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Further monetary restraint on the part of the Central Bank of Ghana to keep its policy rate at 13.5 percent and support “still-sluggish domestic demand”–coupled with recently initiated oil production that will increase from an initial 50,000 to around 120,000 bpd within three to six months per Tullow Oil and also help the country achieve real GDP growth of roughly 13 percent next year (versus 6.5 in 2010)–should maintain the attraction of impending primary auctions of cedi denominated, 3-year sovereign paper which remain “the most attractive local debt market opportunities in Sub-Saharan Africa” according to Absa Capital. Demand stemming from said auctions has steadily grown this year as investors become more convinced that hitherto volatile CPI figures have been tamed–inflation reached a five-year high of 20.7 percent in June 2009 but fell to 9.5 percent this past June (declining for the first time since December 2007 below 10 percent). That said, analysts foresee public sector wage increases, higher food prices and utility price hikes all pushing inflation back into double-digits (around 11 percent) in the coming year. Moreover, despite the newfound oil revenue some observers (including the IMF) question the country’s fiscal discipline. While total public debt rose from USD8.5bn in September 2009 to USD11.3bn a year later “the fact remains that at least during the cost-recovery period, fiscal revenues will likely not be substantial enough to fund huge [social and other] infrastructure outlays” Absa wrote earlier this month, highlighting the cost-recovery period as well as a proposed bill before parliament that would automatically siphon some 30 percent of oil-related revenues to a “Stabilisation and Heritage fund.” Nevertheless, finance minister Kwabena Duffuor maintained to Bloomberg in November that the nation’s cash budget deficit would narrow to 7.5 percent of GDP in 2011 from roughly 9.7 percent this year, and then drop to to 4.7 percent in 2012 and 3 percent in 2013 as energy revenue “built up.”
Egypt’s real GDP will expand by 5.1 percent this year and likely between 5.7-6 percent in 2011 according to analysts, though at least two concerns loom: (i) fiscal decline exacerbated by both political uncertainty (i.e. cryptic succession plans and Muslim Brotherhood-inspired social unrest) and rising inflation (core is beyond the central bank’s unstated 6-8 percent comfort area, per Credit Suisse, while headline also markedly outpaces the MENA average) that tends to manifest itself into both government supported wage and subsidy growth; and (ii) deterioration in the current account (fueled in part by the aforementioned stimuli as well as softening Western demand, which accounts for 30% of the country’s export markets). International investors, it seems, are stuck in a wait-and-see period–the FT noted in mid-December, for instance, that the country’s MSCI index noticeably lagged the EM index’s YTD performance (2.7 versus roughly 9 percent) while Barclays wrote to investors that “FDI flows–historically the most significant component for capital inflows–remain lower than pre-crisis levels,” while J.P. Morgan noted that volatility in portfolio flows (Net foreign holdings of Egyptian T-bills stood at $9.2 billion in mid-October–compared with $530.4 million in December 2009–before selling off in response to a currency drop off that could have more room to fall if either or both of the two most cited reasons underpinning it (i.e. the central bank’s accommodation for exporters and/or the public’s anxiety of life post-Mubarak, who’s been in power since 1981) hold water. “Without the more sticky support from FDI inflows, this volatility will likely feed into the financing of the CA,” Barclays warned this month, while concurrently suggesting selling overvalued Egypt 20s and buying Qatari Dinar 20s in the short-term as the pair’s typical 100-150bp spread had converged to parity. Long-term, however, the story behind Egypt remains one of growth: the FT wrote that “while many neighbouring bourses are buoyed by hydrocarbon revenues…the EGX’s potential is underpinned by a less volatile asset–Egypt’s 80m consumers, many of whom are rapidly becoming wealthier. moreover, the stock market is the best regulated bourse in the region, bankers and fund managers say.” Yet ideologically the country is still far enough removed from what most economists would theoretically like to see (and arguably what the country absolutely needs to keep pace with the annual 650,000 new job seekers, as well as to chip away at a 40 percent poverty rate) for some investors to feel truly comfortable. Widening gross public debt, for instance, has socialist roots, while food and energy subsidies not only hinder stability but also “crowd out priority spending on social and infrastructure needs,” per the IMF. And without true reform in these and other areas such as the press and legitimate political opposition groups, religiously themed or not, Egypt’s $20bn a year in FDI vision may be far-fetched. That said, even putting aside larger issues such as price stability and poverty–less radical improvements such as increased corporate and retail lending (the former of which admittedly hinges largely on the lack of proper financial auditing) could provide the economy with enough cash to either help spur greater reform or at least deemphasize foreign cash flows.
