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Markets hate uncertainty and Tuesday’s price action in EPU, Peru’s index fund, was indicative of such as investors eagerly eye Sunday’s impending Presidential run-off.  Interestingly, though Fujimori may be considered “more pro-business than the leftist candidate Humala” other observers point out that in fact “Keiko has few incentives to govern democratically, while Humala faces constraints that may force him to govern democratically.”  Meanwhile The Economist somewhat brazenly slags the entire lot off, opining that regardless of who emerges “the single-minded pursuit of foreign investment and economic growth that marked [outgoing President Alan] García’s presidency now seems to be drawing to an end [and] many Peruvian democrats will have nightmares in the coming weeks.”  A bit much, no?  Peru remains one of the fastest growing countries in the world, up 8.8% annually in 2010 (the BRIC median, for comparison) and projected by Barclays to trail only China for current year domestic output on the back of hitherto both monetary and fiscal stimulus.  Moreover the central bank (BCRP) has not overly lagged the curve (per Taylor’s Rule) and prices remain in line with the targeted 3% upper band; the 25bp hike on May 12 (to 4.25%), while below expectations, was more a commentary on the relative slowdown to date and the private sector’s risk averse approach to the election run-up whereby GDP proxies such as electricity consumption and cements sales have visibly dipped.  To this end, policy rates should tighten fairly substantially post election to 5.5% by year’s end and, per Barclays analysts, will likely be more front-loaded in the event Fujimori wins.  That said, they write, whomever wins will need to navigate the country away from a purely economic and more towards a social agenda: “Peru’s socio-economic conditions and institutional weaknesses explain why, despite impressive growth over the last several years, Mr. Humala’s seemingly radical proposal continues to appeal to a third of the population.”  While ominous sounding, it’s hard to completely divorce oneself from a pragmatic central bank in a high growth economy, especially when copper may finally look healthy again.  More uncertainty.


With 500 blog entries now under our belt (salut!) we persevere onwards and reexamine South Africa, the impetus being Macro Man’s recent roast–“to summarize, you have a labor market with excess supply and pockets of rapid wage inflation and your most profitable and export-friendly sector cannot seem to increase production to capture that increased demand as much as they should”–as well as a quick check-up on our call made back in March to short rand (ZAR) on strength.  As TMM points out, the essential paradox upon which South Africa’s macro picture rests relates to its widening current account (CA) deficit, which from a low 2.5% of GDP in Q210 is expected by analysts to rise to roughly 4.0% by Q411 despite the fact that its terms of trade have been on a secular favorable sprint during the past decade (correlated neatly, I’d argue, with China’s investment-intensive growth model).  This means that while the rand has enjoyed a nice commodity-fueled run, its strength feeds through to consumer spending and capital projects which in turn require a higher level of imports.  At the same time exports seem hamstrung as unemployment remains sheepishly high, production figures dither and an ever-wobbly ANC ruling party remains ever-wedded to trade unions–a partnership unlikely to inspire any near-term resurgence in the capital account (needed to finance the aforementioned CA gap) which as Macro Man uneasily points out, is basically all portfolio funded (i.e. it can vamoose quicker than DSK from a Sofitel penthouse).  Something has to give, and so far that’s been government debt–once roughly a quarter of GDP and now forecasted by Barclays to rise to roughly 44% in the next year.  With this kind of macro backdrop one could swear that China’s Minsky moment has already come, but alas, the country’s shadow finance sector has stepped in nicely to counter Beijing’s hitherto brake job.  Per the currency inflation continues to be muted versus expectations and growth estimates (3.6%) fall far below not only EM peers, but also where they were prior to the last cycle’s first hike in 2006 (5.1%), such that the consensus seems comfortable with the SARB’s 5.5% repo rate to remain rigid through year’s end.  That said per the Bank’s comments unit labor costs registered 7.7% in Q410, which as Bank Governor Gill Marcus pointed out was the result of high wage settlements (averaging 8.2% in Q111) and poor labor productivity (2.2% in Q410; a further clue into dithering exports?).  Coupled with continued reserve accumulation last month and last year’s outflow easement measures it seems clear that the SARB continues to worry about rand strength, though as the above demonstrates the strong currency may not only be fleeting, but also is surely a red herring when compared with the country’s more fundamental flaws.

