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Following a four-month civil war and three missed coupon payments the Cote d’Ivoire ‘32 eurobond, which traded as low as 34 cents on the dollar last year but YTD remains, among hard currency sovereign debt, by far the best performing developing market credit, continues to look attractive given the recent IMF-World Bank Heavily Indebted Poor Country (HIPC) debt reduction scheme announcement of over $6bn (roughly one half of its present, public debt composition with the expectation that additional bilateral debt relief will be realized in coming years (though IMF forecasts still envision external debt as comprising around half of GDP through 2013, in spite of an expected 2x increase in gross investment which will help pad domestic output).  That yields remain relatively sticky to SSA peers, however (the bond yielded ~8.5 percent last Friday), is a testament not just to the still undeclared arrears repayment schedule (and formal exit of default) but also lingering social tensions as well as uncertainty regarding structural, institutional reforms in crucial (read cocoa/coffee) economic sectors and persistent, budget straining energy expenditures (last year’s subsidy to the electricity sector for instance, which is financed with a portion of gas revenues, amounted to CFAF 104.5 billion compared to a target of CFAF 74.8 billion) which officials hope will be offset by newly passed and thus hitherto untested tax reforms (designed to expand the revenue collection base).  To this last point, the Ouattara regime’s late-April foray into the regional debt market underscores that the need for external financing will be omnipresent, particularly with the trend of lower cocoa prices since March 2011 correlating neatly with the country’s newfound and expected current account deficit going forward which, per the balance of payments must be somehow financed.  However, said financing is largely tied to both the supply and demand prospects for the crop, and as we’ve detailed in the past the long term supply issues are highly dependent on replacing an aging tree stock and [concurrently] vastly augmenting yields.  Moreover even near-term supply concerns persist despite last season’s weather buffeted record surplus (evidenced by the market’s apparent backwardation), a signal for some at least that “reforms” may have been haphazardly rushed in part to appease Paris Club debtors at the expense of adequately addressing a host of concerns from domestic farmers.

The Ivory Coast initially defaulted on a $29m coupon payment to its $2.3bn dollar-denominated eurobonds due 2032 and looks to do the same again vis a vis a $28.6m interest payment due by June 30, per Finance Minister Charles Koffi Diby, though in fairness if the Greeks can get away with putting lipstick on a pig and deeming it a “soft reprofiling” so should anybody else.  To that end at least in the case of West Africa’s jewel there’s cocoa (not to mention oil, coffee, gold, cotton, palm oil and rubber) in them thar hills, a fact not lost on debt holders whose paper has now rallied 58 percent to roughly 55.286 cents on the dollar since its record low on March 16.  Moreover it seems that the path to normalcy is at least doable in one case–the African Development Bank just gave $169 million in budget-support funding while the IMF’s Rapid Credit Facility (RCF) may disburse as much as USD130mn (as well as start talks on a new three-year program which in theory could grant relief for some $3bn of external debt) to repair public infrastructure, production facilities and private property when a committee considers the Ivory Coast’s request for support in July–whereas the other conjures up images of square holes and round pegs (Moody’s now gives you 50/50 odds).  That said, as the IMF is quick to point out per the Ivory Coast, the security situation especially remains “a major concern,” adding that the state’s growth target of -6.3% (+2.4% in 2010) is “ambitious” and its fiscal position can be expected to “weaken substantially” in 2011 (a budget deficit of 8.5% is projected) given lower tax revenue collection and higher expenditures.  Thus, as analysts with Barclays noted, “while the IMF viewed that budget support from bilateral and multilateral donors was likely to be sufficient to cover most of the deficit, it noted that it is unlikely to be enough to cover substantial external debt service obligations due to official creditors this year.”  For now the wildcard continues to be cocoa, exports of which were halted during the crisis, and more pointedly how well President Ouattara is able to smooth over social division and quell ongoing violence–particularly in the western portion of the country which grows 250,000 tons a year, a fifth of national output, but [where] many farmers abandoned their plantations for months because of daily attacks from ethnic militias allied to one side or another [and where] villages were razed, and thousands of people displaced.”  Keep in mind even pre-crisis the infrastructure underpinning yields was questionable at best; throw in deserted farms and the looming threat of black pod disease and the IMF may be right to question future cash flows.

