, Sub-Saharan exchange rates have largely come under pressure in the second half of 2011, perpetuating a vicious cycle whereby both currency and inflationary pressures demand fiscal and monetary (policy rates) tightening that in turn tends to impede output (GDP) expansion.
From an overall macro fundamental perspective, therefore, we remain attracted to those countries wherein net reserve coverage (defined as foreign-exchange (FX) reserves plus current account (CA) surplus, less short-term external debt) provide monetary authorities with ample artillery by which to stem depreciation pressures through increased FX sales. This ability, or lack thereof, we believe to be of the utmost importance in terms of stabilizing real rates of return that external capital demands in both the short and long run—investment flow that, if depended on to finance a CA deficit, for instance, is not merely valuable but in fact wholly vital to the state’s operations. Moreover, strong coverage allows a given central bank the luxury of easing rates should global conditions require it, a further fillip to growth that in theory should also pad domestic equity valuations relative to peers given, all else equal, a less onerous cost of capital.
Nigeria, for instance, despite relatively strong reserves (albeit currently static and within a continual annual downtrend) has seen its inflation worries persist as the recently devalued naira, coupled with ominously high fiscal spending and next year’s proposed fuel subsidy removal (which is likely to push inflation up if implementation is phased in) indicate consumer price expectations will stay wedded to the upside. That said, supportive bond yields keep inflation-adjusted real rates in a comfortably positive territory such that further downside currency risks are negligible going forward, in our view. Yet the country’s CA surplus, at an estimated 9% of GDP for 2011, remains highly dependent on oil revenues and moreover, much like reserve, has decreased steadily over the past four years (~16.8% of GDP in 2007). As demand side dynamics continue to underpin import growth, underwhelming FX reserve trends could deteriorate and further restrict fiscal and monetary options in 2012, acting as a headwind on both GDP and equity markets.
[1] Singh, Manmohan. Velocity of Pledged Collateral: Analysis and Implications. IMF WP/11/256. Nov. 2011.
As hinted here earlier, sub-Saharan frontier markets may be distinguished in part by their monetary prudence and overall macro policies. While foreseeing an impending rise in Eurozone related global market volatility earlier this fall (and by extension the SSA region’s near-term growth prospects), for instance, we theorized that commodity exporters such as Ghana would enjoy enhanced terms of trade, augmenting FX reserves as well as tempering price stickiness such that capital costs remained controlled while the option to ease interest rates remained relatively viable–all in contrast with net importers such as Kenya and Uganda (a notable exception to this ongoing thesis remains South Africa, for reasons outlined here, while Nigeria’s disappointing reserves accumulation YTD and hitherto pesky inflation have in turn brought about six different attempts to normalize rates during the year). That said, a tipping point does exist even in the most price sensitive of countries such that once inflation pressures lessen (a function, it should be pointed out, not only of supply side factors but also demand side ones such as private sector credit expansion) monetary policy can remain static or even perhaps loosen such that local bonds look a bit more palatable. Absa Capital noted yesterday, for instance, that following the deceleration in November’s headline inflation to 29% from the previous 30.6%, the Bank of Uganda’s (BoU’s) MPC left its central bank rate (CBR) unchanged at 23% (up 300 basis points from the last hike in October) at its policy meeting‘last Friday while observing that “prospects for lower annual inflation rates have strengthened”. At the same time, Bank Governor Emmanuel Tumusiime Mutebile pointed out commercial bank lending to the private sector declined by 20.9 per cent between September and October, a trend he expects to continue as “the slowing down of bank credit growth will help to ameliorate inflationary pressures over the coming months”. All this bodes well for fixed income, though an always mindful eye on domestic food prices wouldn’t be for naught.
As both Thailand’s Prime Minister (Yingluck Shinawatra, “elected in a landslide just four months ago” per the Economist) and economy continue to suffer (industrial production plunged 35.8% y/y and capacity utilization fell below 50% to 46.4% in October–the lowest respective prints on record as analysts ponder annual growth revisions), its markets spent the last week pricing in an expected 25-50bp rate cut from the Bank of Thailand’s (BoT) impending monetary policy decision–1w and 1m Bibor dropped 3bp and 7bp, respectively for instance, while the 14d repo rate at the last 14d BoT bilateral repo fell 3bp per observers. And while inflation continues to creep up ultimately the discord between headline and core should allow officials some leeway to not only maintain their hitherto credible inflation-fighting creed but also help preserve an enviable current account surplus (see chart) seen by officials as an effective inflation tempering tool but now under pressure from the plunging Bhat and dithering exports. To this end, despite some rate cut front running in the bond markets (2 and 5 year debt have narrowed by roughly 30bp during the past month) the yield curve has further room to steepen per Barclays, which cites in particular the 5y’s “ample systemic liquidity” in addition to lingering output contraction in 2012 which will likely persuade officials not to spare further easing if deemed necessary. That said, one shouldn’t discount the role that Thailand’s net reserve coverage will also play in helping policy makers accommodate.