Aside from the need to hold [parliamentary] elections later this fall, enact a council to draft a new constitution, elect a new president and then form a new government–all while managing an ever-simmering divide between sectarian and secular parties and also redefining its geopolitical role (a recent rapprochement with Iran, for instance, along with the notion of curtailing historically below-market natural gas shipments to Israel have the region’s moderates in a flux)–the most pressing issue underpinning valuations in Egypt centers around the country’s financing needs and specifically the stability of FX reserves and by extension portfolio flows.  In a recent research note Barclays analysts remarked that the country’s total production index (a function chiefly of manufacturing, construction and tourism) was down by 25.3% and 22% y/y in January and February and forecast that resulting pressures on fiscal and current account deficits (total state revenues for the nine months to date, fiscal year, are down 5%) could bring Egypt’s gross fiscal financing (i.e. fiscal deficit + debt amortization) needs to 36% of GDP–though much of this is held by local banks who can be expected to rollover debt holdings.  Equally troubling is the fact that although imports are down 15.4% y/y, inflation continues its ascent: March and April headline inflation rose 11.5% and 12.2% y/y, respectively, up from 10.8% y/y in February, and an average of 10.5% over the past year, driven primarily by fruit and vegetable prices but also exacerbated by a deflating currency and wage hikes and subsidies (the latter account for over half of public spending, “limiting the government’s room to manoeuvre in terms of immediate cuts to current expenditures” per analysts).  Nevertheless the expectation of an IMF-World Bank lead lifeline should be adequate and implementation will theoretically place a ceiling in investors’ eyes regarding liquidity risk and hence encourage foreign investment.  Barclays concluded, for example, that the “availability of larger reserve positions – something the IMF and neighbouring Arab countries can help with . . . will go a long way in reassuring investors that Central Bank reserves are enough to cap any significant EGP depreciation pressures and help reduce concerns surrounding the fiscal risks – both in terms of reducing the cost of financing and lengthening its maturity structure, as well as easing the medium-term liquidity burden on the local banking system.”  Ratios to keep an eye on regarding the success of this venture are the country’s overall deficit (estimated to be about 11.4% of GDP by June 2012 versus a pre-revolt estimate of 7.9%), and public debt-to-GDP (~77.9% of GDP compared with 72.8% at end-June 2010).  In the meantime, while capital inflows back into the bond and equity markets are likely to remain subdued, per observers, now might be the time to start thinking about a bottom: arguably sticky institutional foreign money accounts for the bulk of remaining portfolio holdings and the EGX30 now has roughly two months of stable performance under its belt since the March reopening.

Stanford economist [John] Taylor’s Rule is often used by analysts to get a sense of how far from “idealized” monetary policy a given central bank sits by taking into account information conveyed by output gaps, inflation, neutral levels for policy rates and the exchange rate; Taylor’s blog post from last fall approximates the level against which corrective actions should theoretically be taken and I like to think of it as how far ‘behind’ or ‘ahead’ of the curve rates currently sit.  While not a predictor of short-term policy action by any means, it can give insight into whether or not the market might be overly anticipatory of impending action.  Turkey, right now, is a perfect case in point.  New central bank (CBT) governor Erdem Basci’s first meeting last month seemingly extended the Bank’s hitherto dovish efforts to use unorthodox, macro-prudential measures rather than aggressive rate hikes to counteract the G20’s third-fastest growth rate in 2010, holding the policy rate (the one-week repo) at 6.25 percent but lifting the reserve requirement ratio [for foreign and local banks] on one-month lira deposits to 16 from 15 percent, and raising the ratio on FX deposits >1yr to 12 from 11 percent.   This against the backdrop of nominal wage growth (+18%), domestic demand (+25%) and credit growth (30-40%) in 2010 however that has aggravated the country’s deteriorating current account (CA) deficit beyond expectations (9.8% of GDP in March versus 8-8.5% projected) and, per last week’s Economist, will likely “pressure” the government following next month’s election (where AK is likely to win a third term of single-party rule) to “tighten fiscal policy and the central bank to raise interest rates”.   That said the CBT remains firm in its conviction that the economy is suffering the effects of over-borrowing rather than overheating per se, a distinction that should make all the difference to policy watchers and bond holders and makes the latter continued buyers of Turkish debt, especially as many market participants change their paradigm away from hawkish, rate hike expectations (at least near-term 2011; ultimately analysts see a rise to 8.00 percent by Q12012).  To that end, per Taylor’s Rule Turkey remains only slightly behind the curve (~200bp) when aggregating its policy and reserve rates, a function largely of lira appreciation as well as just a slight output gap (symptomatic of its 44% employment rate–the OECD’s lowest) which augments the stance that consumer lending growth is best left tackled through non-rate measures.  The former in particular has played a role in holding down inflation so far, though the CBT revised its inflation forecast for end-2011 to 6.9% (from 5.9% versus a 5.5% target) and consensus forecasts calls for 7-7.5% citing higher oil prices and taxes on textiles.