Holders of Lebanon’s recent 1.5 trillion Lebanese pound ($1 billion) sale of seven-year government debt–the country’s longest maturity for domestic borrowing–at a 7.9 percent coupon rate are buying IOUs from one of the world’s most heavily indebted nations (gross public debt was $51.1bn in 2009 or 148% of GDP, compared with a peak of 180% in 2006 post Israel-war), mired in political tenions, where the “problem remains on the expenditures side, not on the revenues side,” per Nassib Ghobril, head of research at Byblos Bank SAL, and where parliament has failed to ratify a proper budget since 2005. That said, political deadlock is actually a blessing in disguise in terms of curbing any expansionary fiscal ambitions since constitutional law precludes spending from exceeding a 12th of the previous legal budget in any given month during impasse. A stable-to-slightly declining fiscal deficit (funded in the meantime by commercial banks, which now hold close to 60% of total debt), coupled with projected real growth rates between 6-7.5% over the next three years fuelled chiefly by GCC tourism and domestic demand (underpinned by higher remittances and subsequent deposit growth from residents and non-residents that grew 8-10% y/y over the past nine months, swelling banks’ assets to nearly 326% of GDP in December as the collective lending portfolio grew by nearly 20% y/y) should help counter the possibility of deterioration among rival political factions overly spiking spreads. Additionally, banks’ stout liquidity will help finance the infrastrcture improvements needed to sustain real growth. Moreover, analysts with Barclays opine that that central, Banque du Liban has become increasingly nimble and pragmatic over the course of the last decade and can now “easily accommodate further pressures [on the Lebanese pound, pegged currently to the dollar at a band of 1,501-1,514 pounds] should they recur. Its reserves, at USD32bn amount to more than 55% of short-term debts and cover almost 72% of the country’s money supply, putting the country in a much better position than in previous instances of extreme political tension.” Finally, Ghobril noted to Bloomberg that in addition to testing the market’s appetite for longer maturities in the local currency, the bond sale “helps the government further shift the financing of the deficit and the composition of the public debt from foreign currencies to Lebanese pounds.” At present, roughly 40 percent of Lebanon’s debt is foreign denominated. In sum, the story heading in 2011 remains the same: while Lebanon’s growth story looks promising, a lack of fiscal certainty makes it hard for many investors to make a clear, long-term call.
Jakarta-based PT Panin Sekuritas, whose Panin Dana Maksima fund has returned an annualized 45 percent over the past five years, noted to Bloomberg last week that inflation concerns were “overstated” and that consumption growth was “likely to hold up” in 2011 even in the face of potential rate hikes. Jakarta’s Composite index has risen roughly 42 percent this year, making it the best performer among Asia’s 10 biggest indices. Higher inflation, however, would dampen domestic spending which accounts for roughly two-thirds of output, as would a rate increase–the central bank has kept benchmark rates at a record low at 6.5 percent for 16 months, effectively underpinning demand. Headline inflation rose to 6.3% y/y in November (from 5.67 in October and exceeding the Bank’s stated target of 4-6% in 2010 and 2011) on the back of higher global food commodity prices which many analysts expect to remain elevated, at least until spring harvesting. To that extent, the current La Niña weather pattern’s heavier-than-usual rainfall may likely prove a boon to future harvests, meaning a further uptick in inflation may not necessarily force the Bank’s hand. Analysts with Barclays add that ideologically the Bank is not likely to aggressively tighten policy as it “has a bias to use liquidity management tools rather than the policy rate. This is driven by BI’s concerns that a rate hike would further widen interest rate differentials and attract additional ‘hot money’ inflows.” That said, last week’s decision by lawmakers to approve a government proposal to gradually limit the sale of subsidized fuel in 2011 will have inflationary effects not only on headline numbers, but also on “core” measures via transport related feed through. As the WSJ wrote, said reform was much needed as it will boost [the country’s] ability to finance badly needed projects to upgrade its transportation and other infrastructure, which could increase Indonesia’s attractiveness as an investment destination.” Barclays sees a 50-80bp uptick on a staggered basis, which may even be on the high end when compared with other estimates. Yet no matter what, somewhat slower growth appears in the cards and most 2011 GDP estimates have been slightly revised accordingly. Nevertheless FDI flows from China and India especially are robust on the back of manufacturing and resources, and most analysts expect a sovereign upgrade in 2011. How this translates into the yield spread, which recently hit a three-year low of 402 bp against U.S. treasuries (10-year spread) against the backdrop of the aforementioned inflation issue will be interesting.
