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.