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Investors eyeing Peru, South America’s fastest-growing economy over the last half-decade, remain cautiously optimistic that newfound president-elect Ollanta Humala, the former army officer who officially takes to the stage this week, is more bark than bite vis a vis alleged socialist leanings: the overall moderate ideology of recent economic team appointments, for instance, suggests more pragmatism than populism, though the ambiguity of an impending mining sector profit windfall tax regime saw the proportion of private sector firms considering increasing investment in the next six months decline from more than 50% in Q1 11 to approximately 10%.  This private investment pullback, in fact, combined with the lingering effects of contracting public expenditures (20% government-project capex reduction over the first four months of the year) stemming from the relatively restrictive election-time, legal framework, should contain inflation in the near-term (~3.0% in 2011 and 2.5% projected in 2012) though at the expense of the output gap, a dynamic which analysts expect will slash GDP growth from 8.8% last year to roughly 6.5% in 2011 (confirmed by the recent slowdown in the consumption of durable goods and investment) and around 5% next year.  What will be interesting to monitor, therefore, is the extent to which Humala’s policy agenda moderates (the minimal gasoline price increase, which left prices 16% below international prices per analysts, was a start) to compensate–a phenomenon which should translate into a public sector balance deficit (as a % of GDP).  At the same time, monetary policy (current rate is 4.25%) should remain dovish given the slackening backdrop, meaning said deficit’s inflationary effects over the longer-term could be somewhat amplified.  Yet fiscal expansion should not necessarily be viewed negatively; not only is Peru sitting on a sound fiscal foundation (expected gross public debt of ~22% of GDP and a reserves to external debt ratio of 1.12x), but spending could go a long ways towards reversing an inequality gap that appears to be boiling over: observers note that in January 2010, 35% of the social conflicts presented at least one event of violence, while in May 2011, this proportion increased to 51%, causing analysts with Barclays to remark last month that “Peru’s socioeconomic conditions and institutional weaknesses show the need for greater government presence in areas in which it currently lacks and in which all these social conflicts clearly emerge.”  Let the juggling act begin.

Nigeria’s relatively muted inflation figures for June (10.2% y/y from 12.4% in May) included food inflation (51% of CPI) at its lowest level in more than three years (9.2% y/y from 12.2% in May) and a drop as well in housing inflation (including household water, electricity, gas and other energy prices) to 16% y/y from 18.7% the month prior which, taken alongside the recent removal of regulations hitherto requiring foreign investors to hold the country’s sovereign paper for at least one year helped to shift the yield curve lower (ahead of Wednesday’s auction analysts with Absa Capital noted that “yields from the 2-20y space are now in the 9.5-11.8% range versus 10.5-13% in early July”).  That said a more prudent approach may consider that despite the suddenly surprisingly favorable inflation outlook, augmented no doubt by the naira’s 3.6% dollar appreciation over the past one and a half months (likely fueled in part by the aforementioned forex-friendly reform as well as a fairly volatility free 2.2mbpd of oil production in the past six months), central bank (CBN) Governor Lamido Sanusi’s rhetoric this summer has been continually hawkish for good reason: analysts expect inflation to creep upwards in the second half of the year to between 11-12%, a figure that excludes the impact stemming from the impending removal of fuel subsidies which remain in question but should ultimately help shore up at least one facet of fiscal vulnerability (Barclays wrote in July, for instance, that “currently the import price of fuel and added margins are more than double the retail price of N65/litre, which means one can expect the fuel price to rise sharply . . . [and] a significant effect on inflation”).  Thus while the CBN’s last policy rate boost came in May (+50bp) and the latest round of price inflation numbers may serve to somewhat delay another tightening bout, ultimately better entry points on the credit should reveal themselves in time.

