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.

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