An admittedly lofty price target for Tanzania Breweries comes in spite of a restrictive cost of capital estimated using a somewhat convoluted approach that borrows concepts from valuation wonk and professor Aswath Damodaran, professor Vivian Okere’s 2007 paper on WACC and frontier markets as well as more unsystematic, within firm or “project risk” mitigating factors derived from the Erb-Harvey-Viskanta Cost of Capital Model. As Okere notes, however, this “is not science”–a point reiterated by the relative illiquidity and concentration of frontier equity markets that makes gauging country risk premiums among other inputs so subjective. To this latter question a 2011 IESE market risk premium survey conducted via practitioners within 56 different countries added increased color, though the self-reinforcing nature of herds is of little comfort. In any event it’s best to err on the side of caution, we feel, given that an overly zealous WACC can at worst be thought of as an implicit margin of safety if nothing else and there are plenty of other avenues within the valuation model to express optimism.
While headline inflation in Tanzania fell to 19 percent y/y in March (from 19.4 in February) on moderating food (25.7 versus 26.7), housing (17.4 versus 19.5) and transport (9.7 versus 10.9) metrics, core measurements (8.8 up from 8.6) remain sticky, a phenomenon we’ve observed particularly among net importers. Interestingly in Tanzania’s case a deteriorating trend in the current account (-8.0, -13.7 and -12.5 percent of GDP respectively in 2010-2012f), however, has not seen a concurrent breakdown in import cover as gross reserves have actually remained fairly static over that period, rising at last count to $3.76 billion, or 4.1 months of cover, from $3.59 billion last June (3.6 months EOY11). This despite the shilling’s ubiquitous freefall since 2009 and all-time low of 1,850 against the dollar in late October which has since retraced back to its 17-week consolidation low of 1,570 as aggressive central bank (BOT) intervention sought to mop up liquidity via hiking the repurchase rate and minimum reserve levels while a directive halving the maximum net open position limit forced banks to jettison dollars (a strategy similar to neighboring Kenya’s, for instance). The 100-week support level of 1,550 appears likely should downside support break.
Given the reserves delta (i.e. rate of change) actually rose over the BOT’s intervention period, resiliency in terms of absolute levels of foreign reserves is likely a function of strong external financing of the balance of payments via FDI flows since existing regulations deny non-residents to ability to hold local currency assets, as well as diverse breadth and relative value of exports which tend to make Tanzania less exposed than peers to external trade shocks (evidenced by its relative Contagion score strength versus Kenya). Speaking to the former point, given continent wide dynamics the country’s steady FDI backing isn’t surprising: a 2011 Ernst & Young study, for instance, predicts investment projects in Africa will roughly double to US$150bn by 2015 based in part on their attractive hurdle rates.[i] To the latter issue while minerals (i.e. gold) made up approximately 40 percent of exported foreign trade flows, manufactured goods (~26 percent) rose over 90 percent y/y and account for an increasing portion of the export basket, though as a whole current account dynamics are still largely correlated with energy prices, gold prices and Chinese demand (~15 percent of exports), none of which are exactly strong tailwind catalysts at the moment.
We believe said correlations are likely to keep the shilling in a secular downtrend (and by extension keep monetary policy tight) given our opinion that its underlying drivers are more structural than cyclical (i.e. energy regulator EWURA’s recent 4.1 percent price hike should be offset by normalizing food price inflation following the drought), a function not only of wanting infrastructure (perennial power tariff hikes, reported and forecasted by stated-owned TANESCO, may be necessary for requisite foreign investment but they are the natural consequence of poor hydrology in catchment areas which negatively impact hydroelectric power generation[ii]) but also non-tariff trade barriers which the five-member East African Community (EAC) concluded in a 2009 study contributed to low regional trade flows despite member state commitment to abolish them.