Moody’s raised Sri Lanka’s sovereign rating outlook to Positive from Stable over the weekend, projecting sustainable growth rates of around 8-9 percent over the medium term on the back of a “peace dividend that has accrued to the economy and the security environment”–part of which stems from the tangible addition of the country’s now-bloated armed forces (which tripled in number during the recent civil war) from security and service work to “development work” (which certainly beats them having to address tough questions from pesky panelists).  Per some observers Sri Lanka still faces “a number of challenges including high fiscal deficit, lack of infrastructure (though the aforementioned military can help address that) and high dependence on short-term foreign financing”–though we quibble which much of that premise and agree with Barclays that a closer examination suggests an imminent, one-notch upgrade in the sovereign rating later this year to low BB, given “strengthening external balances, rising investment and progress on fiscal consolidation.”  Indeed, while the trade deficit will likely continue to deteriorate this year given commodity prices, the trend not only looks to be stemming but hitherto supportive remittances and FDI flows continue to keep the overall balance of payments in an advancing surplus.  Analysts note, for instance, that despite tensions in the Middle East (which accounts for the bulk of remittances) inflows were up 28% y/y in Q1 while FDI inflows, meanwhile, were up 160% y/y during the same period and look directly correlated to tourist arrivals (up 50% in 2010) and overall tourist revenues which, while currently roughly 1% of GDP “could easily double over the coming two to three years.”  Turning to the fiscal story the government appears committed enough to capping current expenditures at roughly 7% of GDP, while tax-simplification measures contained in the latest budget should augment revenue collection and lower the oft-cited public debt to GDP measure under 80%, a development which, coupled with the state’s plan to raise 4x the amount (versus last year) of its financing from domestic sources (up to ~78% projected) in lieu of external ones, should go a long way in addressing an admittedly large and growing debt overhang and determining its ultimate sovereign credit status.  Finally, per monetary policy sticky core inflation numbers to date given in part this spring’s fuel price hike and electricity tariff adjustment as well as ever-mounting FX reserves ($USD7.1bn in early June versus the low of $USD1.3bn in early 2009) will likely see the central bank (CBSL) willing to accept a stronger LKR as the primary normalization tool (assuming annual inflation remains somewhat muted and hovering around 8.0-8.5%), thus keeping policy rates (since January’s 50bp cut repo and reverse repo rates sit at 7% and 8.5%, respectively) unchanged and post-war growth rates that much more unfettered.  In sum, Sri Lanka is poised to outperform emerging-Asia peers as its post-war paradigm continues to unfold.

Morgan Stanley’s recent note extolling Nigeria’s potential to economically outmaneuver South Africa by 2025 doesn’t strike us as particularly riveting, if for no other reason that the terms of trade/consumption thesis upon which both ‘top down’ pictures presumably rest underpins fundamentals in one (per its 2011 projections Barclays writes that Nigeria’s current account–15.8% of GDP estimated, up from 8.2 last year–is “likely to record a healthy surplus in 2011 [while] FX reserves, at $38USDbn, are still comfortably above 10 months of imports”) while seemingly undercutting them in the other (fickle, portfolio funded C/A deterioration).  With massive inequality in both countries still the elephant in the room vis a vis inflation expectations going forward, ample reserves also leave the CBN with more arrows in its currency-defense quiver; CBN Governor Sanusi’s emphasis on an enduring 3% band of USD/NGN150 for the naira looks reasonable, though a growing fiscal deficit (still muted given overall, low debt levels of just below 20% of GDP) and the planned removal of fuel subsidies mean that even an anticipated further 75bp of rate hikes by year’s end could be inadequate.  Yet unlike in South Africa, where unrest feeds increasingly spiraling wage demands (which in turn supports real purchasing power and thus consumer spending, wears on the supply side and capacity utilization rates) and “dictator[s] in waiting”, social reform in Nigeria may have the potential to leverage an already buoyant informal economy and accelerate the contribution from increasingly important non-commodity sectors (Absa Capital wrote this week, for instance, that the National Bureau of Statistics (NBS) now expects average real GDP growth to increase from 7.9% in 2010 to 8% in 2011 largely as a result of increased activity in the non-oil sectors, particularly from trading, construction, finance and telecommunications).  That said, while social reform hitherto in Nigeria has been more than vote-snaring lip service (analysts maintain that the Niger Delta’s improvement to well over 2mn barrels over the past year are proof-positive that unemployed, restive youths have been allayed), cynics argue that promises aside, President Goodluck Jonathan is destined to feel the effects of North-South instability inherent to the latest governors’ row relating to implementation of the Minimum Wage Act.

