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Shedding over N4 trillion of toxic debt to  the state-run AMCON starting in 2010 was the first step in a cycle for Nigerian banks which has now come full circle in that still subdued impairment charges have neatly correlated with rising ROEs and improved capital adequacy ratios (CAR)–now up sector-wide to  over 17 percent from sub-10 percent levels  two years ago–that reflect, in part, lower risk weighted assets–once a headwind but now collateral for high yield paper that[alongside sticky money market rates] pads net-interest margins as well as overall net interest income in the face of suddenly sluggish credit growth (a phenomenon the central bank (CBN) labeled this spring as “indicative of a disturbing trend of growth in lending to States and Local governments at the expense of the core private sector”, though as RenCap analysts point out roughly 80 percent of Nigeria’s private credit goes to sectors of the economy that account for ~23 percent of real GDP growth).

Banks’ role in developing the real economy (read providing credit) comes concurrent, however, with a continued drive to (arguably) over-provision, seen for example in Diamond Bank’s 1H12 results wherein provisioning rose 18.3 percent q/q against an annual impairment decline of roughly 10 percent–an example of the differences stemming from the newly adopted International Financial Reporting Standards (IFRS), which replaced Generally Accepted Accounting Principles (GAAP) and has had a direct impact on lowering the aforementioned impairments at certain banks while actually raising required provisions at others: analysts stated that First Bank , Zenith and UBA all saw impairment charges decline between 20-38%, for instance (in essence the method of provisioning is based upon an informed rather than prescribed rate assessment process).  Yet to what extent banks build out and/or adopt the capacity to leverage the new standard standard and moreover apply it effectively to future asset buildout is just the sort of “sustainable change” alluded to by the CBN that will define and ultimately differentiate Nigerian banks once general  impairment drivers disappear from earnings and funding profiles become more competitive.   Moreover,  some pundits also fret about how the IFRS mark-to-market ethos will impact various [hitherto opaque] credit portfolios, especially given how counter-party credit risk will imediately be passed onto balance sheets and require offsetting flexibility in reserving.

Alongside overall asset and non-interest income growth, Fitch wrote last fall that “cost management [can be] expected to take on increased focus” within the Nigerian banking sector; indeed, most explictly this sort of “efficiency”  (often proxied by non-interest expenses as compared with revenue or in some cases total assets) may be magnified given the fine line between containing risk and capturing its returns inherent to a business model that post-Lehman and under Basel III looks to discourage rather than encourage it in the first place.  Touting falling NPLs and higher capital levels  as a sign of “strength” is thus somewhat misguided.   A recent paper in fact (“Effect of Capital Adequacy on the Profitability of the Nigerian Banking Sector”) reiterates the “non-significance between CAR and selected bank profitability and performance metrics” while suggesting regulators focus rather on “intrinsic elements of bank operational activates” in terms of cultivating stability.  For Nigeria’s banks, the work has just begun.

From Alterio’s SSA report last week:

Countering relative disinflationary trends across SSA are diverging currency dynamics which can be swayed by both fundamental and technical reasons.  The Central Bank of Kenya’s somewhat surprising decision this week to keep its policy rate unchanged at 18 percent, for instance, is otherwise shilling supportive in both the near and medium-term as it comes despite higher-than-anticipated declines in both headline CPI (16.7 percent y/y in February from an 18.6 annual average over the preceding two months) as well as private sector credit growth (28% y/y in January versus 30.9% in December 2011) and against a backdrop of lower food inflation and impending base effects which should further reduce price pressures despite hitherto sticky core inflation (ex food and fuel) that detracts from the country’s balance of payments.  Technically the shilling has returned to levels not realized since last April at which point it began a fairly hasty plummet of over 20 percent against the dollar (characterized by a nasty feedback loop whereby negative real rates on short term [91/182-day] debt—which ultimately rose over seven-fold over the course of just a few months—initiated ever strident dollar demand as the central bank furiously tried to maintain its import cover ratio) while finally peaking in October.  Given our subdued outlook for inflation as well as the central bank’s hitherto ‘ahead of the curve’ hawkishness over the past year (+1200bp overall since January 2011) other things being equal (they never are) present levels (i.e. 82-84 consolidation) should support a USD/KES bottom and ultimately provide an impetus to the upside past 83.6 and through the 84 level.  That said even if the shilling ultimately retraces some of its near-term rally, macro conditions are such that 2011’s volatility can be comfortably set aside for the appreciable future, a plus for both public and private equity risk sentiment.

That said, though credit growth has subsided Kenya’s MPC remains unsatisfied, we feel, by demand-related pressures on both imports and consumer goods.  As a percentage of output Kenya’s private sector lending still outpaces M2 money supply, a relationship authorities would prefer to invert.  Therefore KES weakness may also be dependent on the pace of further private sector deleveraging.  Looking to Nigeria, on the other hand, one may find a potential USD/NGN bottoming that could signal perceived transitory inflation dynamics are extensively capped to the downside as well given an ongoing secular trend of dollar demand for imports continuously exceeding supply.  Fundamentally the currency has deteriorated for over a year as dollar demand for imports generally exceeded supply while last fall the central bank, failing to meet demand at the official market, lowered the midpoint of its exchange-rate band to 155/dollar from 150.  Concurrently, however, from a technical level the pair also looks problematic; indeed a glance at the weekly chart since Q42010 shows both strong support and resistance at 155, while recent hammer patterns indicate that a move back towards 160 is increasingly likely.