[i] Available at: http://www.ey.com/Publication/vwLUAssets/2011_Africa_Attractiveness_Survey/$FILE/11EDA187_attractiveness_africa_low_resolution_final.pdf
[ii] Maposa, Vincent. The Tanzanian Electricity Industry. Frost & Sullivan. September 2011. Available at: http://www.frost.com/prod/servlet/market-insight-top.pag?Src=RSS&docid=241672142
While we were not necessarily surprised by the Central Bank of Kenya (CBK) decision last week to keep its policy rate unchanged at 18 percent given the current and forward looking dynamics (short-end yields have narrowed sharply since January) to both inflation (Headline CPI 15.6 percent y/y in March from a cyclical peak of 19.7 last November, with food inflation—36 percent of the total basket—down to 22.1 from 26.2 and transport inflation moderating from 28 to 15.9 over that same period) and exchange rate appreciation (KES/USD up ~29 percent since mid-October partially on the back of timeframe restrictive currency restrictions relating to currency borrowing by offshore banks as well as final round policy rate hikes) we still find the overall tight monetary policy current to be subtly shifting underneath the surface as officials seem to be just as, if not more concerned with export (i.e. manufacturing) competitiveness than with underlying price pressures and currency stability (factoring in a weaker than expected Q4 2011, we expect overall economic growth rate of roughly 4 percent in 2011 versus 5.6 in the previous year as net exports act as a drag on consumer driven output). That said while our target rate per a Taylor’s rule analysis indicates the CBK could reasonably slash some 400bp from its benchmark rate through 2012 in order to buoy growth, we acknowledge the MPC continues to see potential upside risks to inflation given a deteriorating current account deficit (~12 percent of GDP in 2011 versus 7.8 in 2010) as well as sticky core figures—11.2 percent y/y compared with the government’s short-term target of 9 percent, a testament to rising crude prices (~20 percent of the country’s imports) given food’s previously stated disinflation—as well as above-target credit extension that taken together keep its policy mindset circumspect, especially given lingering La Niña effects as well as unusual tropical cyclone activity in the Indian Ocean that will likely delay long rains, impacting electricity generation and agricultural production and further underpinning food and fuel prices.[i]
Additionally, on a technical front USD/KES rests gingerly atop its 200dma support line and appears to have made a sort of rounding bottom or saucer pattern typically indicative of a reversal in price behavior. The pair now trades again roughly in line with the reaction highs of February, a level which also served as support one year ago while preceding an ultimately rapid ascent to the 106 level. Simply put, therefore, the pair is at a critical zone of truth whereby a definitive break one way or the other would likely be more than transitory, a view corroborated by historical volatility (HV), i.e. the standard deviation of day-to-day log price changes expressed as an annualized percent. For example, we examined a 5-day moving average of the ratio between the pair’s short term and long term HV, looking for spots whereby the relationship dipped below and then traded above .5, implying reversion to the mean volatility (we cite Professor Turan G. Bali’s 2006 study in particular regarding the mean-reverting behavior of stochastic volatility)[ii] and an impending price break. Interestingly the recent potential bottom in USD/KES coincided with an approximate 6-week stretch of low (<.5) relative volatility, and given that the average has again receded we would suspect a similar, albeit more sustained breakout looms. While given its recent history of protracted consolidation periods (see 2008-2009 and 2010-2011) we target a near term run to 84 in the coming month.
Trade recommendation: While mindful of said currency dynamics rising real rates (i.e. policy rate less headline inflation), which have now shifted into positive territory, should offset technical movements enough such that the sharp decline in the short-end (-157bp in March from the previous auction) is likely to give way to a more tempered rate of decline such that in the near term we see enough near-term downside, rather than upside risk to inflation as well as an adequately supportive currency environment (assuming authorities maintain current restrictions) to continue to recommend un-hedged local bonds.
[i] Bali, Turan G. and Demirtas, Ozgur K. Testing Mean Reversion in Stock Market Volatility. September 2006. Available at: http://papers.ssrn.com/sol3/papers.cfm?abstract_id=936647
Despite myriad reassuring market signals, namely improved dong sentiment (evidenced by the absence of premium on unofficial USD/VND and an expected continued surplus of over USD2bn in the country’s balance of payments despite a likely [petrol fueled] customs trade deficit widening given an improving structural flow [i.e. FDI/remittance] to leakage dynamic), declining 5yCDS premiums (~530bp in October 2011 to ~270 last month) and annualized inflation projections now well below August’s 23 percent peak and last year’s 18.6 percent average (triggering a reverse repo cut in March, followed by refinance and discount rate cuts this month), the central bank’s (SBV) monetary tightrope act remains treacherous given ongoing commercial bank consolidation and moderating credit extension (11 percent last year [versus a 22 percent government target] and average annual growth >35 percent from 2006-10) that comes against the backdrop of slowing growth. A mooted about plan to remove deposit rate ceilings by July, for instance, and thus adopt a more efficient market-oriented paradigm contrasts with the IMF’s opinion that lower deposit rates make it more difficult for weak lenders to attract funds (though in theory at least capped deposit rates may also pressure further dong depreciation) and is indicative of the slippery slope the SBV current navigates in trying to weed out weak lenders and bolster the dong’s credibility while concurrently lowering lending rates.
