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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 FT‘s piece Wednesday on South Africa’s inequality risks highlighted “the contrast between expectations and reality” that underpins a “growing discontent among [the country’s] unemployed youth” (youth unemployment currently runs at roughly 50 percent, an estimated 2.m between age 18-25). The same themes–though admittedly cultivated from a far different context in South Africa given apartheid–of income inequality and corporate cronyism are in fact being emphasized and examined across the world (in South Africa, substitute mining for finance and Julius Malema’s nationalization movement is not too far removed in ideology from that of OWS) in a “political black swan” moment of sorts that Nassim Taleb astutely warns may deteriorate into a broader and more meaningful class struggle. The dilemma is magnified in a country like South Africa, however, if for no other reason than mining’s output fuels an appreciating terms of trade which, at least in theory, should help attack unemployment and drive domestic wage inflation across all sectors. Yet said reality remains elusive, and the deficiency lies largely in persisting supply side gaps (momentum growth remained negative in September in both the mining and manufacturing sectors) that act as a headwind on growth (beyondbrics noted that “economists have revised down their GDP forecasts for 2011 from around 3.5 percent growth to 3 percent or lower and predict 2012 is likely to be tougher”) while both headline CPI (up to 5.7 percent in September from 5.3 percent the previous month) and real retail sales growth (up to 7.1% y/y in August from an upwardly revised 3.0% in July and above Bloomberg consensus estimates of 5.2% y/y) remain sticky. This stagnating divergence is a central banker’s worst nightmare, and indeed the Reserve Bank’s rates (5.5 percent) are at a 30-year low, unchanged throughout the year since 650bp of slack between 2008-2010. That said per SARB Deputy Governor Daniel Mminele “there is no evidence thus far to suggest that [inflation] pressures are becoming entrenched”; indeed, while most analysts don’t foresee any sort of monetary policy normalization until late 2012 at the earliest, we see room for further cuts as early as this winter. Our continued recommendation of being long duration and short ZAR is thus a testament not only to the aforementioned supply barriers, but also to the probability that in such an environment discretionary spending will ultimately need a catalyst sooner rather than later (to wit, consumer confidence fell sharply in Q3).
While mainstream financial commentators continue to grasp onto the Sub-Saharan (SSA) growth story in their arguably fruitless short term, safe-haven search, the IMF’s recent World Economic Outlook (WEO) report was a bit more circumspect in its nuanced observation that despite relatively strong fiscal and current account balances (versus advanced economies), growing cash reserve liquidity and the fact that it is “one of the few places in the world with a rising labor force”, the premise of contagion across many African frontier markets remains palpable. To that end, the IMF noted, “a faltering U.S. or European recovery could undermine prospects for exports, remittances, official aid and private capital flows.” That said, emerging markets in general and select frontier ones should benefit from an expected paradigm shift–at least for the near term–of collective, central bank dogma away from rigid inflation targeting towards a more dovish, holistic approach to rate setting that would theoretically embrace more fluid inflation targets, especially to the degree that fiscal policy remains conservative. Admittedly, this sort of monetary policy makeover across EM/FM central banks would likely need the initial support of their more developed brethren. Moreover, not all markets are equally immune to temporary bouts of price elasticity; while U.S. core PCE inflation (the Fed’s preferred gauge) hovers just under 2% y/y, the IMF expects SSA inflation to average 8.4% and 8.3% in 2011 and 2012, respectively (versus 7.5% in 2010), testament to a stickier and hence greater vulnerability to enhanced energy and food commodity volatility. Yet to the extent that central banks choose to overlook breached inflation target ceilings, growth should be smoother across more emerging and frontier markets than not, a phenomenon displayed nearly by The Economist’s graph, inset.
South Africa’s monetary policy committee (SARB) harped on the receding global backdrop in its recent dovish decision to maintain the benchmark rate at a 30-year low; yet coupled with continued albeit slowed growth in output in demand-led sectors (i.e. retail trade, financial and personal services) as well as in discretionary spending (in a bit of warning sign, on a 3m/3m seasonally adjusted and annualized basis sales growth turned negative for the first time since October 2009) and discretionary credit (last up 20.2% YTD in Q2), the SARB’s general theme underscored a mantra of growth support (it downgraded its GDP forecasts to 3.2% for 2011 and 3.6% for 2012, from 3.7% and 3.9%, respectively, previously) compared with concern over inflation (though a weakening rand, per our somewhat prescient forecast from this spring, complicates matters), and we suggest studying other markets to ferret out similar dynamics whereby dovish policy could provide a fillip to aggregate domestic demand. Moreover, certain economies like Ghana (and other key commodity exporters) could be set to see the best of both worlds, i.e. lingering accommodative policy together with hitherto low inflation. While not “safe”-havens per se, these are the kinds of economies to key in on when discerning among emerging and frontier economies and while developed growth sputters.
