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As ratings agency reports go, Fitch’s latest Sub-Saharan write-up wasn’t so much controversial as it was cautionary; specifically, its point relating to inadequate infrastructure is one common to most if not all emerging and frontier economies (outside of Asia, at least), a discouraging and productivity/growth-stunting phenomenon The Economist duly noted last week while concluding that “most [Latin American] countries neither save nor invest enough [and] do not use their resources efficiently” due at least in part to an over-dependence on monetary tightening whereby “low savings, high interest rates and protective tariffs on inputs make investing unusually costly.”  Ultimately, moreover, ever burgeoning consumption in said economies–and by extension the hitherto elusive global re-balance fundamental to PIMCO’s ‘new normal’ paradigm–may be heavily correlated with just how efficiently this investment deficiency corrects.  To this end, McKinsey theorized last winter that the glaring disconnect between savings and the pragmatic need for more emerging and frontier-sponsored capital investment is destined to usher in a new secular shift away from equities and towards bonds over the next decade (as incentives align) meaning that this month’s drastic global equity dip may be more harbinger than herring.  That said, it may also invite an awkward limbo period for central banks as efforts to moderate inflation are tested by increased fiscal outlays which could augment borrowing costs even more if deficit to growth rates become overly stretched.  Nigeria’s current inflation picture is a perfect case in point: while July’s core inflation, which excludes farm produce items from the CPI, was unchanged from the previous month at 11.5% y/y, Barclays opined earlier this summer that “CBN Governor Sanusi has been very outspoken about government’s excessive spending” even though some it at least looks geared towards addressing a woefully underdeveloped electricity sector and oil revenues should be long-term sticky.   Yet the lion’s share of spending excess, per some pundits, stems not only from steep, public sector wage increases but also a patronage-driven political system.

While crude’s recent decline saw a concurrent slump in Nigeria’s 2021, $500mm sole Eurobond issue given that the state relies on crude exports for roughly 95 percent of foreign-currency earnings (vital in order to keep the naira within a 3% band of USD/NGN150 per the central bank’s unstated mandate), energy strategists with Barclays remained bullish with their near and long-term price forecasts, maintaining Friday that despite “concern about the potential path of OECD demand” against the backdrop of recent, downwards GDP revisions “a series of problems and disappointments on the supply side has produced a sharp slowdown in the pace of non-OPEC supply growth, providing the market with further insulation from the slowing of demand.”  Yet as we indicated last month the CBN’s habitually hawkish policy rhetoric, which manifested itself with a 75bp hike only one week later, continues to point to the prospect of further tightening in the near-term given the government’s need to attract capital flows and also cushion against inflation expectation uncertainties tied to the imminent implementation of a new minimum wage law (as well as an overall fiscal deficit projected to be just above 4% of GDP this year), removal of fuel subsidies and liquidity injections all in the coming fiscal quarter.  Thus while Nigeria’s FX reserves are still slated to remain comfortably above USD30bn to nearly one year’s worth of imports–a good metric for bond holders to monitor–the country’s yield curve remains in the midst of an upward shift that should still invite caution.

Analysts with Barclays noted in late June that offshore and local fund managers alike remained short duration in South Africa but based their valuations “on different frameworks (nominal yields and market inflows for the former, expectations of a tightening cycle and higher inflation for the latter).  Yet the somewhat swift shift in sentiment to longer duration debt (evidenced by a 22bp bull flattening in last Thursday’s yield curve) is not necessarily surprising; as we noted weeks before that, South Africa’s relatively muted core inflation coupled with myriad and mounting roadblocks in the ever-dithering labor sector were all in fact explicit red flags rather than herrings and screamed for continued slack in monetary accommodation.  Recent data only supports this thesis: Absa Capital reminded clients Friday, for instance, that on the heels of July’s wretched PMI figures published earlier in the week “showing a massive deterioration to 44.2 (53.9 prior)”, manufacturing sector capacity utilization is up “only 0.7pp y/y . . . indicative of the still relatively subdued activity in the industry, where utilization remains below its long-term average of around 84% . . . and around 15% lower than its pre-recessionary peak . . . [a reflection of] the headwinds the sector continues to face.”  The domestic forward rate agreements (FRA) curve has also taken note, with the shorter end (December) declining steadily from its 5.9 percent peak in May indicating a widening belief that the economy’s outlook is subdued and rates will stay soft at least until next January.  Yet even that take looks to be too sanguine, especially since current real GDP forecasts are built on the assumption that demand-side factors will make up for the aforementioned supply-side slump.  Because households remain leverage sticky (debt-to-disposable income remains just below 80%), banks remain spooked by credit quality concerns (the country’s National Credit Regulator recently noted that accounts 3 months or more in arrears continue to rise) and core inflation remains more than a full percentage point below headline inflation (where as before the last rate hike in 2006 it sat only 0.4pp under the target) we look for continued downwards pressure on the FRA curve as longer duration bonds will continue to be the vehicle of choice.

The Economist somewhat glumly opined this week that for all its recent progress (the economy has hitherto rebounded close to pre-crisis levels, up 5.6% y/y in 2010, the strongest expansion in the past three years) “Kenya still often feels like a country running to stand still.”  Indeed the near-term future continues to look bearish for both policy rates (the monetary backdrop leans towards tightening despite the central bank’s (CBK) latest 180 on its late June 175bp overnight rate hike) and the currency (USD/KES closed last week at 90.90, -1.0% w/w) as sharply surging headline inflation (+14.5% y/y in June from negligible levels at the end of 2010) on the back of food inflation (+22.5%) caused chiefly by East Africa’s worst drought in over 50 years will likely dampen growth (last week Absa Capital lowered Kenya’s overall GDP projection for 2011 from well above 5% to 4.8% while noting that Kenya Power, the country’s sole electricity distributor announced rationing measures) while also causing a marked deterioration in C/A balances (above 9% of GDP in 2011 projected from 7.4% in 2010) as high import demand for both food and fuel are exacerbated by weaker rates (buoyed additionally by CBK reserve replenishment)–creating a negative feedback loop of sorts for the country’s fundamentals in which the output gap widens despite increased fiscal expenditures as reduced or removed import duties help cushion price rises on one hand but also dent progress being made on the very infrastructure projects needed to sustain growth (and woo foreign capital investment) on the other, bloating fiscal deficits (7% of GDP projected, now 2x that seen in 2008) in the process and returning us to square one.  Meanwhile Kenya’s 20-share index is down nearly 25% YTD while the 91-day t-bill yield remained 9% at the latest auction compared with 3% at the end of Q1, a symptom of entrenched negative real rates.  If only such clouds contained rain.


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August 2011
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