Yet while looser monetary policy feeds M2 growth (total money supply up ~1.06 percent in 1Q2012) and presumably fuels liquidity (local papers cited an unnamed SBV Deputy Governor in March, for instance, as saying that it was both “unfeasible and unnecessary to impose a cap on lending interest rates as [they] will automatically go down on surplus liquidity and easing inflation expectations”) interbank market health–which on its face appears healthier YTD–looks to also be correlated with the efficiency and speed of consolidation as falling rates, rather than a function of confidence, could be symptomatic of risk aversion as growing NPLs make stronger balance sheets within the sector less rather than more likely to lend to weaker ones. As has been pointed out the vast discrepancy between how loans are classified may be a roadblock to reform as it tends to vastly understate the country’s climbing (since 2006) non-performing loan (NPL) trend (2012 sector NPL forecasts from Fitch, for instance, are more than 2x those provided by the state) given differences in loan classification between two accounting systems.
At present, per the Vietnam Accounting Standard (VAS) banks classify amounts of NPLs that cannot be paid in lieu of the gross outstanding loan, while per the International Accounting Standard (IAS) method the entire loan amount is the basis (as an aside, a further reason underlying the country’s NPL gap may also relate to the inability of most Vietnamese banks to build out or adapt their internal risk management/credit rating strategies to the herein linked 2005 directive). Larger than acknowledged NPLs would theoretically magnify risk and also threaten to accelerate a negative feedback loop which I’d argue strikes at the foundation of the very sector consolidation efforts deemed so integral to the country’s macro stability in the first place. One proxy for this thesis, and the extent to which a liquidity crunch is already or may soon be underway is the velocity of interbank loans as bad debts and subsequent recollections between banks rise.
“Sell the news” could theoretically apply to the sudden rash of Saudi equity related articles of late highlighting bullish managers such as Mark Mobius and John Burbank (to that end we’ve been bulls for years; see archive) as well as the domestic Tadawal’s (TASI) underlying fundamentals including (i) a [forward] p/e of around 14.5 (all time historical highs are just over 15); (ii) a relative [dividend] yield versus local debt/peer payouts (i.e. ~0.6 percent on 1y government debt and a projected payout of 3 percent from the MSCI Emerging Markets Index, though admittedly myriad GCC countries sport a higher yield including Qatar, Abu Dhabi and Bahrain–all of which have lower premiums as well) and (iii) an impending invitation to foreign investors with an eye towards ultimately garnering MSCI ‘emerging’ status.
That said even though the TASI looks to be stalling against 7800-8000 resistance after recently making 40-month highs, the long term retains its same promising premise–a fast growing (2.1 percent annual population growth versus the 1.2 percent global average) young and more economically/politically inclusive demographic underpinned by an oil and gas export-fueled investment boom that has spillover effects on other sectors (construction, building) and is itself a function of government spending, well capitalized banks (whose foreign liabilities have fallen in recent years against a large (15 percent) savings pool and moreover a generally non-interest bearing deposit base) with low exposure to European funding sources (and subsequent liquidity tightening) and an inherent competitive advantage particularly in the production of fertilizer, aluminum, steel and petroleum-based products. In a sense most if not all of these factors are intertwined and dependent upon one another, which is either comforting or not depending upon one’s perspective. Saudi PMI remains comfortably expansionary (~60) and in lockstep with aggregate demand/wage supportive fiscal spending (+ ~2.4 percent forecast in 2012 on top of a 23 percent increase in 2011), for instance, while credit volatility is also smoothed by the state via deposit growth. As I related to someone recently one cannot understate the role that public sector deposits in Saudi Arabia play in supporting liquidity. Over the past 5 years Saudi banks have exhibited loan to deposit ratios ~80 percent at extremely low volatility relative to GCC peers. However, even during cautionary periods for the sector (i.e. the latest European bank/funding crisis) wherein Saudi commercial banks have increased their central bank deposits, government deposits in the banking sector have risen in kind, smoothing an otherwise net contraction in credit growth (% change y/y government deposits with local banks have trended upwards since February 2010) as gross private sector credit continues to rise (to this end the latest consumer borrowing data sits at +21.8% y/y, a record high). The catalyst supporting the state driven dynamic is rising net foreign assets (NFAs) which in turn drives broad money growth (M3) and finally the money multiplier, meaning Saudi equities could theoretically still be ‘cheap’ for quite some time.