The interplay because geopolitics and equity markets–especially when it comes to relatively under capitalized and illiquid developing markets–has been well documented this year against the backdrop of MENA social unrest.  But when it comes to trading sovereign debt the importance of insightful political stability and transparency analysis becomes almost as integral a facet to assessing risk premiums as are more conventional fiscal measures.  Beyond Brics notes, for instance, the “strong recovery” in Ivory Coast ’32s which fell to 35 cents on the dollar during last month’s nadir and following a missed $29m interest payment at the beginning of the year but have since rallied to 54.6 cents.  If only I could have had that crystal ball when a risk consultant back in December emailed me out of the blue asking for my prognosis.  That said, while the bounce-back no doubt stems largely from Alassane Ouattara’s official ascent into power, social unrest remains problematic–especially since much of it hinges on the hitherto unresolved issue of land reform that also lies at the center of ensuring cash flows from cocoa–the economy’s lifeblood and thereby a bond holder’s best friend–remain stable.  Aid money will help meet debt arrears as will forgiveness of nearly a quarter of debt outstanding, but a fractious constituency may remain fractured longer than expected and shouldn’t be discounted.  Meanwhile, in similar fashion analysts with Barclays suggested taking profits on Nigeria’s 2021 Eurobond given its spread narrowing to date vis a vis the benchmark Ghana ’17s despite higher oil prices and improving fundamentals.  The call may be prophetical given news of ‘orchestrated’ post-election violence, the country’s history of slumping oil production following elections in 1999, 2003 and 2007, and an uptick in seized, illegal arms shipments to Lagos.  To that end, disruption to Nigeria’s light sweet crude output “would come as a double blow for refiners already scrambling to replace the loss from Libya,” per analysts.

Cocoa prices continue to seemingly stall now a full week now into the one-month export ban imposed by the UN-backed government of Alassane Ouattara, strengthening the case for at least an intermediate top.  May Cocoa surged 7.5 percent last week to an intraday high of £2,307 a ton in London on first word of the impending physical flow disruption, though it just as quickly pared gains and finished up just 2 percent at £2,160.  While later that week the price closed at a six-month high of 2,269, it currently sits at 2,175/ton and–to the degree that the overall market is in surplus (the FT noted that “even taking into account the problems in Ivory Coast, there may be a surplus of about 50,000-100,000 tonnes, breaking four consecutive years of poor crops, the longest shortage period in the cocoa industry since 1965-69″) thanks in part to an above average October-February harvest not only domestically but also in neighboring Ghana (which supplies roughly twenty percent of global supplies, or half that of the Ivory Coast; see chart right), the 33-year high of £2,714 realized last year will likely stick.  Lackluster demand growth will also tend to be bearish for short term prices: Rabobank wrote to clients in December, for instance, that “the slow rebound in growth [in the U.S. and Europe] after the financial crisis is a function of confectioners’ using substitutes such as palm oil and reducing product sizes to support margins” and is likely to continue in 2011.

Political uncertainty aside—a prolonged struggle could disrupt this spring’s mid-crop which in turn could fundamentally disrupt hitherto hedged trading houses and production makers—a long-term secular rise in cocoa remains viable given the lack of infrastructure and investment to date in the Ivory Coast.  Analysts note that “issues range from aging and mature trees which need renewal (cocoa trees mature approximately four years after planting while peak yields can be maintained for about 30 years); the lower usage of fertilisers and pesticide by farmers for tree maintenance and substitution away from cocoa into rubber.  Tempering this envisioned supply shock, however, is the possibility of an enduring uptick in Ghana’s cocoa production capacity—Cocobod, the state’s cocoa board, estimates this year’s crop is already 40 percent higher than last year and believes it will reach its 800,000 ton target by the close of the season (which thus far has helped make up for the estimated 100,000-300,000 tons trapped in Ivory Coast warehouses), and aims to raise annual production to one million tons within two years.  Thus far, officials state, better weather, increased use of pesticide and fertilizer and overall better planting techniques have underpinned the bumper crop.  An additional amount of uncertainty in the market stems from smuggling as well as the possibility of price differentials across countries—Ghana lost around 100,000 tons of beans to the Ivory Coast last year due to price arbitrage.  That said, increased border security and additional quality and monitoring personnel have largely curbed reverse flows, a Cocobod source claimed.

Cocoa’s political impasse-inspired climb (said presidential fracas actually dates back to late 2005, the initial election date) may have legs (March futures hit four-month highs in both London and New York yesterday) if indeed the row in Côte d’Ivoire between Alassane Ouattara and incumbent Laurent Gbagbo (both of whom have sworn themselves in as president) doesn’t subside.  Per one trader: “We need a resolution pronto or the likelihood of unrest could continue. If it gets too hostile at origin, the steamship lines are less likely to visit [Ivory Coast] ports.”  Still an ag-based economy (cocoa, coffee, palm oil), the country is also the continent’s largest rubber exporter and is seeking a bigger presence in oil and gas a la neighboring Ghana.  Yet as The Economist glumly noted over two years ago, any return to the [relative] stability and prosperity it was once known for in West Africa may be difficult to achieve (for vastly different reasons) with either man in control:

“The candidates are not a reassuring lot.  Mr Gbagbo was a fiery opposition leader who fought for years against Félix Houphouët-Boigny, who ruled Côte d’Ivoire for decades. Mr Gbagbo’s clan indulges in rampant corruption, especially in cocoa, which accounts for a third of exports and is worth $1.5 billion a year. With oil soon to be extracted in large amounts, Mr Gbagbo’s people will be keener still to hang on to power. Mr Bédié became president after Houphouët-Boigny died in 1993, made a hash of things, and offers little new. Mr Ouattara, long kept out of politics because his foes said he was not a native Ivorian and so was disqualified, proved his economic credentials at the IMF and in regional economic bodies but might find it hard to hold the fragile country together.”