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.

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.

As hinted here earlier, sub-Saharan frontier markets may be distinguished in part by their monetary prudence and overall macro policies.  While foreseeing an impending rise in Eurozone related global market volatility earlier this fall (and by extension the SSA region’s near-term growth prospects), for instance, we theorized that commodity exporters such as Ghana would enjoy enhanced terms of trade, augmenting FX reserves as well as tempering price stickiness such that capital costs remained controlled while the option to ease interest rates remained relatively viable–all in contrast with net importers such as Kenya and Uganda (a notable exception to this ongoing thesis remains South Africa, for reasons outlined here, while Nigeria’s disappointing reserves accumulation YTD and hitherto pesky inflation have in turn brought about six different attempts to normalize rates during the year).  That said, a tipping point does exist even in the most price sensitive of countries such that once inflation pressures lessen (a function, it should be pointed out, not only of supply side factors but also demand side ones such as private sector credit expansion) monetary policy can remain static or even perhaps loosen such that local bonds look a bit more palatable.  Absa Capital noted yesterday, for instance, that following the deceleration in November’s headline inflation to 29% from the previous 30.6%, the Bank of Uganda’s (BoU’s) MPC left its central bank rate (CBR) unchanged at 23% (up 300 basis points from the last hike in October) at its policy meeting‘last Friday while observing that “prospects for lower annual inflation rates have strengthened”.  At the same time, Bank Governor Emmanuel Tumusiime Mutebile pointed out commercial bank lending to the private sector declined by 20.9 per cent between September and October, a trend he expects to continue as “the slowing down of bank credit growth will help to ameliorate inflationary pressures over the coming months”.  All this bodes well for fixed income, though an always mindful eye on domestic food prices wouldn’t be for naught.

The combination of expected-persisting monetary accommodation along with a hitherto sticky, macro-proof global demand profile for diesel (influenced further by the looming likelihood in China of a weather-aggravated supply shortage in the coming months) make West African crude and, by proxy, its sovereign credit our holiday frontier market wish list security of choice.  The latter phenomenon–i.e. the burgeoning diesel/gasoline spread (see chart below)–continues to play on an ongoing theme, namely per one pundit the “diverging drivers behind the consumer and industrial activities as [developed market] high unemployment and stagnant wages continue to crimp consumer spending, while industrial and manufacturing activity [particularly in developing economies] are revving up.”  Barclays energy wonk Paul Horsnell further elaborated on diesel’s EM-fueled, relative buoyancy in a research note from last week:

“Ever since the migration of non-OECD countries to the margin of the oil market, diesel demand has received a significant boost on a global scale, given the bias of diesel in the oil mix in these countries. Its dominant position in commercial freight traffic has made it a fast growing demand component in countries characterised by large distances in internal trade and by strong underlying economic growth. For instance, in China, significant government investment in the road system and a mandate in 2000 that all trucks should run on diesel by 2010 facilitated the rapid expansion of domestic diesel demand. Beyond road transport, diesel also continues to be the primary fuel employed in China’s rail system, as well as being a major fuel for several significant types of marine transport. A similar picture can be painted for India, where diesel makes up 70% of road fuel use due to the intensity of truck and bus fuel consumption as well as the increasing penetration of diesel within the passenger car segment. In a country with some degree of oil product price subsidisation still in place, diesel prices are considerably more politically sensitive than gasoline. It has, therefore, usually proved easier to allow retail gasoline prices to rise with international markets, while retail diesel prices can often be stickier, with the current retail price discrepancy between gasoline and diesel almost double in India.”

Thus despite this weekend’s report indicating Asia would cut its African sourced imports to a three-month low, we expect lower or “sweet” sulfur blends (about half of the average Brent) from Angola and Nigeria (versus heavier or “sour” grades from Saudi Arabia and Iran) and their associated higher (up to twice more) distillate yield to continue to be in vogue.  The Chinese in particular continue to suffer from tight supply side dynamics–“especially in the country’s Northern, Eastern and Central regions” per Horsnell–such that net product imports (at 322k b/d in October, higher than the year-to-date average of 286 thousand b/d) will likely continue to trend up.  And while Nigeria, Africa’s largest oil producer, plans to export 2.18m b/d of crude next month, with Angola second at 1.72m, we remain impressed with the relative price stability in Ghana in the face of oil output that, while growing, still fell short of expectations.  Granted, Ghana’s fiscal targets (both its own and those set by the IMF) were predicated on abnormal output, and thus the initial 5.5% of GDP deficit estimate may turn out to be a bit pollyanna given President John Atta Mills’ looming showdown with Nana Akufo-Addo (close runner-up in 2008) next year.  Yet inflation expectations remain sanguine enough (CPI +8.6% y/y in October from 8.4% in September, in line with consensus, while non-food inflation was unchanged at 11.3% y/y, suggesting still modest inflationary pressure per analysts) that the country’s 12.5% policy rate will most likely remain unchanged into 2012.  To echo our sentiment from last spring, therefore, Ghana’s 2017 Eurobonds remain attractive versus peers.