The IMF Executive Board’s lack of revelations in concluding its USD1.3bn Stand-By Agreement (SBA) this week with Angola (initiated in November 2009) was not surprising and moreover the expected final disbursement of 132.9 validates in our view the completion of a paradigm shift in terms of (i) macroeconomic stability and (ii) fiscal accountability (in this case another way of singling out the predictability of oil revenue transfers to the Treasury via [hitherto opaque] quasi-fiscal operations by Sonangol, the state oil-company-cum sovereign wealth vehicle). To the first point the National Bank of Angola’s (BNA) introduction of a benchmark interest rate last fall (in addition to an interbank (LUIBOR) rate, which in practice acts as a guide for monetary policy and as a reference rate for commercial bank lending rates) provided a key fillip to enhanced monetary credibility upon which much of extreme exchange rate volatility traditionally emanates. Indeed the BNA, which manages a floating exchange rate regime and utilizes an auction system as its primary tool for setting the exchange rate, saw inflation reach record lows in H2 2011 (from 15.3 percent at the end 2010 to within the 12 percent targeted band one year later) while its external position grew, allowing it to ease rates by 25bp in January while the 182-day T-bill rate, which began 2011 at 11.4 percent, fell to roughly 4 percent at the beginning of this year.
The disinflationary trend is an ideal backdrop for the newly effected energy sector FX regime requiring the financial intermediation of petroleum operations by banks domiciled in Angola[i], though the efficiency and ease of said defacto de-dollarization will hinge largely, the IMF notes, on the development of kwanza-denominated saving instruments. The implication on domestic bank revenues going forward, needless to say, is quite positive, though what effects increased onshore dollar liquidity will have on the kwanza as well as the monetary aggregate are less clear. To this end an IMF working paper on Angola from 2009 remains pertinent especially given how the country’s M2 and credit growth have rapidly surpassed nominal GDP growth since the global credit crisis:
“Excess liquidity, which is measured by positive deviations of M2 from its equilibrium level, adds to demand pressures, and contributes to inflation with a lag. This underlines the importance of closely monitoring the broad money growth as well as improving liquidity management. In this context, while greater sterilization efforts by the BNA are warranted to curb the rapid money growth, the analysis also suggests that fiscal policy has a role to play in sharing the burden of further disinflation by ensuring that public spending is in line with the existing macroeconomic and administrative capacity.”[ii]
This observation ties into the second point from above, namely the need for fiscal policy to scale up public investment as a prerequisite of sorts to economic diversification and inclusive growth as well as offsetting strong internal demand dynamics in the face of limited access to imported goods due to poor logistics (which underpins sticky core inflation).
Gross savings as a percentage of GDP, for instance, has actually fallen of late, diverging from the country’s growing current account surplus (itself a function of the country’s Cabinda Crude which ended February at an all-time high of 124USD/bl and accounts for ~96 percent of exports) which per the pair’s standing accounting relationship implies that investment has not only fallen in comparison with output but at a much faster rate (growth in surplus/output is 700bp more than the comparable nominal growth figure). The question remains how to manage fiscal accountability with the need to address inherent, “structural weakness” in the non-oil sector (see Mahvash Qureshi’s 2008 study “Competitiveness of Angola’s Non-oil Sector: Challenges and Prospects”) given the latter increasingly looks to act as a long-term monetary headwind given rising internal demand pressures while the former remains a short term exchange rate driver, a quintessential catch-22 for government officials.