That said, conditions underpinning the country’s latest crop are drawing kudos from farmers and analysts alike as unseasonal rain mixed with lengthy spells of sunshine during the typically-dry December season should yield higher-than-expected volumes.  Keeping this in mind, says one commodity analyst, markets may be ripe for a sharp correction if, for whatever reason, tensions pass sooner rather than later.

Reuters notes in its coverage of the Ivory Coast’s first election in over a decade that “if it goes smoothly, analysts expect it will unblock foreign investment in construction and telecoms and enable reforms to an ailing cocoa sector that feeds 40 percent of world demand.  It may also trigger a rally in Ivory Coast’s $2.3 billion Eurobond (due in 2032), Africa’s largest and one of its most high yielding (roughly 10.2 percent), issued in April in exchange for defaulted debt.”  The country has been effectively split between a rebel-held north and a state-controlled south since a 2002 civil war.  Similar to Botswana’s dependence on diamonds, the Ivory Coast’s fortunes are tied to cocoa (six million of Ivory Coast’s 21 million inhabitants make a living out of cocoa, according to the IMF), a concondrum the country hopes to alter by eventually diversifying its revenue into the rubber industry, power generation and oil exploration.  “With respect to investment, there is a lot of interest in Cote d’Ivoire, but people are waiting to see what happens,” said Wayne Camard, the International Monetary Fund country head.  “There could be substantial inward investment as well as local investment once security, and belief in the system, has been re-established.”  Cocoa prices hit their highest level in 33 years on the back of Ivory Coast’s low output, and many analysts wonder whether the country’s ability to meet rising demand will ever be adequate given the woeful state of its infrastructure and other supply-related issues.  That said, Blooomberg notes that “donor nations have linked the scrapping of $3 billion of Ivory Coast’s $14 billion in international debt to an overhaul of the cocoa industry,” meaning there is certainly incentive for more state investment going forward that would theoretically improve the industry’s aggregate supply.

Bloomberg notes that the pound, which is used to trade cocoa in Africa and in London, rose on Friday by as much as 2.4% against the US dollar after a three-day slump of 4.2%. Cocoa, which gained 31% in 2008 and has risen by 6.3% YTD, had fallen earlier this week based mainly on speculation that supply from Ghana, the biggest grower after Ivory Coast (the two combine for nearly 60% of world production), would expand because of recent rainfall in some of the country’s main producing regions that would boost the harvest (which started in September and runs until June).  On Friday, however, cocoa futures for May delivery climbed $23, or 0.9%, to $2,672 a metric ton on ICE Futures U.S. in New York.

Yet Michael Ragazzo, president of MBL Commodities Ltd. in New York, indicated that he is still “bullish” on cocoa because of the forecast for a third straight year of production deficits.  In late December, officials in the Ivory Coast, for instance, estimated that the upcoming 2008-2009 cocoa harvest would be 1 million tons, which is down from 1.3 million tons a year ago.  Perhaps another reason to be keen on the bean, however, is that over the past 6 months, the British pound has fallen more than 20% against the Euro and close to 30% against the dollar. To that extent, the pound looks oversold. Or is it? Kathy Lien wonders whether the quantitative easing that the Bank of England is expected to undertake will drive EUR/GBP back towards parity.

Financial Times filed a rather dour report recently on the sorry state of the Ivory Coast’s cocoa industry, which accounts for roughly 40% of global supply.  Prices in London rose by nearly 70% last year to reach 23-year highs last month, trading at £1,820 a ton (though that also reflects sterling’s fall).  Prices in New York, denominated in dollars, rose by more than 30%.

Today, the industry’s prospects appear decidedly sickly.  Political turmoil that followed the outbreak of a civil war in 2002 has hindered the investment needed to replace ageing trees. Cocoa-growing, formerly a source of pride, has lost its prestige.  The cloud hanging over Ivory Coast’s cocoa industry has fuelled a gravity defying rally in cocoa prices even as the global slowdown has caused prices for other commodities to slump.

With some care, experts say activity in Ivory Coast’s cocoa belt could rebound. But unless a rescue effort is mounted soon, analysts argue this year’s poor harvest could mark the start of a drawn-out decline that will boost cocoa prices for years to come.  “If the status quo continues, then the cocoa sector is likely to die a slow death,” said Daniel Sellen, lead agricultural economist with the World Bank in Abidjan. “A complete collapse of the sector cannot be ruled out if there is no action.”

With large numbers of cocoa trees on the cusp of the 25-year mark at which productivity falls sharply, some fear Ivory Coast could be on the edge of a structural shift towards years of declining production, leaving the world’s market more dependent on supplies from Ghana, Nigeria and Cameroon, and from Indonesia.

JGW

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