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While we were not necessarily surprised by the Central Bank of Kenya (CBK) decision last week to keep its policy rate unchanged at 18 percent given the current and forward looking dynamics (short-end yields have narrowed sharply since January) to both inflation (Headline CPI 15.6 percent y/y in March from a cyclical peak of 19.7 last November, with food inflation—36 percent of the total basket—down to 22.1 from 26.2 and transport inflation moderating from 28 to 15.9 over that same period) and exchange rate appreciation (KES/USD up ~29 percent since mid-October partially on the back of timeframe restrictive currency restrictions relating to currency borrowing by offshore banks as well as final round policy rate hikes) we still find the overall tight monetary policy current to be subtly shifting underneath the surface as officials seem to be just as, if not more concerned with export (i.e. manufacturing) competitiveness than with underlying price pressures and currency stability (factoring in a weaker than expected Q4 2011, we expect overall economic growth rate of roughly 4 percent in 2011 versus 5.6 in the previous year as net exports act as a drag on consumer driven output).  That said while our target rate per a Taylor’s rule analysis indicates the CBK could reasonably slash some 400bp from its benchmark rate through 2012 in order to buoy growth, we acknowledge the MPC continues to see potential upside risks to inflation given a deteriorating current account deficit (~12 percent of GDP in 2011 versus 7.8 in 2010) as well as sticky core figures—11.2 percent y/y compared with the government’s short-term target of 9 percent, a testament to rising crude prices (~20 percent of the country’s imports) given food’s previously stated disinflation—as well as above-target credit extension that taken together keep its policy mindset circumspect, especially given lingering La Niña effects as well as unusual tropical cyclone activity in the Indian Ocean that will likely delay long rains, impacting electricity generation and agricultural production and further underpinning food and fuel prices.[i]

Additionally, on a technical front USD/KES rests gingerly atop its 200dma support line and appears to have made a sort of rounding bottom or saucer pattern typically indicative of a reversal in price behavior.  The pair now trades again roughly in line with the reaction highs of February, a level which also served as support one year ago while preceding an ultimately rapid ascent to the 106 level.  Simply put, therefore, the pair is at a critical zone of truth whereby a definitive break one way or the other would likely be more than transitory, a view corroborated by historical volatility (HV), i.e. the standard deviation of day-to-day log price changes expressed as an annualized percent.  For example, we examined a 5-day moving average of the ratio between the pair’s short term and long term HV, looking for spots whereby the relationship dipped below and then traded above .5, implying reversion to the mean volatility (we cite Professor Turan G. Bali’s 2006 study in particular regarding the mean-reverting behavior of stochastic volatility)[ii] and an impending price break.  Interestingly the recent potential bottom in USD/KES coincided with an approximate 6-week stretch of low (<.5) relative volatility, and given that the average has again receded we would suspect a similar, albeit more sustained breakout looms.  While given its recent history of protracted consolidation periods (see 2008-2009 and 2010-2011) we target a near term run to 84 in the coming month.

Trade recommendation:  While mindful of said currency dynamics rising real rates (i.e. policy rate less headline inflation), which have now shifted into positive territory, should offset technical movements enough such that the sharp decline in the short-end (-157bp in March from the previous auction) is likely to give way to a more tempered rate of decline such that in the near term we see enough near-term downside, rather than upside risk to inflation as well as an adequately supportive currency environment (assuming authorities maintain current restrictions) to continue to recommend un-hedged local bonds.

[i] Bali, Turan G. and Demirtas, Ozgur K.  Testing Mean Reversion in Stock Market Volatility.  September 2006.  Available at:


Despite myriad reassuring market signals, namely improved dong sentiment (evidenced by the absence of premium on unofficial USD/VND and an expected continued surplus of over USD2bn in the country’s balance of payments despite a likely [petrol fueled] customs trade deficit widening given an improving structural flow [i.e. FDI/remittance] to leakage dynamic), declining 5yCDS premiums (~530bp in October 2011 to ~270 last month) and annualized inflation projections now well below August’s 23 percent peak and last year’s 18.6 percent average (triggering a reverse repo cut in March, followed by refinance and discount rate cuts this month), the central bank’s (SBV) monetary tightrope act remains treacherous given ongoing commercial bank consolidation and moderating credit extension (11 percent last year [versus a 22 percent government target] and average annual growth >35 percent from 2006-10) that comes against the backdrop of slowing growth.  A mooted about plan to remove deposit rate ceilings by July, for instance, and thus adopt a more efficient market-oriented paradigm contrasts with the IMF’s opinion that lower deposit rates make it more difficult for weak lenders to attract funds (though in theory at least capped deposit rates may also pressure further dong depreciation) and is indicative of the slippery slope the SBV current navigates in trying to weed out weak lenders and bolster the dong’s credibility while concurrently lowering lending rates.