Though admittedly no one really knows what goes on behind the scenes in Beijing, the recent decision to keep rates on hold despite a 28-month high in inflation suggests that growth still trumps price stability even as President Hu mentioned last week that managing the latter was a “priority.” To some analysts this reluctance to tighten monetary policy is a deeply rooted, psychological one that extends across much of Asia. An Economist piece last week, for instance, notes that “Asia’s policymakers remain ‘paranoid about growth scares from the West.’ They do not want to repeat the mistake of 2008, when they were caught tightening even as the financial crisis struck.” At the same time, Goldman Sachs projects, much of the price run-up may naturally subside as America’s inventory build-up, which traditionally feeds Asian component-makers and which has been on a tear over the past year, subsides. If not, Beijing may be in fact be just as guilty as the U.S. of ‘kicking the can down the road’, though as long as the two act in tandem perception can theoretically trump reality ad infinitum, a ploy not likely lost on Messrs Hu and Obama. That said, eventual rate hikes are inevitable.
Regardless, China’s rate decision was a big shot for risk trades and in particular could exacerbate certain markets such as a copper that some warn are already stretched. Copper climbed to a record $9,267.50 a ton on Dec. 14 and has gained 22 percent this year as China-led demand outpaces supply (see graph). And while some analysts note that alumnium may in fact have greater upside at this point than copper given its role as an alternative, the outlook remains strong for copper as well. This should benefit frontier markets like Zambia in particular, the continent’s top copper producer. Against this backdrop analysts at Barclays expect the country’s current account deficit to halve in 2011 (from a projected 2.3% of GDP) while FDI-supported output growth continues–inflows mainly into the mining and manufacturing sectors reached record levels totalling USD4.3bn (27% of GDP) in 2010, more than double the total FDI inflow of USD1.8bn in 2009,” analysts wrote. This has largely been a function of Zambia’s courtship of Chinese investment into two “Special Economic Zones”, one serving the mining industry in Chambishi in the northern Copper Belt, and the other a nascent manufacturing-for-export hub near the capital. Assuming the copper price acts as expected, look to see how Zambia’s maiden USD500mn Eurobond in H111 reacts.
Analysts note that S&P’s recent [B to B+] upgrade and Fitch’s August [B+] affirmation of Kenya’s credit was largely a function of the East African country’s stable economic (real GDP growth of 5.1% y/y in H110, driven principally by the agricultural, manufacturing, and trading sectors) and political outlook. On the latter point, the country’s new constitution became law in August and leaders point to it as the pillar underpinning an ambitious “Vision 2030” program that seeks in essence to modernize and grow the economy with the help of international investment. Yet as The Economist pointed out immediately following the referendum, “differences between the country’s leading ethnic groups [are] huge, illustrating a persistently worrying ethnic polarisation of politics” that calls into question the viability of the stability sought.
Moreover, Barclays Capital opined this month that while the country’s current account deficit “improved significantly in the year to July, falling to USD1.7bn from USD2.2bn last year,” the trade deficit deteriorated marginally (import growth rose on the back of an increase in oil imports–23% of total imports) in that period and can be expected to further widen going forward “should global prices of oil and food increase in 2011” and/or the recovery in Europe stalls since it is “the destination of 20% of the country’s export goods and is the origination port for more than 20% of Kenya’s tourist arrivals.” Additionally, the government’s infrastructure program “is likely to be stepped up next year” and will also push up spending for investment goods (28% of total imports). Said fiscal expansion pushed the state’s deficit to roughly 7% of GDP this year, up from 4.4% in 2009, but should temper going forward thanks in part to the country’s USD500mn Eurobond, postponed in 2007 but now planned for 2011.
Turkey bulls such as myself have some pretty concrete indicators to watch going forward: while long-term the outlook remains positive–despite the fact that near-term fiscal discipline remains somewhat lax in the face of impending elections in mid-2011–Barclays Capital recently noted that AKK’s popularity (not to mention the increasingly probability of a ratings upgrade from Fitch) should reinforce discipline: “the government has been able to issue debt at nominal interest rates significantly below nominal GDP growth, which is likely to lower the government’s interest bill in the years to come. If the government manages to move the deficit to 3% by 2012, we estimate the debt ratio falls well below 40%–a safety threshold often used for EM countries,” analysts wrote this month. So one pertinent measure to track is gross public debt as a percentage of output, which currently sits at 42.5% projected down from 45.5% in 2009. To this end, it’s importance to note that even if the political will, post-election, to curb spending is lacking the state could be afforded breathing room through continued improvement in its tax revenue/GDP profile, where it was tied with Mexico in last place as of two years ago.