The combination of expected-persisting monetary accommodation along with a hitherto sticky, macro-proof global demand profile for diesel (influenced further by the looming likelihood in China of a weather-aggravated supply shortage in the coming months) make West African crude and, by proxy, its sovereign credit our holiday frontier market wish list security of choice. The latter phenomenon–i.e. the burgeoning diesel/gasoline spread (see chart below)–continues to play on an ongoing theme, namely per one pundit the “diverging drivers behind the consumer and industrial activities as [developed market] high unemployment and stagnant wages continue to crimp consumer spending, while industrial and manufacturing activity [particularly in developing economies] are revving up.” Barclays energy wonk Paul Horsnell further elaborated on diesel’s EM-fueled, relative buoyancy in a research note from last week:
“Ever since the migration of non-OECD countries to the margin of the oil market, diesel demand has received a significant boost on a global scale, given the bias of diesel in the oil mix in these countries. Its dominant position in commercial freight traffic has made it a fast growing demand component in countries characterised by large distances in internal trade and by strong underlying economic growth. For instance, in China, significant government investment in the road system and a mandate in 2000 that all trucks should run on diesel by 2010 facilitated the rapid expansion of domestic diesel demand. Beyond road transport, diesel also continues to be the primary fuel employed in China’s rail system, as well as being a major fuel for several significant types of marine transport. A similar picture can be painted for India, where diesel makes up 70% of road fuel use due to the intensity of truck and bus fuel consumption as well as the increasing penetration of diesel within the passenger car segment. In a country with some degree of oil product price subsidisation still in place, diesel prices are considerably more politically sensitive than gasoline. It has, therefore, usually proved easier to allow retail gasoline prices to rise with international markets, while retail diesel prices can often be stickier, with the current retail price discrepancy between gasoline and diesel almost double in India.”
Thus despite this weekend’s report indicating Asia would cut its African sourced imports to a three-month low, we expect lower or “sweet” sulfur blends (about half of the average Brent) from Angola and Nigeria (versus heavier or “sour” grades from Saudi Arabia and Iran) and their associated higher (up to twice more) distillate yield to continue to be in vogue. The Chinese in particular continue to suffer from tight supply side dynamics–”especially in the country’s Northern, Eastern and Central regions” per Horsnell–such that net product imports (at 322k b/d in October, higher than the year-to-date average of 286 thousand b/d) will likely continue to trend up. And while Nigeria, Africa’s largest oil producer, plans to export 2.18m b/d of crude next month, with Angola second at 1.72m, we remain impressed with the relative price stability in Ghana in the face of oil output that, while growing, still fell short of expectations. Granted, Ghana’s fiscal targets (both its own and those set by the IMF) were predicated on abnormal output, and thus the initial 5.5% of GDP deficit estimate may turn out to be a bit pollyanna given President John Atta Mills’ looming showdown with Nana Akufo-Addo (close runner-up in 2008) next year. Yet inflation expectations remain sanguine enough (CPI +8.6% y/y in October from 8.4% in September, in line with consensus, while non-food inflation was unchanged at 11.3% y/y, suggesting still modest inflationary pressure per analysts) that the country’s 12.5% policy rate will most likely remain unchanged into 2012. To echo our sentiment from last spring, therefore, Ghana’s 2017 Eurobonds remain attractive versus peers.
Analysts note that with expansionary fiscal policy boosting money supply growth (14.4% y/y in August) and [private-sector] credit expansion, “GCC countries remain well positioned in the event of a global downturn”. Yet said effects seem especially and comparatively potent in Qatar where, per Barclays, “M3 growth jumped the most, by 24.4% y/y [versus] more moderate growth observed in Saudi Arabia (15% y/y) and the UAE (12.4% y/y), while concurrently headline inflation, which [GCC weighted-average] region wide turned upward for the first time in 2011 in September, remains somewhat subdued given a still shaky real estate sector. Said M3 jolt, in turn, continues to jostle its way onto regional bank balance sheets, with deposits registering double-digit growth in August–Qatar again leading the pack at 18.6% y/y. Coupled with Abu Dhabi’s International Petroleum Investment Co.’s (IPIC) $3.75b, three-tranche foray into capital markets alongside Union National Bank’s international debt debut, pundits and punters alike now envision a rash or rally of sorts revolving around Abu Dhabi and Qatar issuers in particular given both “ongoing funding needs” as well as a “need to enhance/diversify” said funding bases. Thus investors eying an increasingly stable and profitable sector (GCC collective average bank ROE stood at 13.9% in June, versus a 2005-2010 average of 18.9%) would be wise to perk up should debt capital markets indeed entice new concessions in the near term.