Analysts with Barclays noted in late June that offshore and local fund managers alike remained short duration in South Africa but based their valuations “on different frameworks (nominal yields and market inflows for the former, expectations of a tightening cycle and higher inflation for the latter). Yet the somewhat swift shift in sentiment to longer duration debt (evidenced by a 22bp bull flattening in last Thursday’s yield curve) is not necessarily surprising; as we noted weeks before that, South Africa’s relatively muted core inflation coupled with myriad and mounting roadblocks in the ever-dithering labor sector were all in fact explicit red flags rather than herrings and screamed for continued slack in monetary accommodation. Recent data only supports this thesis: Absa Capital reminded clients Friday, for instance, that on the heels of July’s wretched PMI figures published earlier in the week “showing a massive deterioration to 44.2 (53.9 prior)”, manufacturing sector capacity utilization is up “only 0.7pp y/y . . . indicative of the still relatively subdued activity in the industry, where utilization remains below its long-term average of around 84% . . . and around 15% lower than its pre-recessionary peak . . . [a reflection of] the headwinds the sector continues to face.” The domestic forward rate agreements (FRA) curve has also taken note, with the shorter end (December) declining steadily from its 5.9 percent peak in May indicating a widening belief that the economy’s outlook is subdued and rates will stay soft at least until next January. Yet even that take looks to be too sanguine, especially since current real GDP forecasts are built on the assumption that demand-side factors will make up for the aforementioned supply-side slump. Because households remain leverage sticky (debt-to-disposable income remains just below 80%), banks remain spooked by credit quality concerns (the country’s National Credit Regulator recently noted that accounts 3 months or more in arrears continue to rise) and core inflation remains more than a full percentage point below headline inflation (where as before the last rate hike in 2006 it sat only 0.4pp under the target) we look for continued downwards pressure on the FRA curve as longer duration bonds will continue to be the vehicle of choice.
Morgan Stanley’s recent note extolling Nigeria’s potential to economically outmaneuver South Africa by 2025 doesn’t strike us as particularly riveting, if for no other reason that the terms of trade/consumption thesis upon which both ‘top down’ pictures presumably rest underpins fundamentals in one (per its 2011 projections Barclays writes that Nigeria’s current account–15.8% of GDP estimated, up from 8.2 last year–is “likely to record a healthy surplus in 2011 [while] FX reserves, at $38USDbn, are still comfortably above 10 months of imports”) while seemingly undercutting them in the other (fickle, portfolio funded C/A deterioration). With massive inequality in both countries still the elephant in the room vis a vis inflation expectations going forward, ample reserves also leave the CBN with more arrows in its currency-defense quiver; CBN Governor Sanusi’s emphasis on an enduring 3% band of USD/NGN150 for the naira looks reasonable, though a growing fiscal deficit (still muted given overall, low debt levels of just below 20% of GDP) and the planned removal of fuel subsidies mean that even an anticipated further 75bp of rate hikes by year’s end could be inadequate. Yet unlike in South Africa, where unrest feeds increasingly spiraling wage demands (which in turn supports real purchasing power and thus consumer spending, wears on the supply side and capacity utilization rates) and “dictator[s] in waiting”, social reform in Nigeria may have the potential to leverage an already buoyant informal economy and accelerate the contribution from increasingly important non-commodity sectors (Absa Capital wrote this week, for instance, that the National Bureau of Statistics (NBS) now expects average real GDP growth to increase from 7.9% in 2010 to 8% in 2011 largely as a result of increased activity in the non-oil sectors, particularly from trading, construction, finance and telecommunications). That said, while social reform hitherto in Nigeria has been more than vote-snaring lip service (analysts maintain that the Niger Delta’s improvement to well over 2mn barrels over the past year are proof-positive that unemployed, restive youths have been allayed), cynics argue that promises aside, President Goodluck Jonathan is destined to feel the effects of North-South instability inherent to the latest governors’ row relating to implementation of the Minimum Wage Act.