Yet while looser monetary policy feeds M2 growth (total money supply up ~1.06 percent in 1Q2012) and presumably fuels liquidity (local papers cited an unnamed SBV Deputy Governor in March, for instance, as saying that it was both “unfeasible and unnecessary to impose a cap on lending interest rates as [they] will automatically go down on surplus liquidity and easing inflation expectations”) interbank market health–which on its face appears healthier YTD–looks to also be correlated with the efficiency and speed of consolidation as falling rates, rather than a function of confidence, could be symptomatic of risk aversion as growing NPLs make stronger balance sheets within the sector less rather than more likely to lend to weaker ones.  As has been pointed out the vast discrepancy between how loans are classified may be a roadblock to reform as it tends to vastly understate the country’s climbing (since 2006) non-performing loan (NPL) trend (2012 sector NPL forecasts from Fitch, for instance, are more than 2x those provided by the state) given differences in loan classification between two accounting systems.

At present, per the Vietnam Accounting Standard (VAS) banks classify amounts of NPLs that cannot be paid in lieu of  the gross outstanding loan, while per the International Accounting Standard (IAS) method the entire loan amount is the basis (as an aside, a further reason underlying the country’s NPL gap may also relate to the inability of most Vietnamese banks to build out or adapt their internal risk management/credit rating strategies to the herein linked 2005 directive).  Larger than acknowledged NPLs would theoretically magnify risk and also threaten to accelerate a negative feedback loop which I’d argue strikes at the foundation of the very sector consolidation efforts deemed so integral to the country’s macro stability in the first place.  One proxy for this thesis, and the extent to which a liquidity crunch is already or may soon be underway is the velocity of interbank loans as bad debts and subsequent recollections between banks rise.

“Sell the news” could theoretically apply to the sudden rash of Saudi equity related articles of late highlighting bullish managers such as Mark Mobius and John Burbank (to that end we’ve been bulls for years; see archive) as well as the domestic Tadawal’s (TASI) underlying fundamentals including (i) a [forward] p/e of around 14.5 (all time historical highs are just over 15); (ii) a relative [dividend] yield versus local debt/peer payouts (i.e. ~0.6 percent on 1y government debt and a projected payout of 3 percent from the MSCI Emerging Markets Index, though admittedly myriad GCC countries sport a higher yield including Qatar, Abu Dhabi and Bahrain–all of which have lower premiums as well) and (iii) an impending invitation to foreign investors with an eye towards ultimately garnering MSCI ’emerging’ status.

That said even though the TASI looks to be stalling against 7800-8000 resistance after recently making 40-month highs, the long term retains its same promising premise–a fast growing (2.1 percent annual population growth versus the 1.2 percent global average) young and more economically/politically inclusive demographic underpinned by an oil and gas export-fueled investment boom that has spillover effects on other sectors (construction, building) and is itself a function of government spending, well capitalized banks (whose foreign liabilities have fallen in recent years against a large (15 percent) savings pool and moreover a generally non-interest bearing deposit base) with low exposure to European funding sources (and subsequent liquidity tightening) and an inherent competitive advantage particularly in the production of fertilizer, aluminum, steel and petroleum-based products.  In a sense most if not all of these factors are intertwined and dependent upon one another, which is either comforting or not depending upon one’s perspective.  Saudi PMI remains comfortably expansionary (~60) and in lockstep with aggregate demand/wage supportive fiscal spending (+ ~2.4 percent forecast in 2012 on top of a 23 percent increase in 2011), for instance, while credit volatility is also smoothed by the state via deposit growth.  As I related to someone recently one cannot understate the role that public sector deposits in Saudi Arabia play in supporting liquidity. Over the past 5 years Saudi banks have exhibited loan to deposit ratios ~80 percent at extremely low volatility relative to GCC peers. However, even during cautionary periods for the sector (i.e. the latest European bank/funding crisis) wherein Saudi commercial banks have increased their central bank deposits, government deposits in the banking sector have risen in kind, smoothing an otherwise net contraction in credit growth (% change y/y government deposits with local banks have trended upwards since February 2010) as gross private sector credit continues to rise (to this end the latest consumer borrowing data sits at +21.8% y/y, a record high).  The catalyst supporting the state driven dynamic is rising net foreign assets (NFAs) which in turn drives broad money growth (M3) and finally the money multiplier, meaning Saudi equities could theoretically still be ‘cheap’ for quite some time.