More pressing, present concerns however relate to the country’s large and growing balance of payments deficit. While Turkey’s current-account deficit (CAD) sits at levels last seen during the 2006-2007 boom (6% of GDP projected, versus 2.3% year-end 2009), Barclays observes, and is a stark commentary not only on rising domestic, credit-fueled (27% y/y real growth in October) growth and low-savings, but also dependence on imported hydrocarbons and raw materials, compared with several years ago “the composition of financing is more precarious as FDI coverage of the deficit has fallen from 60 percent pre-Lehman to roughly 14%, twelve months rolling per Barclays (see graph left): “The remainder is short term trade credit and residents drawdown of foreign assets. The main capital inflow in the pre-Lehman years was medium and longer-term borrowing (ie, syndicated loans) by banks and non-bank corporates. Today, banking sector’s net borrowing is pretty much flat and corporates remain large net re-payers of debt. In other words, while the corporate sector continues to de-lever, past borrowing from banks is being replaced by portfolio money.” But while this trend is more EM than Turkey specific per se, analysts project that robust fundamentals underpinned by negative real interest rates to spur spending, as well as an overnight borrowing rate of just 1.75% (to discourage pure carry trades) and hitherto a lack of capital controls seen elsewhere make it more likely than not that short-term inflows will continue unfettered. That said, the strengthening lira, which is likely to see further appreciation in 2011 as core and headline inflation likely converge and a new CBT governor (in April) mulls the timing of inevitable rate hikes (from 7.00% now) will not do wonders either for exporters or for its CAD deficit, which Barclays projects remaining flat for the next two years. Short-term portfolio flows must ultimately be replaced by a renewed uptick in FDI though the FT noted last week that “high energy costs, rigid labor laws, high social security premiums and the formidable unregistered economy are all challenges,” not to mention “legal grey areas and bureaucracy.” Turkey’s EU ascent has always been predicated on its desire for recognition; for now, anyway, the scrutiny faced by prospective FDI should give it as much of the limelight as it desires, for better or for worse.
Caravan Capital Management’s recent paper on frontier equity markets makes several salient points. For starters, in reference to the S&P Frontier BMI Index and the MSCI Frontier Markets Index the fund notes:
“Commodity prices tend to drive corporate earnings indirectly through overall GDP growth, as well as the relative strength of many frontier currencies. As a result, the returns of the frontier market indices are heavily correlated with crude oil and copper spot price returns. In a regression the individual correlation coefficients between the annualized returns of the MSCI Frontier Index and the annualized spot price returns of West Texas Instrument Crude Oil and London Metals Exchange Copper were 0.51 and 0.32 respectively for the 10 years ending 11/30/2009. While investing in the frontier markets can provide an indirect hedge against inflation for investors based in the developed world, commodity price fluctuations are also a cause of return volatility.”
Per liquidity, one of the chief characteristics used to classify stock markets within emerging and frontier economies, the fund writes:
“While over $560 billion of securities traded per month for the emerging markets, only $33.7 billion traded for the frontier markets. However, even this large disparity is deceiving as most of that volume came from the much more liquid Gulf countries. When these countries are removed from the frontiers, total monthly volume decreases substantially to $7.4 billion. More dramatically, the monthly volume of all exotic [i.e. those countries not included by either of the two aforementioned indices] frontier markets was a mere $520 million per month over this period.”
On a per trade basis, this relative lack of flow translates into a per trade cost 5-18x (bp) that of emerging markets, the piece calculates. Finally, as to expected returns the paper highlights the fact that while the simple average of trailing P/E ratios for members of the MSCI Frontier Index vs. the country members of the MSCI Emerging Markets Index as of 4/30/2010 was 11.8 compared with 14.8 for the latter, “these lower valuations may not be wholly justified by this perception of risk, based on one important observation; many frontier equity markets are still dominated by local market participants who rationally demand higher returns to compensate for the country specific risk they experience. However, from the perspective of global investors, much of this country specific risk should be effectively reduced through diversification within a global portfolio.”