Against the lingering backdrop of an overextended China (and by extension, Brazil et al.) and Friday’s shockingly moribund U.S. NFP report (as Zero Hedge tweeted, ‘less than six weeks until Jackson Hole…’) now is the time for portfolio managers to truly discriminate among emerging and frontier markets and specifically consider reducing exposure to high-beta names that are likely all-too uncomfortably correlated to the kick-the-can, er, ‘risk on’ trade.  Per Barclays, Qatar ’20 and ’30 sovereigns, for instance, as well as quasi-sovereign corporate names like Rasgas and Qtel are likely to benefit in the near-term not only from their hitherto underperformance (~20bp spread widening YTD) but from ever-improving macro fundamentals (21.5% y/y GDP, CA surplus 25.3%/GDP in June, a seemingly perpetually subdued, GCC-low 2% annualized headline inflation rate projected for 2011 and GCC-leading annualized export growth) as well as the implementation of the recently announced National Development Strategy 2011-16 ($USD226bn budget) that analysts expect will “boost the non-oil sector activities, particularly on the investment side.”  Furthermore fiscal stimulus in Qatar (money supply growth up 29.9% y/y in April versus GCC average of 17.3%) and its corresponding deposit growth (up 18.2% y/y) remains muted and quite manageable in the context of a budget breakeven oil price (now ~$40/b) more than half that of say, Saudi Arabia, while credit trends (bank credit to the private sector in Qatar expanded by 5% y/y in April versus a GCC forecast of 8.6% y/y in 2011 as post Arab-Spring liquidity mean reverts) also look positive.

While back-to-back easing announcements from Ghana left us surprised, nothing compares of late to the State Bank of Vietnam’s (SBV) 100 bp reverse repurchase rate cut (to 14% as of Monday) which came on the heels of June’s inflation reading of 21%–a 31-month high–and the ensuing consensus among analysts for a 100 point hike.  At first blush the dovish cuts seem counter to the state’s alleged, newfound resolve away from its hitherto growth fetish and towards a more prudent, macroprudential mantra.  Indeed, Barclays reiterated its “underweight” call this week citing heightened risk, though admittedly this comes just one month after it expressed a “constructive view on [the] sovereign” in the belief that “the government is taking appropriate steps to tackle growth, inflation, currency and banking system vulnerabilities.”  Yet a more nuanced take tells a different story and suggests that the SBV still may have its eye on the ball despite this latest Jekyll and Hyde routine.  Consumer prices actually slowed on a monthly basis in June, for instance, and broad money supply growth remains relatively subdued, up just 2.45 percent YTD versus 7.5 percent during the first five months of 2010, which bodes well for H211 figures and the thesis that this summer marks inflation’s peak.  To that end February’s announced policy paradigm shift has effectively reversed the once runaway spread between the unofficial USD/VND rate and spot (a proxy measure for domestic confidence in the currency), meaning that measures to curtail dollar lending and black market trading, as well as to increase the attractiveness of holding dong deposits are becoming entrenched.  What has failed to take hold, however, is a healthy borrowing and lending dynamic among domestic banks which explains why growth, at 5.6 percent annualized, still lags the state’s now twice-cut GDP target (6 percent currently for 2011 from 7-7.5 percent initially).  While “reasonable lending rates” per one CEO should be 15-18 percent and deposit rates at 13-15 percent, for instance, one report this week stated that banks were offering to pay dong deposits at 20 percent while charging companies roughly 25 percent, well above the central bank’s deposit rate ceiling of 14 percent and the catalyst for a further liquidity squeeze as companies become reluctant to borrow and banks reluctant to lend.  The vicious cycle has triggered a liquidity scare of sorts–at least in the country’s ‘productive’ sectors, i.e. agricultural companies, export businesses and SMEs–against the backdrop of further FX reserve development (USD13.5bn at the end of May from USD12bn at the end of 2010, per the IMF), part of the country’s strategy of managing an omnipresent trade deficit made feasible given historical sticky structural flows (FDI, remittances).  Macroprudential policy isn’t just about price stability, but also the way in which capital is deployed.  There’s no reason the SBV can’t pursue both agendas at once.


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July 2011
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