The IMF Executive Board’s lack of revelations in concluding its USD1.3bn Stand-By Agreement (SBA) this week with Angola (initiated in November 2009) was not surprising and moreover the expected final disbursement of 132.9 validates in our view the completion of a paradigm shift in terms of (i) macroeconomic stability and (ii) fiscal accountability (in this case another way of singling out the predictability of oil revenue transfers to the Treasury via [hitherto opaque] quasi-fiscal operations by Sonangol, the state oil-company-cum sovereign wealth vehicle).  To the first point the National Bank of Angola’s (BNA) introduction of a benchmark interest rate last fall (in addition to an interbank (LUIBOR) rate, which in practice acts as a guide for monetary policy and as a reference rate for commercial bank lending rates) provided a key fillip to enhanced monetary credibility upon which much of extreme exchange rate volatility traditionally emanates.  Indeed the BNA, which manages a floating exchange rate regime and utilizes an auction system as its primary tool for setting the exchange rate, saw inflation reach record lows in H2 2011 (from 15.3 percent at the end 2010 to within the 12 percent targeted band one year later) while its external position grew, allowing it to ease rates by 25bp in January while the 182-day T-bill rate, which began 2011 at 11.4 percent, fell to roughly 4 percent at the beginning of this year.

The disinflationary trend is an ideal backdrop for the newly effected energy sector FX regime requiring the financial intermediation of petroleum operations by banks domiciled in Angola[i], though the efficiency and ease of said defacto de-dollarization will hinge largely, the IMF notes, on the development of kwanza-denominated saving instruments.  The implication on domestic bank revenues going forward, needless to say, is quite positive, though what effects increased onshore dollar liquidity will have on the kwanza as well as the monetary aggregate are less clear.  To this end an IMF working paper on Angola from 2009 remains pertinent especially given how the country’s M2 and credit growth have rapidly surpassed nominal GDP growth since the global credit crisis:

“Excess liquidity, which is measured by positive deviations of M2 from its equilibrium level, adds to demand pressures, and contributes to inflation with a lag. This underlines the importance of closely monitoring the broad money growth as well as improving liquidity management. In this context, while greater sterilization efforts by the BNA are warranted to curb the rapid money growth, the analysis also suggests that fiscal policy has a role to play in sharing the burden of further disinflation by ensuring that public spending is in line with the existing macroeconomic and administrative capacity.”[ii]

This observation ties into the second point from above, namely the need for fiscal policy to scale up public investment as a prerequisite of sorts to economic diversification and inclusive growth as well as offsetting strong internal demand dynamics in the face of limited access to imported goods due to poor logistics (which underpins sticky core inflation).

Gross savings as a percentage of GDP, for instance, has actually fallen of late, diverging from the country’s growing current account surplus (itself a function of the country’s Cabinda Crude which ended February at an all-time high of 124USD/bl and accounts for ~96 percent of exports) which per the pair’s standing accounting relationship implies that investment has not only fallen in comparison with output but at a much faster rate (growth in surplus/output is 700bp more than the comparable nominal growth figure).  The question remains how to manage fiscal accountability with the need to address inherent, “structural weakness” in the non-oil sector (see Mahvash Qureshi’s 2008 study “Competitiveness of Angola’s Non-oil Sector: Challenges and Prospects”) given the latter increasingly looks to act as a long-term monetary headwind given rising internal demand pressures while the former remains a short term exchange rate driver, a quintessential catch-22 for government officials.

[i] Van Welzen, Pieter:  New foreign exchange regime for the Angolan oil and gas sector.  Available at:

[ii] Klein, Nir and Kyei, Alexander.  Understanding Inflation Inertia in Angola.  May 2009.  WP/09/98.


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