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Given that one of our core themes hitherto in 2012 for SSA relates to improved inflation prospects (based on myriad factors including base effects, firming currency dynamics and perhaps most importantly–given its typical CPI weighting–a marked decline in food inflation) and by extension a general tilt away from monetary tightening and towards [comparative] easing, local bonds continue to look particularly appealing given a secular widening in yields across the region since 2010 may be in the process of retracing. To this end this week’s Alterio report explored both Nigeria and Zambian local debt in terms of perceived impending [real] yield retracement potential:
Real [364-day T-Bill] yields look most attractive in Nigeria (nearly 4x the SSA average) where naira appreciation of over 2 percent since the beginning of the month also continues to outperform other countries in our coverage area given increased USD supply from oil firms (in addition to normal bi-weekly CBN auction flow) and decreased demand stemming in part from the ongoing, oil import subsidy probe. Furthermore monetary policy, which we now gauge as only slightly ahead of the curve (based on our estimates of neutral real prime rates and 1-year forward price expectations) should remain near term supportive despite a hitherto cumulative 575bp increase in the policy rate in 2011 given the still uncertain pass through effects of January’s fuel subsidy row detailed in our report last week. That said not only should any price spike be transitory in nature but it should also be comparatively muted given the real yield dynamic which we expect will only entice additional foreign inflows in the coming months. Underpinning yield retracement is ongoing fiscal discipline as the federal government’s commitment to maintaining a deficit of less than 3 percent in 2012 looks increasingly credible given the Budget Office’s statement this week that the benchmark oil price for the annual budget would remain USD 70/bbl.
Likewise Zambian inflation-adjusted yields (at nearly 2x the regional average) could also retrace in the short term despite the fact that policy rates already sit in line with the curve per our estimates and moreover unlike Nigeria currency dynamics are not nearly as supportive. The kwacha remains our second worst performing currency over the past twelve months, for instance, despite the expectation of a relatively subdued inflationary environment given the introduction last month of a revised [albeit still food-weighted at >50 percent] consumer basket (indeed CPI eased to 6% y/y in February from 6.4% in January as both food and non-food price pressures moderated) which should keep headline numbers within the central bank’s target band. To that end this week the USDA’s chief economist projected a sharp decline in global food prices for 2012, though given the opposite outlook for fuel prices as well as an increasing fiscal deficit (along with a comparatively low reserve-to-GDP ratio and our coverage area’s most taxing short-term external debt burden, per our original sin methodology) we fear that inflation could be stickier than thought such that our policy bias is now moderately tighter. Yet it should be noted that the government’s plans to increase external borrowing this year at the expense of lower local supply should place a defacto ceiling on yields, meaning that despite tighter liquidity conditions of late which saw the most recent T-bill auction’s overall bid-to-cover ratio decline to 0.6 from 1.2 the scope for further yield widening is limited in our view.
My latest contribution to Alterio’s weekly market review introduces two new metrics–the “original sin” calculation mentioned in my previous post which plays upon a theme explored by Barry Eichengreen, Ricardo Hausmann and Ugo Panizz back in 2003, namely per Paul Krugman “the long-standing notion that developing economies are especially vulnerable to financial crises because they borrowed in foreign currency” (though as Krugman aptly noted last fall even ‘developed’ countries have succumbed to said sin, one of several conundrums at the core of Europe’s existential crisis). The second is a derivation of John Taylor’s guideline for central bank interest rate manipulation that we hope will help shed light on the degree to which a given sub-Saharan monetary policy committee may be ‘ahead’ or ‘behind the curve’, so to speak.
The exercise in part validates our present OW position in Nigerian debt given current trend dynamics for foreign reserves that help ease an otherwise [comparatively] high short-to-long term external debt ratio. Moreover, the fact that Nigeria’s policy rate sits wholly inline with our Taylor Rule inspired target, along with our projection that regional inflation rates have peaked while pass-through effects from Nigeria’s recent, partial fuel subsidy lift are likely to be transitory in nature. To that end today’s inflation announcement for January, while 12.6% y/y compared with 10.3% in December was less pronounced than initially feared and moreover the naira’s continued strength (a function in part of crude) should act as a tempering headwind in the coming months such that the CBN’s 575bp front run of rates last year may have already effectively priced in even a temporary, H1 rise in inflation.
Manoj Pradhan’s thought provoking FT piece touches on some of the very themes and factors I’m attempting to articulate and quantify per my ongoing “contagion” score model now featured as part of the weekly macro analysis at Alterio Research and in fact expounds on the nature of my analysis hitherto via an ‘original sin’ metric, i.e. “the amount of short-term external debt relative to the total external debt burden as well as the amount of FX reserves held” as well as the consideration of those countries with current account deficits that concurrently run credit growth in excess of nominal GDP growth. Moreover, as Pradhan aptly points out, local authorities with balance of payments issues do have some mitigating mettle in their arsenal to combat relatively sudden capital inflow shocks–“when an economy is no longer able to roll over its gross liabilities (usually private sector liabilities), it may well use its [gross] assets,” he writes. Finally, while Pradhan correctly dismisses the notion that emerging markets have decoupled from developed ones (“the shock that triggers a sudden stop [in portfolio flows] is likely to come from developed markets”), frontier market asset managers are quick to point out that frontier equities are least historically correlated–.64 versus .86 (BRIC) and .92 (Emerging Markets) to global stocks, per Silk Invest’s 2012 outlook. That said the effects of developed-derived shocks remains real as the EU remains a major trading partner with certain African economies in particular. To this end, in line with its downward revision of global growth the IMF also revised Sub-Saharan Africa’s 2012 growth down by 0.3 percentage points to 5.5% (4.9% in 2011) and 0.2 percentage points in 2013 to 5.3%. Yet certain countries look comparatively insulated per the Alterio model; Ghana, for instance, features a diversified export basket, improving current account dynamic and benign inflationary environment such that its reserves to output ratio should remain healthy and growth relatively robust in 2012. We feel this is of particular importance to bond investors, though as future research of ours will highlight there are also ramifications on the cost of capital and thus equity valuations which may be overlooked.