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Buffeted by an “unparalleled infrastructure, flexibility in production volumes and policy machinery”, all of which make it per Barclaysthe key player at the margin of the oil market” Saudi Arabia remains relatively insulated contra developed market-derived contagion–more so than any other GCC economy.  Increasing non-hydrocarbon imports, for instance, are a proxy for improving and resilient domestic demand driven chiefly by expanding private sector credit (9.8% y/y in October, compared with 8.7% in September) within a domestic banking system comparatively unconstrained by the high loan-to-deposit ratios (inversely correlated with liquidity) observed in UAE, Qatar and Oman, or the significant reliance on funding from European banks (and hence external funding base exposure to that sector’s ongoing deleveraging) seen in the UAE and Qatar (on the contrary funding remains largely based on customer deposits in Saudi Arabia at ~70% of total assets in 2011h1 versus 57.9 GCC avg).  To that end we remain intrigued (see our original thesis from last March) by the Saudi banking sector heading in 2012, home to nearly one-third of Global Finance’s recent “Safest Emerging Markets Banks” Top 20 rankings.  This doesn’t necessarily come as a surprise given capital adequacy (CAR) and non-performing loan (NPL) dynamics matched only by Qatar in terms of dual attractiveness while liquid asset ratios—i.e. cash, central bank certificates of deposit, interbank deposits and high-grade fixed income securities—are over 50% for certain Saudi banks (2x those seen by other GCC institutions).  And while one weakness of the sector in our view remains its credit/funding concentration (i.e. a predominantly corporate profile), banks such as Banque Saudi Fransi are targeting a larger retail base and the lower cost deposits and higher interest margins which come with it.

Admittedly the conservative asset growth and high risk aversion within the Saudi banking sector is largely a function of environment; aside from timeless speculation surrounding succession the Kingdom’s macro viability, for instance, remains intrinsically wedded to its swing-production power within OPEC and the ensuing, relative size and stability of its energy receipts which tie neatly in with the comparative,  aforementioned liquidity of its banks’ funding base (the government remains a major and/or majority shareholder of banks such as Samba Financial Group).  Indeed recent oil production cuts (from a peak of 9.9mb/d in August) during oil’s near-convergence earlier this year to the estimated fiscal breakeven oil price are symptomatic of an increasingly pragmatic state that, against an Arab Spring/Euro Malaise backdrop remains keen on fiscal expansion (25% y/y in 2011 and, despite official rhetoric of easing next year most analysts still envision spending momentum to continue with the overall effect being the state’s budget surplus will remain static if not increase slightly in 2012) and thus as ardent as ever in supporting a defacto price floor in crude (though citing non-OECD demand trends in particular, many energy analysts argue a reprise of oil’s post-Lehman price crash would be quite remote anyway) which should help translate into ‘backwardated’ markets for the appreciable future and thus even larger coffers for the Kingdom to tap.

I’ll be providing macroeconomic analysis going forward through Alterio Research, an independent research firm founded last year by Fabrice Yanou.

Last week I focused on Nigeria and this week’s concentration shifted to Kenya, where a number of dynamics have been in play since the summer, testing central bankers and causing a currency flux.  My hope going forward is to continue to evolve the sophistication of commentary while offering institutional and retail investors alike a top-down view of the primary economic catalysts inherent to a given Sub-Saharan sovereign, a shifting paradigm and backdrop against which equity valuations are continuously refined.  Last week’s macro report follows:

Against the backdrop of rising developed market equity correlation and volatility, in conjunction with ongoing liquidity contraction (i.e. what the IMF deems the absence of “financial lubrication”[1]) stemming not only from the post-Lehman deleveraging paradigm but also from the (best case) renovation or (worst case) deterioration and ultimate destruction of the EU’s monetary union, Sub-Saharan exchange rates have largely come under pressure in the second half of 2011, perpetuating a vicious cycle whereby both currency and inflationary pressures demand fiscal and monetary (policy rates) tightening that in turn tends to impede output (GDP) expansion.

From an overall macro fundamental perspective, therefore, we remain attracted to those countries wherein net reserve coverage (defined as foreign-exchange (FX) reserves plus current account (CA) surplus, less short-term external debt) provide monetary authorities with ample artillery by which to stem depreciation pressures through increased FX sales.  This ability, or lack thereof, we believe to be of the utmost importance in terms of stabilizing real rates of return that external capital demands in both the short and long run—investment flow that, if depended on to finance a CA deficit, for instance, is not merely valuable but in fact wholly vital to the state’s operations.  Moreover, strong coverage allows a given central bank the luxury of easing rates should global conditions require it, a further fillip to growth that in theory should also pad domestic equity valuations relative to peers given, all else equal, a less onerous cost of capital.

Nigeria, for instance, despite relatively strong reserves (albeit currently static and within a continual annual downtrend) has seen its inflation worries persist as the recently devalued naira, coupled with ominously high fiscal spending and next year’s proposed fuel subsidy removal (which is likely to push inflation up if implementation is phased in) indicate consumer price expectations will stay wedded to the upside.  That said, supportive bond yields keep inflation-adjusted real rates in a comfortably positive territory such that further downside currency risks are negligible going forward, in our view.  Yet the country’s CA surplus, at an estimated 9% of GDP for 2011, remains highly dependent on oil revenues and moreover, much like reserve, has decreased steadily over the past four years (~16.8% of GDP in 2007).  As demand side dynamics continue to underpin import growth, underwhelming FX reserve trends could deteriorate and further restrict fiscal and monetary options in 2012, acting as a headwind on both GDP and equity markets.

[1] Singh, Manmohan.  Velocity of Pledged Collateral: Analysis and Implications.  IMF WP/11/256.  Nov. 2011.

As hinted here earlier, sub-Saharan frontier markets may be distinguished in part by their monetary prudence and overall macro policies.  While foreseeing an impending rise in Eurozone related global market volatility earlier this fall (and by extension the SSA region’s near-term growth prospects), for instance, we theorized that commodity exporters such as Ghana would enjoy enhanced terms of trade, augmenting FX reserves as well as tempering price stickiness such that capital costs remained controlled while the option to ease interest rates remained relatively viable–all in contrast with net importers such as Kenya and Uganda (a notable exception to this ongoing thesis remains South Africa, for reasons outlined here, while Nigeria’s disappointing reserves accumulation YTD and hitherto pesky inflation have in turn brought about six different attempts to normalize rates during the year).  That said, a tipping point does exist even in the most price sensitive of countries such that once inflation pressures lessen (a function, it should be pointed out, not only of supply side factors but also demand side ones such as private sector credit expansion) monetary policy can remain static or even perhaps loosen such that local bonds look a bit more palatable.  Absa Capital noted yesterday, for instance, that following the deceleration in November’s headline inflation to 29% from the previous 30.6%, the Bank of Uganda’s (BoU’s) MPC left its central bank rate (CBR) unchanged at 23% (up 300 basis points from the last hike in October) at its policy meeting‘last Friday while observing that “prospects for lower annual inflation rates have strengthened”.  At the same time, Bank Governor Emmanuel Tumusiime Mutebile pointed out commercial bank lending to the private sector declined by 20.9 per cent between September and October, a trend he expects to continue as “the slowing down of bank credit growth will help to ameliorate inflationary pressures over the coming months”.  All this bodes well for fixed income, though an always mindful eye on domestic food prices wouldn’t be for naught.


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December 2011
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