Analysts and pundits alike increasingly admit that when analyzing Venezuela, official public sector statistics “are becoming less reflective of the real performance of the country’s finances.”  For instance despite the 27.5% rise in price per barrel of domestic oil in 2010, state oil company PDVSA’s net profits fell 30.5% as “fiscal contributions” to the leftist government of Hugo Chávez rose 35%, the public sector deficit (as a % of GDP) shrank 1.6 percentage points and total fiscal expansion declined by roughly twice that figure.  Much like the country’s one-time “parallel” exchange rate in 2005, when per The Economist “Chávez pegged the bolívar at 2.15 to the dollar [but] also tolerated a legal parallel market that kept the country supplied with hard currency at a higher rate (providing countless opportunities for arbitrage)”, there now exists an informal public sector in Venezuela that not only systematically siphons money from the oil group (which in turn starves investment and hampers production, underpinning a rising defacto price floor but also arguably stoking domestic inflation pressures) but opaquely spreads it to, per Barclays, “quasi-fiscal” funds such as the “Fund for National Development” (FONDEN, which most critics blast as merely a 2012 campaign support tool) and a “Chinese Fund” that stems from the nations’ 2007 pact in which China gets uber-cheap oil shipments in exchange for an implicit revolving line of rainy-day credit.  Yet ironically while potential bond holders would normally quiver at the egregious lack of accounting inherent to this parallel public finance universe, PDVSA hoovering provides a handy ceiling vis a vis ever-pesky transfers to regional authorities.  Moreover the PDVSA bonds themselves, which most investors tend to link synonymously with the sovereign, are probably safer in comparison.  Analysts noted this spring, for instance, that creditors would likely fare better with PDVSA than the sovereign given the direct claim on offshore assets and USD denominated oil revenues.  The most immediate play on spreads, which widen as crude falls, would involve buying the firm’s 2017 [NY law, 8.5% coupon and ~12% yield] issuance and the 2014 [local law, 4.9% coupon] credit, the price differential of which (between the latter and the former) has actually increased this spring (despite the legal discrepancies between the two) due primarily to supply factors: the central bank, originally owned most of the USD2.6bn, 2017 issue and has been selling USD120m per week for the past three months.  As this selling subsides however, and more importantly as crude investors regroup and find a new trading range for the commodity (against the backdrop of a secular narrowing of the historically large gap between Brent and ‘heavy’ Venezuelan crude due to refining dynamics), look for the aforementioned price divergence to converge considerably.

Although the Bank of Ghana’s Monetary Policy Committee is widely expected to again maintain its Prime Rate–the rate at which it lends to commercial banks–at 13.5 percent, the state’s expansionary fiscal policy (namely ever growing public finances) is such that any unexpected slowdown in its current account (CA) deficit reduction (from 8.5% of GDP in 2010 to a 2.2% forecast in 2011 and dependent on high prices for gold, cocoa, and oil and a near doubling in the latter’s production to an estimated 120,000bdp by year’s end and over twice that by 2013) combined with inflation lingering above the Bank’s 8.5% target could tempt policy makers to hike the policy rate sooner than expected as a sort of preemptive strike.  Yet at last count March inflation (9.1% y/y) surprised slightly to the downside even as food inflation (which accounts for 45% of the country’s CPI) ticked higher to 4.7% y/y in March from 4.6% the previous month.  However given that the pass-through impact from domestic fuel prices–which are adjusted once a quarter,  jumped 30% on average in January and theoretically were set to be raised again last month–have already made their way through producer prices, which have risen each of the past two months, it seems likely that the inflationary trend will be upward; Absa Capital analysts, for instance, expect a 50bp hike by Q411.  That still, however, leaves the Bank relatively dovish within SSA.  With this in mind the recent commodity sell-off makes Ghana’s widening 2017 Eurobond spreads ever-more attractive, especially since the Cedi looks to remain supported by trade flows, foreign reserves and robust near-term growth prospects (12.8% projected in 2011).  Finally, the Bank’s latest credit extension survey [to both businesses and households] continues to improve, a positive for the country’s non-oil sector.