To that end, against the backdrop of lower volatility, not only do frontier markets exhibit “significantly lower correlations to the developed markets than do the emerging markets,” but even strictly among frontier markets diversification is more easily attainable than it is among emerging countries given that “in the five years ending 4/30/2010, the emerging markets averaged a cross correlation of 0.64, while the standard frontiers averaged 0.28, and the exotic frontiers averaged a mere 0.07.”
The FT recently concluded that emerging Europe “shares some characteristics with other emerging markets in Latin America and Asia, such as a cheaper workforce, but also some of the more negative aspects of developed Europe, including high levels of social spending and relatively low savings rates.” So does something have to give, or can the best of these economies have it both ways? As it stands presently, the piece noted, central Europe came out of the [credit] crisis divided into three parts–a central core consisting of members of the Visegrad regional grouping of Poland, the Czech Republic and Slovakia, “with fairly strong public finances, strong banking sectors and decent growth prospects,” the Baltics to the north which face prolonged pain and the Balkans to the south including Hungary, where two-thirds of household debt is mainly in Swiss francs (oy vey!) and draconian regulatory headwinds on domestic banks will likely stifle output and consumption for some time, per Political Capital, a Budapest-based think tank.
Poland and Slovakia are both attractive ways to play emerging Europe, though admittedly their performance is strongly correlated with Germany as the two have become somewhat integral members to that country’s export-focused supply chain. Poland’s deficit (7.9% of GDP) and rising public debt (55%) are troubling high and in addition to already pushing back the country’s initial 2012 euro adoption target, may ultimately require spending cuts, analysts warn. That said, part of the decifit hike has been a function of a pension system overhaul over the past decade whereby the country has shifted employee pension contributions to private funds from the state-run system in order to curb the rise of obligations as the country’s demographic pyramid deteriorates and also to meet the EU’s deficit and debt criteria. To this end, by 2020 Hungary is projected to have the highest old-age dependency ratio among emerging market economies of 30.1%, up from 24.0% in 2010, while other countries with an old-age dependency ratio over 20.0% in 2020 will include Poland, Romania, Russia and Ukraine. Yet against the backdrop of continued largesse (€67bn from Brussels between 2007-2013 have turned Poland into “the EU’s largest construction site”), increased geopolitical clout and a politically and economically pragmatic approach to Russia in regards to energy and trade, Poland may be in the perfect position to adroitly navigate away from the negative and towards the positive aspects of emerging Europe.
Cocoa’s political impasse-inspired climb (said presidential fracas actually dates back to late 2005, the initial election date) may have legs (March futures hit four-month highs in both London and New York yesterday) if indeed the row in Côte d’Ivoire between Alassane Ouattara and incumbent Laurent Gbagbo (both of whom have sworn themselves in as president) doesn’t subside. Per one trader: “We need a resolution pronto or the likelihood of unrest could continue. If it gets too hostile at origin, the steamship lines are less likely to visit [Ivory Coast] ports.” Still an ag-based economy (cocoa, coffee, palm oil), the country is also the continent’s largest rubber exporter and is seeking a bigger presence in oil and gas a la neighboring Ghana. Yet as The Economist glumly noted over two years ago, any return to the [relative] stability and prosperity it was once known for in West Africa may be difficult to achieve (for vastly different reasons) with either man in control:
“The candidates are not a reassuring lot. Mr Gbagbo was a fiery opposition leader who fought for years against Félix Houphouët-Boigny, who ruled Côte d’Ivoire for decades. Mr Gbagbo’s clan indulges in rampant corruption, especially in cocoa, which accounts for a third of exports and is worth $1.5 billion a year. With oil soon to be extracted in large amounts, Mr Gbagbo’s people will be keener still to hang on to power. Mr Bédié became president after Houphouët-Boigny died in 1993, made a hash of things, and offers little new. Mr Ouattara, long kept out of politics because his foes said he was not a native Ivorian and so was disqualified, proved his economic credentials at the IMF and in regional economic bodies but might find it hard to hold the fragile country together.”
That said, conditions underpinning the country’s latest crop are drawing kudos from farmers and analysts alike as unseasonal rain mixed with lengthy spells of sunshine during the typically-dry December season should yield higher-than-expected volumes. Keeping this in mind, says one commodity analyst, markets may be ripe for a sharp correction if, for whatever reason, tensions pass sooner rather than later.
JGW
Frontier Markets 