The FT‘s Kenya oriented pullout from late October underscored the contextual dichotomy present between those investors [rightfully] weary of the country’s NSE Index, down 44.6 percent YTD at the time compared with the benchmark MSCI Frontier Markets Index’s -20.1 showing (though it was SSA’s best performer in 2010, up 28.3 percent), versus an ever burgeoning brigade of “public money, alternative asset managers, funds of funds, family offices [and] public and private pension funds coming onstream almost every month” into private equity, a phenomenon whose efficiency will only be enhanced, per Edward Burbidge, a Nairobi-based corporate finance advisor, by both an SME exchange (geared towards smaller-to-medium sized firms in lieu of the generally not practical costs and regulations associated with public listing) as well as a proposal to raise capital limits allowed to be invested (currently only 5 percent) by domestic institutional investors such as pension funds and collective investment schemes. While long-term investors such as Templeton’s Mark Mobius continue to correctly emphasize the economy’s inherent potential, we noted this summer that the Central Bank of Kenya’s (CBK) dovish dithering in the face of increasingly entrenched inflation (core inflation more than doubled to roughly 13% from March-September) left it continuously behind the curve, perpetuating a vicious spiral whereby declining fundamentals exacerbated a deterioration of the balance of payments (analysts estimate the country’s CA deficit in H1 2011 doubled y/y to approximately 12% of GDP), eroded by an ever-wobbly schilling (KES, down 23% YTD against the USD to mid-October and now at ~97/dollar). Lo and behold, headline inflation printed 18.9% y/y in October-the highest rate in three years-driven chiefly per the CBK by food inflation fueled in part by over-zealous domestic credit expansion. Finally, however, the response seems apropos: Tuesday’s 550bp hike by the monetary policy committee to 16.5% (following a 400bp bump in early October) surpassed consensus expectations and may help temper yields (Tuesday’s 91-day treasury yield was at 15.31% versus 9.71% at end-August and 3% at end-March 2011, per Absa Capital) and schilling weakness alike, especially if the government’s request to further tap the IMF’s Extended Credit Facility (ECF) is obliged (Kenya has hitherto withdrawn USD170mm from the USD509mm, 3y program agreed to with the Fund last January). Regardless, however, the underlying macro-theme to remember about Kenya remains the growing, negative net export contribution to growth, which will counteract whatever monetary policy exists to try to stabilize the schilling–stability that should ultimately be of interest to public and private investors alike.
With Europe’s woes undoubtedly solved (trifling quibbles aside) and sovereign integrity intact (R.I.P. CDS), Tunisia and Morocco–two frontier markets relatively and acutely tied to the EU’s ultimate fate (to wit, 75% of Tunisian exports are destined for the EU) in particular seem poised to benefit. For even if the realities of moribund or at least muted growth as well as an entrenched downwards trajectory in manufacturing PMI remain in Europe’s cards, the illusion of sovereign stability may now be adequately vivid such that external financing–namely remittances (per Barclays, the EU remains the main source of remittances to most non-oil exporters in MENA, specifically up to 85-90% in Tunisia and Morocco) and net FDI flows (deemed critical to boosting growth and exports)–won’t turn fickle. The situation looks especially precarious in Tunisia, where FDI fell more than 150% q/q following the spring uprising and is projected to fall from 1.4bn in 2010 to 0.3. That said, the country’s “so-far-smooth plan for its transition to full democracy” looks hitherto credible, while GCC flows (chiefly from both Saudi Arabia and Qatar) coupled with multilateral lending by international financial organizations such as the World Bank and the IMF (not to mention support from the Deauville Partnership which involves, in addition to the G8, the UAE, Saudi Arabia, Kuwait, Qatar, and Turkey) should, at least in the near-term, help support macro fundamentals by partially offsetting deepening current account balance deficits (5.2 and 5.6% of GDP in 2011 in Morocco and Tunisia, from 4.2 and 4.7 percent respectively last year) with fiscal balance support and thus provide an implied ceiling to both CDS and z-spread.