Several recent mainstream media pieces (including The Wall Street Journal linked herein), picking up on a research paper from the African Development Bank, underline a common point, though it’s one that frontier savvy mangers and investors have been harping on for quite some time now–namely that the growth rate of Africa’s middle class continues to accelerate, while consumption expenditures in turn continue to converge with developing countries (a phenomenon we’ve highlighted previously vis a vis Morocco and Tunisia, specifically, with Europe.  That said, the study in question–which delineates middle class by purchasing power parity and daily per capita expenditures (as well as the fact that it is “likely not to derive its income from agricultural and rural economic activities [but rather from] salaried jobs or small businesses), and further subdivides it into “floating”, “lower” and “upper” regions, admits there exists a “high concentration in the lower ranks” vulnerable to exogenous shocks (to that end, the percentage of the continent’s middle class without said wobbly “floating” class has actually dipped slightly in the past thirty years).  As the authors point out this applies most notably to the three most populous countries in Africa, Nigeria, Ethiopia and Egypt “where more than half of the middle class is in the floating category, living on less than $4 per day.”  Not surprisingly, the paper concludes that going forward “Africa’s middle class [will be] strongest in countries that have a robust and growing private sector,” while pointing out that statistically “enhancement of a country’s human resources through greater access to education and improved healthcare shows [the highest] positive correlation” with the size of a respective, middle class.”  So what’s an investor to do?  We continue to look for the most robust countries that offer exposure not only to these specific paradigm shifts relating to sustainable middle class composition as well as continual improvements to the ease of private sector wealth creation and the renovation and nurturing of physical (and social) infrastructure, education and health care, but also natural resources–wealth from which will [theoretically] help hasten a given economy’s transition away from commodity export reliance, encourage foreign investment and thus fuel the development and maturation of local sovereign and ultimately corporate debt markets–the true crucible and/or vanguard of enduring political, social and economic change to the continent, in our opinion.  The ever-mobile Mark Mobius, for example, hit on these same points recently, highlighting Nigeria, Ghana and Kenya in particular.

Nigeria’s key policy rate sits at 7.5 percent after the latest 100bp hike in March but look for the Central Bank of Nigeria (CBN) to steadily tighten in the coming months as March CPI (+12.8% y/y from 11.1 in February) printed above expectations and the prevailing fiscal trends suggest near-term relief may still be some time away.  To that end, analysts with Absa Capital noted recently that “the federal government’s plans to restructure the oil and gas sector also pose a risk as a reduction in fuel subsidies is planned.”  This of course is in addition to newly re-elected President Goodluck Jonathan’s ongoing electricity sector reform (which despite recent improvements per observers “is still only just below 4GW (August 2010 peak) compared with the target generation capacity of around 7GW” and a long-term target of 40GW that will ultimately require huge private investment), as well as his need to address an ever “turbulent” north, where UN data shows an average income of$718/capita in the northernmost 19 states–roughly half the figure of the remaining 17 states.  And while the IMF’s projection of 6.9% real growth in 2011 is largely a function of the country maintaining an average daily oil production at or greater than 2mbpd (revenue from which contribute around 80% of the government’s total), further unrest remains a real possibility such that the recent z-spread narrowing of Nigeria 21s looks overdone versus Sub-Saharan peers, especially when coupled with the CBN’s likely policy trend.  Yet a watchful eye on fallout from the impending Petroleum Industry Bill (PIB), monthly oil figures and FX reserves are all crucial for future re-entry, since the degree to which Nigeria can be comparatively shielded from rising food costs and can also subsidize lingering discontent is largely correlated to its energy prowess.


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May 2011
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