Market frenzy received additional filips this week upon rumors that not only may China opt to essentially underwrite Italian debt (adding further confusion, perhaps, to the whole ‘Made in Italy/China” kerfuffle), but furthermore that perhaps the entire BRIC contingent would pass around a continent-wide, boosting collection jar in what some cynics quipped would ultimately amount to an ironic albeit ill-fated form of reverse-colonization.  The comment ties nicely with last week’s Economist piece noting Angola’s sudden Portuguese shopping spree, a “first for Africa” whereby national oil company-cum-sovereign wealth vehicle, Sonangol, “acts as the government’s main dealmaker and overseas investor.”  This got us to thinking that despite Absa Capital’s recent warning to clients that “the current bout of financial market turbulence and fears of a global economic slowdown . . . provide a new impediment to [sub-Saharan] growth . . . which may have a dampening effect on growth prospects in the region” there should emerge a divergence in performance between the region’s commodity net-buyers and sellers, which in turn should augment their respective monetary policy flexibility (i.e. to not have to choose between growth and inflation, a priceless luxury for any economy and especially against a stagnating global backdrop).  The former group, admittedly, is commodity-derived cash rich and thus dependent on its exports to help build FX reserves, temper policy rates and buoy credit.  Yet, per Absa, “in the absence of a sharp deterioration in global growth, commodities should remain an important pillar of growth [in Ghana, Nigeria and Angola], where firm oil prices of above USD110/bbl continue to support growth [and help] economic activity remain robust.”  The latter group, meanwhile, already victims largely to poor diversification among its economic sectors, may get stuck in an inflation-importing conundrum a la Kenya currently, where climbing inflation (16.7% in August) sits in stark contrast with, per comments made by the country’s monetary policy committee, a relatively glum growth outlook for 2011H2.

As ratings agency reports go, Fitch’s latest Sub-Saharan write-up wasn’t so much controversial as it was cautionary; specifically, its point relating to inadequate infrastructure is one common to most if not all emerging and frontier economies (outside of Asia, at least), a discouraging and productivity/growth-stunting phenomenon The Economist duly noted last week while concluding that “most [Latin American] countries neither save nor invest enough [and] do not use their resources efficiently” due at least in part to an over-dependence on monetary tightening whereby “low savings, high interest rates and protective tariffs on inputs make investing unusually costly.”  Ultimately, moreover, ever burgeoning consumption in said economies–and by extension the hitherto elusive global re-balance fundamental to PIMCO’s ‘new normal’ paradigm–may be heavily correlated with just how efficiently this investment deficiency corrects.  To this end, McKinsey theorized last winter that the glaring disconnect between savings and the pragmatic need for more emerging and frontier-sponsored capital investment is destined to usher in a new secular shift away from equities and towards bonds over the next decade (as incentives align) meaning that this month’s drastic global equity dip may be more harbinger than herring.  That said, it may also invite an awkward limbo period for central banks as efforts to moderate inflation are tested by increased fiscal outlays which could augment borrowing costs even more if deficit to growth rates become overly stretched.  Nigeria’s current inflation picture is a perfect case in point: while July’s core inflation, which excludes farm produce items from the CPI, was unchanged from the previous month at 11.5% y/y, Barclays opined earlier this summer that “CBN Governor Sanusi has been very outspoken about government’s excessive spending” even though some it at least looks geared towards addressing a woefully underdeveloped electricity sector and oil revenues should be long-term sticky.   Yet the lion’s share of spending excess, per some pundits, stems not only from steep, public sector wage increases but also a patronage-driven political system.

While crude’s recent decline saw a concurrent slump in Nigeria’s 2021, $500mm sole Eurobond issue given that the state relies on crude exports for roughly 95 percent of foreign-currency earnings (vital in order to keep the naira within a 3% band of USD/NGN150 per the central bank’s unstated mandate), energy strategists with Barclays remained bullish with their near and long-term price forecasts, maintaining Friday that despite “concern about the potential path of OECD demand” against the backdrop of recent, downwards GDP revisions “a series of problems and disappointments on the supply side has produced a sharp slowdown in the pace of non-OPEC supply growth, providing the market with further insulation from the slowing of demand.”  Yet as we indicated last month the CBN’s habitually hawkish policy rhetoric, which manifested itself with a 75bp hike only one week later, continues to point to the prospect of further tightening in the near-term given the government’s need to attract capital flows and also cushion against inflation expectation uncertainties tied to the imminent implementation of a new minimum wage law (as well as an overall fiscal deficit projected to be just above 4% of GDP this year), removal of fuel subsidies and liquidity injections all in the coming fiscal quarter.  Thus while Nigeria’s FX reserves are still slated to remain comfortably above USD30bn to nearly one year’s worth of imports–a good metric for bond holders to monitor–the country’s yield curve remains in the midst of an upward shift that should still invite caution.


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