Though still up by over 40 percent YTD, Egypt’s benchmark equity index looks ripe for a near-term correction—a thesis we’ve put forth in recent weeks primarily on the back of the country’s wobbly and inadequate external financing state which we estimate should continue to strain borrowing costs, adding stress to the country’s terms of trade while further crowding out private borrowers before it is resolved. Adding to our concern are possible negative feedback loops emanating from the country’s financial sector and its repercussions on growth and fiscal performance. A newly released working paper from the IMF[i], for instance, details “significant links between emerging market banks’ asset quality, credit and macroeconomic aggregates” while specifically pinpointing a reversal in [gross rather than net] bank related and foreign portfolio and bank flows [and not FDI] as the most statistically relevant (i.e. highest R-squared correlation) independent variable considered upon which asset quality (NPL/total loans) depends. Ensuing growth contraction, weaker terms of trade and depreciating nominal exchange rates ultimately can negatively impact balance of payments (as well as possibly the feedback channel on investment, per the authors, given “new orders for capital equipment [would be] more expensive in an environment of deteriorating private sector balance sheets”).
The IMF’s findings echo a rather ominous assessment of the Egyptian bank sector from Moody’s last November wherein analysts noted in the midst of various downgrades that “although data published by the Central Bank of Egypt (CBE) points to lower non-performing loans for the system as of June 2011 . . . these figures benefit from the CBE’s directive allowing different NPL classification rules for retail and tourism loans for three and six months, respectively, after the January 2011 revolution . . . [and we] expect that the full extent of asset-quality issues will begin to emerge in the next few quarters…” To wit Commercial International Bank (CIB), Egypt’s largest private creditor by assets (third overall) and one of five institutions whose local and foreign-currency deposit ratings were slashed last fall, disclosed in its recent full-year 2011 earnings report that while its NPL ratio stood at 2.8 percent (up slightly from 2.7 in 2010 but in line with historical averages and well under the GCC mean since Egyptian bank loan books are underexposed to the riskier retail sector in comparison to GCC peers) the absolute number rose by over 20 percent y/y. Taken in tandem with the fact that foreign currency deposits across Egypt rose by 14 percent (an implicit red flag on future asset growth given said deposits must be channeled to foreign currency loans per law) while provisions leapt from LE6mn to 321mn over that same period and one may reason that NPL ratios could indeed be under some strain in future quarters given that net capital flows (as discussed last week) slackened considerably since last July (and are estimated to reach nearly USD6bn FY11/12) while the aforementioned dollar deposit figure grew—suggesting a similar trend for gross flows. Moreover, per the IMF’s capex hypothesis, investment has been a detracting headwind on GDP since early 2011 as real GDP, which averaged ~4 percent annually in the years pre-revolt now struggles to remain above flat.
Note: Where might the EGX be headed? Simple Fibonacci analysis would indicate that because the index failed to retrace even past its .5 retracement (vis a vis the three-year, 2010 high versus the December 2011 low) a broader, secular downtrend remains in tact. Moreover in the short term a weekly close <4300 would indicate that a lower-low from December is likely impending. We expect, however, that a 10 percent correction from today’s levels (~5080), particularly if combined with positive macro and/or geopolitical developments will be well received by investors and offer an impetus for strategic longs to gain traction).
[i] De Bock, Reinout and Demyanets, Alexander. Bank Asset Quality in Emerging Markets: Determinants and Spillovers. IMF WP/12/71.
