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With Europe’s woes undoubtedly solved (trifling quibbles aside) and sovereign integrity intact (R.I.P. CDS), Tunisia and Morocco–two frontier markets relatively and acutely tied to the EU’s ultimate fate (to wit, 75% of Tunisian exports are destined for the EU) in particular seem poised to benefit.  For even if the realities of moribund or at least muted growth as well as an entrenched downwards trajectory in manufacturing PMI remain in Europe’s cards, the illusion of sovereign stability may now be adequately vivid such that external financing–namely remittances (per Barclays, the EU remains the main source of remittances to most non-oil exporters in MENA, specifically up to 85-90% in Tunisia and Morocco) and net FDI flows (deemed critical to boosting growth and exports)–won’t turn fickle.  The situation looks especially precarious in Tunisia, where FDI fell more than 150% q/q following the spring uprising and is projected to fall from 1.4bn in 2010 to 0.3.  That said, the country’s “so-far-smooth plan for its transition to full democracy” looks hitherto credible, while GCC flows (chiefly from both Saudi Arabia and Qatar) coupled with multilateral lending by international financial organizations such as the World Bank and the IMF (not to mention support from the Deauville Partnership which involves, in addition to the G8, the UAE, Saudi Arabia, Kuwait, Qatar, and Turkey) should, at least in the near-term, help support macro fundamentals by partially offsetting deepening current account balance deficits (5.2 and 5.6% of GDP in 2011 in Morocco and Tunisia, from 4.2 and 4.7 percent respectively last year) with fiscal balance support and thus provide an implied ceiling to both CDS and z-spread.


The FTs piece Wednesday on South Africa’s inequality risks highlighted “the contrast between expectations and reality” that underpins a “growing discontent among [the country’s] unemployed youth” (youth unemployment currently runs at roughly 50 percent, an estimated 2.m between age 18-25).  The same themes–though admittedly cultivated from a far different context in South Africa given apartheid–of income inequality and corporate cronyism are in fact being emphasized and examined across the world (in South Africa, substitute mining for finance and Julius Malema’s nationalization movement is not too far removed in ideology from that of OWS) in a “political black swan” moment of sorts that Nassim Taleb astutely warns may deteriorate into a broader and more meaningful class struggle.  The dilemma is magnified in a country like South Africa, however, if for no other reason than mining’s output fuels an appreciating terms of trade which, at least in theory, should help attack unemployment and drive domestic wage inflation across all sectors.  Yet said reality remains elusive, and the deficiency lies largely in persisting supply side gaps (momentum growth remained negative in September in both the mining and manufacturing sectors) that act as a headwind on growth (beyondbrics noted that “economists have revised down their GDP forecasts for 2011 from around 3.5 percent growth to 3 percent or lower and predict 2012 is likely to be tougher”) while both headline CPI (up to 5.7 percent in September from 5.3 percent the previous month) and real retail sales growth (up to 7.1% y/y in August from an upwardly revised 3.0% in July and above Bloomberg consensus estimates of 5.2% y/y) remain sticky.  This stagnating divergence is a central banker’s worst nightmare, and indeed the Reserve Bank’s rates (5.5 percent) are at a 30-year low, unchanged throughout the year since 650bp of slack between 2008-2010.  That said per SARB Deputy Governor Daniel Mminele “there is no evidence thus far to suggest that [inflation] pressures are becoming entrenched”; indeed, while most analysts don’t foresee any sort of monetary policy normalization until late 2012 at the earliest, we see room for further cuts as early as this winter.  Our continued recommendation of being long duration and short ZAR is thus a testament not only to the aforementioned supply barriers, but also to the probability that in such an environment discretionary spending will ultimately need a catalyst sooner rather than later (to wit, consumer confidence fell sharply in Q3).

