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Given the increased attention paid to so-called ‘fat tail’ events stemming hitherto largely from developed market credit excess and threatening to impact liquidity as well as asset correlations and volatility across countries and classes, I’ve decided to attempt to quantify or at least shed light on certain factors which may tend to indicate which economies could be perceived as the most or least vulnerable in a comparative sense to contagion stemming from the weaker trade and portfolio flows associated with periods of contracting global growth (in this sense a country’s ‘openness’ to trade may become a liability).  The “contagion score” model output, which will debut in this week’s Alterio Research report (and whereby proposed contagion propensity is inverse) is thus a function of a given economy’s exposure to trade and commodity prices (expressed as the sum of exports and imports as a percentage of output), its exposure to portfolio flows (shown by either its current account surplus or deficit, the latter of which must be financed either by foreign direct investment or more fickle portfolio flows) and finally the diversity of the makeup of its commodity export basket (and by extension its sources of foreign exchange).

As will be seen, Kenya rates comparatively high per our metrics—a credit plus in light of the various fiscal and monetary headwinds it stands to face in the coming year (this week Finance Minister Uhuru Kenyatta revised real GDP growth down to an expected 5.3 percent in 2012 from the earlier 5.7 projection) including chronically high inflation which, policy rate normalization notwithstanding has perpetuated a marked deterioration in the country’s terms of trade (i.e. export against import value) amplifying a negative net contribution to GDP due to a higher import bill.  To this point, however, we indicated last month the possibility of “a cyclical peak in both rates and inflation” which last week the Central Bank of Kenya’s (CBK) MPC validated, at least for the near term, by keeping its policy rate unchanged at 18 percent while citing a decline in inflation in December (18.9 percent y/y from the previous month’s 19.7) on the back of falling food and fuel prices as well as a contraction in private sector credit demand in November.  Today this thesis was further supported when January’s year-on-year rate slowed to 18.31 percent, though it must be noted that with the smallest Reserves-to-GDP ratio among our SSA coverage, the central bank’s shilling-shoring policy of liquidity sterilization may be tempered enough in the coming months to keep it in a definite wait-and-see policy approach.

Moreover any perceived inflection point in inflation also may be a harbinger of stalling growth.  Hawkish monetary policy certainly played a central role in the shilling’s dramatic year-end turnaround; however as a report this month from HassConsult (which maintains and publishes the country’s sole property price index) demonstrates, higher policy rates concentrated in the final months of the year also influenced a corresponding rise in commercial lending costs, fueling in turn an ensuing glut of delinquent or non-performing loans  that are likely to dramatically impede bank balance sheets (from both an asset and loss reserve standpoint) going forward (Kenya’s mortgage industry grew from Sh19bn in 2006 to Sh61bn in 2010 per a joint CBK/World Bank report) and thereby temper a construction boom labeled last July by the Kenya National Bureau of Statistics (KNBS) as one of Kenya’s top performing sectors having grown by over 10 percent y/y.

While the mere fact that western outlets are openly pontificating in advance on the possibility of an African, or more pointedly, a ‘Nigerian spring’ distinguishes the current fuel subsidy row from the MENA wide, spontaneous surge ignited last year by a Tunisian street vendor’s self-immolation, there is a fil conducteur of sorts–namely an “ever simmering, north-south regional and religious bifurcation” per my macro commentary from last week’s Alterio Research report.  It would be a mistake, however, to simply equate various cultural tensions given at a minimum their inherent contextual and historical differences.  And it would be equally erroneous to expect markets to do so.  Nigerian ’21 yields actually narrowed despite mentions of an industry wide shutdown as the subsidy removal is deemed essential to its credit status per S&P and long term positive for the state’s creditors.  Left unanswered, however, is how the government can simultaneously meet its stated goal of reducing its fiscal deficit to less than 3% of GDP–a key tenet per its central bank in stabilizing the exchange rate and interest rates–while under increasing pressure by the aforementioned social divisions to maintain security and also address myriad and ever-mounting grievances.

Excerpted from this week’s Alterio Research report:

Given in particular the success of Namibia’s USD500mn maiden Eurobond last fall which saw an over-subscription of roughly 5.5x—largely a function, per pundits, of its perception as a proxy on SSA commodity wealth with a similar [Fitch] credit rating (BBB-) to South Africa (BBB+) but an approximate 200bp added spread—most observers expect Zambia’s impending offering in 2012 to be similarly received against a supportive macro backdrop defined chiefly by copper’s potential and relative price resiliency (in the face of developed market aggregate demand contraction) as well as accommodative monetary policy unconstrained by overly zealous inflationary pressures.

To the first point much like the supply side dynamic for crude whereby prices are likely to be supported going forward by limited spare capacity and inventory cover (irrespective of events stemming from China, Europe or even Iran), global mine output for copper—bluntly described by one analyst as ‘disastrous and getting worse’—was on track in late November to contract annually for the first time since 2002 while physical indicators in China (i.e. wire and cable demand and scrap shortages) now pose upside risks given deep discounts already ascribed to the effects of a credit-induced market crash there.  Such price stickiness would not only be welcome to Zambia, where the potential pace of Copperbelt output expansion over the next several years stand to make it the fifth-largest producer in the world, but somewhat imperative to post-election fiscal ambitions and thus of utmost interest to its creditors who will monitor the continued health of a current account balance now slightly in surplus (the 2012 budget, for example, is characterized by increases in social spending and farming subsidies as overall spending is slated to rise to 26.5 percent of gross domestic output from 21 percent).  To this end President Michael Sata’s decision to double mining royalties but withhold a much-ballyhooed windfall tax was not only prudent but in fact obligatory in our view given the unfortunate reality of infrastructural bottlenecks (i.e. transport and power supply related) and skilled-labor shortages that for the appreciable future will relegate Zambia to being a comparatively inefficient, high cost producer (though admittedly bond proceeds would theoretically begin to erode at least some of these concerns).

As to central bank easing, strategists suggest that Sata’s election in fact signaled a monetary policy paradigm shift towards cheaper funding costs.  Indeed within one week of former President Rupiah Banda’s defeat then-central bank Governor Caleb Fundanga, credited by some with helping to temper inflation into single digits for the first time in three decades, was removed.  Since then a 300bp reduction of the reserve ratio for both local and foreign currency deposits as well as the core liquid assets ratio, coupled with a general reduction of base lending rates (for now Zambia lacks an official benchmark rate per se) augmented liquidity while headline inflation fell sharply over the last three months of the year (7.2 percent y/y in December from 8.1 percent in November and 8.7 percent in October).  Taken together, and alongside a fairly resilient currency (due in part to central bank support) real yields remain attractive going forward as investors embrace a new political and perhaps monetary landscape in the new year.

JGW

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