This piece as well as past Maghreb commentaries (as well as weekly sub-Saharan Africa analysis) can be found at: www.alterioresearch.com
From Alterio’s SSA report last week:
Countering relative disinflationary trends across SSA are diverging currency dynamics which can be swayed by both fundamental and technical reasons. The Central Bank of Kenya’s somewhat surprising decision this week to keep its policy rate unchanged at 18 percent, for instance, is otherwise shilling supportive in both the near and medium-term as it comes despite higher-than-anticipated declines in both headline CPI (16.7 percent y/y in February from an 18.6 annual average over the preceding two months) as well as private sector credit growth (28% y/y in January versus 30.9% in December 2011) and against a backdrop of lower food inflation and impending base effects which should further reduce price pressures despite hitherto sticky core inflation (ex food and fuel) that detracts from the country’s balance of payments. Technically the shilling has returned to levels not realized since last April at which point it began a fairly hasty plummet of over 20 percent against the dollar (characterized by a nasty feedback loop whereby negative real rates on short term [91/182-day] debt—which ultimately rose over seven-fold over the course of just a few months—initiated ever strident dollar demand as the central bank furiously tried to maintain its import cover ratio) while finally peaking in October. Given our subdued outlook for inflation as well as the central bank’s hitherto ‘ahead of the curve’ hawkishness over the past year (+1200bp overall since January 2011) other things being equal (they never are) present levels (i.e. 82-84 consolidation) should support a USD/KES bottom and ultimately provide an impetus to the upside past 83.6 and through the 84 level. That said even if the shilling ultimately retraces some of its near-term rally, macro conditions are such that 2011’s volatility can be comfortably set aside for the appreciable future, a plus for both public and private equity risk sentiment.
That said, though credit growth has subsided Kenya’s MPC remains unsatisfied, we feel, by demand-related pressures on both imports and consumer goods. As a percentage of output Kenya’s private sector lending still outpaces M2 money supply, a relationship authorities would prefer to invert. Therefore KES weakness may also be dependent on the pace of further private sector deleveraging. Looking to Nigeria, on the other hand, one may find a potential USD/NGN bottoming that could signal perceived transitory inflation dynamics are extensively capped to the downside as well given an ongoing secular trend of dollar demand for imports continuously exceeding supply. Fundamentally the currency has deteriorated for over a year as dollar demand for imports generally exceeded supply while last fall the central bank, failing to meet demand at the official market, lowered the midpoint of its exchange-rate band to 155/dollar from 150. Concurrently, however, from a technical level the pair also looks problematic; indeed a glance at the weekly chart since Q42010 shows both strong support and resistance at 155, while recent hammer patterns indicate that a move back towards 160 is increasingly likely.
Last week’s Alterio report initiated Maghreb as well as SSA-focused analysis:
Our initial report on Mashrek Maghreb macro conditions comes at an increasingly sensitive time for the region’s economies as roughly one year following a seismic ‘Arab Spring’ lead shift within the culture’s broader civic paradigm the need for political and economic synergy remains as critical as ever to achieving lasting, viable stability and growth given a stark dichotomy between the need to address high unemployment, social inequality, tax reform and subsidies versus the need to maintain fiscal discipline as well as secure financing against a dim backdrop of ever-deteriorating EU demand (EU imports of Moroccan goods grew 7.8 percent in 2011, for instance, down from 19.8 percent growth in 2010), largely uncompetitive export baskets and food/fuel dominated (i.e. price taking) import ones. As we touch upon in this initial commentary, however, there exists within the region—and moreover the broader Middle East at large—a convoluted catch-22 whereby, as described in a recent research note (see citation) the “need for regional economic linkages across the Arab world” sits in direct contrast with “political incentives of Arab elites [that] are not fully aligned with opening regional markets” and by extension helps nurture a fragmented economic model which seems to particularly effect [in terms of total share of merchandise exports as % of GDP] resource-poor, labor abundant countries such as Morocco, Tunisia and Egypt.[i]
The resulting chill on private investment further exacerbates the aforementioned EU macro squeeze and places a greater premium on [and cost to] external financing. The latter element refers to an ongoing [region wide] balance of payments dilemma which will demand continued attention from investors in the coming year given trending declines since 2009 in respective capital accounts (admittedly most acute in Egypt where FDI fell by over 50 percent in 2011 to just over $USD2bn and portfolio flows saw a similarly marked collapse) and weakening trade balances intensified by subsidized, sticky domestic demand (most notably the oil import bill which at ~9 and 7 percent of GDP in Morocco and Tunisia, respectively, is uncomfortably high), a strong correlation to Eurozone growth (more than 88 and 80 percent of Moroccan and Tunisian exports, respectively, go to the EU) and in Egypt’s case a projected gradual depreciation of the EGP (though we do expect the CBE to exert a generally tightening monetary bias over the course of the year while also promoting repatriation of foreign assets and generally tightening liquidity in the domestic banking system to retain deposits) given a dangerously low import cover that has fallen from 6.2 months to 3.7 months since last summer and threatens to further chill capital flows given omnipresent domestic political uncertainty, highlighted most recently by the High Administrative Court’s declaration that the voting system used to elect a new parliament last winter was unconstitutional—a decision that in turn could derail not only a new constitution, but May’s planned elections and an ultimate transition from military-to-civilian rule by year’s end (not to mention potentially jeopardize roughly $4.2bn aggregate in aid requested from the IMF and World Bank)
To this end Egypt’s funding predicament gives us the most pause given the ramifications on the state’s cost of borrowing (evidenced by recent 3-year debt auction yield widening), even though [considering in part how important its export market is for a number of countries] the country scores comparatively higher per both our Contagion Score and Original Sin metrics and also saw a healthy rise in both remittances and Suez Canal receipts during the latest quarterly report which is reserve positive. In light of said ambiguity we plan to continue to monitor official donor’s medium-and long-term lending figures as a proxy to gauge any secular turnaround in creditor sentiment. We also remain cautious about equity valuations at current levels; despite a near 46 percent rebound in 2012, we fear the state’s crowding out of private sector borrowing and the ramifications on growth leave future cash flows vulnerable.