Emerging markets collectively remain “high beta coupled”, so to speak, with their developed brethren per Wednesday’s Lex column, the implication being that an eventual price-to-book convergence and ultimately out-performance (per their relative fiscal fundamentals alone) are in the cards for those investors steely enough to latch on.  Yet while anticipating this homecoming of sorts, now may be the perfect time to finally take a more discerning eye towards EMs instead of lumping them all-together, given that our premise remains that the strong fiscal balance sheets and still largely dormant, demographic dividends upon which much of their stories rest can all-too-easily be undone by an uncouth central bank (not to mention shoddy governance).  Moreover not every economy is equally poised at the same moment to prosper equally, even from the loosest of monetary policies.  Martin Sandbu’s Monday FT piece on Chile and the “middle income trap” is case in point as it underscores the importance of total factor productivity (TFP)—i.e. how efficiently capital and labor are combined–in helping to ease a given population’s transition from developing to developed as its PPP adjusted, GDP/capita invariably rises (in fact, a World Bank report from 2008, “Unleashing Prosperity” demonstrates that TFP is the fundamental driver of real output among developing nations).  With this in mind Sandu notes that “Chile’s record is disappointing”, a mild understatement given that until only recently the figure has been negative.  Even a recent estimate of around 1% sits well beneath the average emerging market annual rate of 2.4% from 2005-2008 (compared to 0.2% in advanced economies for that same period), a number which has admittedly declined per The Conference Board “as transitional productivity effects appear to [be abating] in some of the major emerging economies.”  Thus, as the BCCH (Chile’s central bank) soon embarks on what the consensus now expects to be a 100bp easing cycle delivered in four consecutive 25bp cuts to help combat what analysts expect are downside risks to the 3.9% q/q saar GDP forecast for Q3 11, realize that while the monetary catalyst may be coming, the results could be underwhelming.

From this October’s Business Diary Botswana:

Zambian President-elect Michael Sata’s recent victory over former President Rupiah Banda and his ruling Movement for Multiparty Democracy (MMD) ended two decades of MMD power while concurrently creating a cloud of uncertainty not only for Zambia’s mining industry, which per the World Bank accounts for roughly 70 to 75 percent of the country’s export earnings (albeit only about 10 percent of its tax revenue), but also those supporters of Sata’s Patriotic Front (PF) party who, having been sold a seductive slogan of “more jobs, less taxes and more money in your pockets” may be in for a rude awakening.  Even prior to the hotly contested race, which culminated in a peaceful transfer on September 23rd during an inauguration ceremony in Lusaka, some pundits opined that the 74-year old Sata (formerly a minister in Kenneth Kaunda’s United National Independence Party which ran Zambia from independence in 1964 until its defeat in 1991, at which point he joined the MMD for its first decade of governance) would in practice stray from the provocative, populist platform he so ardently promulgated.  Per The Economist, for instance, in reality “the policies of [Messers Banda and Sanda] look much the same”, an increasingly popular stance among observers predicated not only on perception but also an acknowledgement of the Zambian economy’s precarious reality—namely the vulnerability of its balance of payments to copper prices (see copper spot’s technical analysis, inset).

The lion’s share of Sata’s campaign gusto centered around the premise of redressing the country’s chronic economic imbalance, a pitiful phenomenon whereby one of the continent’s historically richest countries, previously known as Northern Rhodesia while under British Rule until 1964, ultimately became one of the poorest in the following decades “largely as a result of nationalization, mismanagement, plummeting copper prices and soaring debt”.  And while burgeoning BRIC demand eventually provoked a newfound price paradigm for natural resources—most importantly for Zambia, China’s copper consumption grew from about 1.8 million metric tons in 2000 to nearly 5 million metric tons in 2008, trebling China’s share of global consumption in the process—“most Zambians have personally yet to enjoy their new-found prosperity [as] around two-thirds of them, mostly subsistence farmers, still live on less than $2 a day” (in fact, Zambia’s GDP per capita of USD1,300 is well below the median of USD2,960 for similarly rated countries, per S&P, a ratings agency).  Along with an aim to create more jobs and redistribute the country’s wealth, Sata thus vowed to revisit a 25 percent windfall tax on mining revenues that Banda had previously abolished in 2009.  In that interim, Sata reminded his base (a contingent built largely around metropolitan areas and particularly the legions of disenfranchised youth), copper prices had increased from around $3,000/ton to nearly $10,000 to the benefit primarily of Chinese-owned firms, many of whom it is alleged routinely flout domestic labor laws (to say nothing of at least two purported criminal cases of protesting employees being fired upon by their superiors) while paying “slave wages” with Banda’s implicit approval—a Faustian deal of sorts critics claim involved kickbacks.  Undeniably, China’s influence in the country runs deep.  As the Financial Times noted in January, not only have Chinese companies zeroed in on Zambia’s copper and coal reserves, but they have also staked a growing presence in manufacturing and agriculture.  To that end, the Zambian Development Agency reported this year that in a country with an annual gross domestic product of just $13bn, China alone has injected more than $1bn.  Yet the paradox of such largesse creates friction.  “The more we keep the Chinese out, the more we will stay impoverished,” lamented Sebastian Kopulande of the country’s International Trade and Investment Center.

Zeroing in on the mining sector and its role in a perceived larger sphere of corruption, Sata underscored the lack of transparency in the industry and the need for, at the bare minimum, enhanced audits in order for the Zambian Revenue Authority to more efficiently assess its tax owed.  Mounting evidence suggested, Sata stated, that under an industry practice known as “transfer pricing” (whereby subsidiaries of the same company were said to be trading with one another at “arm’s length” in order to theoretically shift profits more efficiently and thereby minimize tax liabilities) the bulk of Zambia’s copper exports, though destined for Switzerland (more than 85 percent of asset portfolios for sub-Saharan Africa pass through tax havens such as Switzerland, home to firms such as Glencore International AG, a leading integrated commodities producer and marketer) never actually arrived at the assumed destination, per Swiss customs data.  And according to one news report, a leaked memo authored by Grant Thornton, a consultancy, at the request of the Zambia Revenue Agency (ZRA) highlighted that the pricing structure for Swiss copper, though “remarkably similar to Zambia’s exported copper”, was nevertheless “six times higher than the funds Zambia received, facilitating a potential loss of some $11.4bn,” nearly the whole of national annual output.

Yet despite Sata’s initial pledge to tackle said opacity, many remain skeptical his ascendance will result in meaningful change given an ever-murky backdrop of slowing global growth and a violent commodity unwind triggered largely by China’s slowdown.  At September’s end, for instance, Shanghai’s Composite Index hit its lowest point since July 2nd, down more than 14 percent this quarter.  Meanwhile copper prices, which at the beginning of July stood “within striking distance of record highs” per The Wall Street Journal, slid by 25% in September alone, while Barclays Capital cut its copper price forecasts to reflect “weaker-than-expected economic activity during the second half of this year, as well as in 2012” (while admitting, however, that “the weak supply picture . . . should help to buffer the downside”).  With this in mind, many analysts do not expect Sata to rock the boat, so to speak, any more than necessary, if at all.  “The risk is that he is coming in at exactly the moment when global commodity prices may have just gone into reverse and we have seen before, including in Zambia, that when prices are falling it becomes much easier for investors to pressure the government to relax transparency,” noted Alex Cobham, chief policy adviser for UK-based charity Christian Aid.  In the meantime both industry and country-wide investors sit in lurch, given the metal’s importance to Zambia’s overall macro well-being.  Yet currency markets seem to suggest that a pragmatic outcome indeed looks most probable.  While the Kwacha fell from 4,810 to 5, 150/$USD during the week of, and immediately post-election, it has since largely recovered.  Moreover analysts point out that given Zambia’s purported mission to ultimately issue a USD500mn eurobond in order to finance infrastructure expenditure (mainly in the transport and energy sectors), it is likely to tread cautiously with the very industry it hopes to help it double copper production within 5 years, less international capital markets, already shaken by the recent global macro developments, become even more reticent.


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October 2011
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