[i] “The economics of the Arab Spring”, OxCarre Research Paper 79, Department of Economics, Oxford University, December 2011.
Given that one of our core themes hitherto in 2012 for SSA relates to improved inflation prospects (based on myriad factors including base effects, firming currency dynamics and perhaps most importantly–given its typical CPI weighting–a marked decline in food inflation) and by extension a general tilt away from monetary tightening and towards [comparative] easing, local bonds continue to look particularly appealing given a secular widening in yields across the region since 2010 may be in the process of retracing. To this end this week’s Alterio report explored both Nigeria and Zambian local debt in terms of perceived impending [real] yield retracement potential:
Real [364-day T-Bill] yields look most attractive in Nigeria (nearly 4x the SSA average) where naira appreciation of over 2 percent since the beginning of the month also continues to outperform other countries in our coverage area given increased USD supply from oil firms (in addition to normal bi-weekly CBN auction flow) and decreased demand stemming in part from the ongoing, oil import subsidy probe. Furthermore monetary policy, which we now gauge as only slightly ahead of the curve (based on our estimates of neutral real prime rates and 1-year forward price expectations) should remain near term supportive despite a hitherto cumulative 575bp increase in the policy rate in 2011 given the still uncertain pass through effects of January’s fuel subsidy row detailed in our report last week. That said not only should any price spike be transitory in nature but it should also be comparatively muted given the real yield dynamic which we expect will only entice additional foreign inflows in the coming months. Underpinning yield retracement is ongoing fiscal discipline as the federal government’s commitment to maintaining a deficit of less than 3 percent in 2012 looks increasingly credible given the Budget Office’s statement this week that the benchmark oil price for the annual budget would remain USD 70/bbl.
Likewise Zambian inflation-adjusted yields (at nearly 2x the regional average) could also retrace in the short term despite the fact that policy rates already sit in line with the curve per our estimates and moreover unlike Nigeria currency dynamics are not nearly as supportive. The kwacha remains our second worst performing currency over the past twelve months, for instance, despite the expectation of a relatively subdued inflationary environment given the introduction last month of a revised [albeit still food-weighted at >50 percent] consumer basket (indeed CPI eased to 6% y/y in February from 6.4% in January as both food and non-food price pressures moderated) which should keep headline numbers within the central bank’s target band. To that end this week the USDA’s chief economist projected a sharp decline in global food prices for 2012, though given the opposite outlook for fuel prices as well as an increasing fiscal deficit (along with a comparatively low reserve-to-GDP ratio and our coverage area’s most taxing short-term external debt burden, per our original sin methodology) we fear that inflation could be stickier than thought such that our policy bias is now moderately tighter. Yet it should be noted that the government’s plans to increase external borrowing this year at the expense of lower local supply should place a defacto ceiling on yields, meaning that despite tighter liquidity conditions of late which saw the most recent T-bill auction’s overall bid-to-cover ratio decline to 0.6 from 1.2 the scope for further yield widening is limited in our view.
JGW