Recent bond price action, the fact that FRAs (forward-rate agreements) currently price in a 50bp hike by South Africa’s Pretoria-based Reserve Bank (SARB) by November 2011 and a recent breakeven rate uptick all suggest that the market now views inflation risks to the upside, particularly on the back of news that various municipalities have applied to raise electricity charges as much as 28 percent from July 1 versus the electricity regulator’s 20.38 percent guideline. Yet some analysts counter that given CPI’s hitherto muted trends (core roughly 3 percent through the first four months of 2011, with headline at 4.2 percent annualized in April) the Bank, which contrasts price data with a 6 percent implicit upper band target, will more likely hold off until January 2012 given recent manufacturing (up 0.4 in April, down from 4.9 percent in March) and wholesaler and retailer business confidence data (48.0 compared to 55 percent in the 1st quarter) that underscores a lingering output gap (manufacturing and mining production remain below pre-recession levels by ~14.5 and 3 percent, respectively, the former reflected again by a disappointing Q1 79.4 percent manufacturing capacity utilization level)–rationale which should serve as the foundation against premature tightening. To that end, demand-pull inflationary pressures look moderate, according to Absa Capital, as both retail sales (9.8% y/y in April after March’s revised 5.3% growth) and credit metrics may have now peaked such that elevated consumer debt levels (77.6% of disposable income)–which initially pushed annualized retail price inflation (1.8 y/y in April) back into post-crash, positive territory–will now serve as a headwind and stunt further spending momentum. Until the recovery is truly “broad-based” look for the SARB to remain dovish and the rand to weaken.
With 500 blog entries now under our belt (salut!) we persevere onwards and reexamine South Africa, the impetus being Macro Man’s recent roast–“to summarize, you have a labor market with excess supply and pockets of rapid wage inflation and your most profitable and export-friendly sector cannot seem to increase production to capture that increased demand as much as they should”–as well as a quick check-up on our call made back in March to short rand (ZAR) on strength. As TMM points out, the essential paradox upon which South Africa’s macro picture rests relates to its widening current account (CA) deficit, which from a low 2.5% of GDP in Q210 is expected by analysts to rise to roughly 4.0% by Q411 despite the fact that its terms of trade have been on a secular favorable sprint during the past decade (correlated neatly, I’d argue, with China’s investment-intensive growth model). This means that while the rand has enjoyed a nice commodity-fueled run, its strength feeds through to consumer spending and capital projects which in turn require a higher level of imports. At the same time exports seem hamstrung as unemployment remains sheepishly high, production figures dither and an ever-wobbly ANC ruling party remains ever-wedded to trade unions–a partnership unlikely to inspire any near-term resurgence in the capital account (needed to finance the aforementioned CA gap) which as Macro Man uneasily points out, is basically all portfolio funded (i.e. it can vamoose quicker than DSK from a Sofitel penthouse). Something has to give, and so far that’s been government debt–once roughly a quarter of GDP and now forecasted by Barclays to rise to roughly 44% in the next year. With this kind of macro backdrop one could swear that China’s Minsky moment has already come, but alas, the country’s shadow finance sector has stepped in nicely to counter Beijing’s hitherto brake job. Per the currency inflation continues to be muted versus expectations and growth estimates (3.6%) fall far below not only EM peers, but also where they were prior to the last cycle’s first hike in 2006 (5.1%), such that the consensus seems comfortable with the SARB’s 5.5% repo rate to remain rigid through year’s end. That said per the Bank’s comments unit labor costs registered 7.7% in Q410, which as Bank Governor Gill Marcus pointed out was the result of high wage settlements (averaging 8.2% in Q111) and poor labor productivity (2.2% in Q410; a further clue into dithering exports?). Coupled with continued reserve accumulation last month and last year’s outflow easement measures it seems clear that the SARB continues to worry about rand strength, though as the above demonstrates the strong currency may not only be fleeting, but also is surely a red herring when compared with the country’s more fundamental flaws.
The rand’s admirable comeback following its unceremonious freefall to begin 2011 (from trough to peak it depreciated from 6.6275 on January 3 to 7.3365 on February 15 against the dollar–making it, aside from Suriname, the world’s worst performer per Bloomberg–but has since rebounded and closed Thursday in Joburg to 6.8855) may have run its course, especially given that January’s manufacturing growth figures (up 1.3% y/y versus 1.9% consensus) missed the mark. Moreover, though recent PMI data and business confidence have created some supply side momentum in the face of comparatively vigorous demand underpinned by relatively subdued core inflation and low interest rates (5.5 percent after three cuts last year), analysts remain skeptical over how quickly the South African Reserve Bank’s Monetary Policy Committee can go hawkish. To that end, “the poor growth we continue to observe in sectors such as construction are still likely to leave the SARB MPC with a sense that a more ‘broad-based’ economic recovery is needed before interest rates can be hiked,” Absa Capital noted. Finally, two additional dynamics remain in play that would suggest selling ZAR on strength: one, reverberations from last year’s outflow easing policy has spurred a greater-than-expected institutional offshore appetite whose scope remains uncertain. Two, the Reserve Bank shows no signs of taking its foot off the FX coffer accelerator.
It’s one thing to hear a money manager, whose fund’s thesis rests on African growth, tout the continent’s impending demographic dividend and accelerating consumption habits; it’s quite another when the world’s biggest retailer takes a punt and sinks its own teeth into the game. Last week’s Economist noted, for instance, that Wal-Mart’s recent $4.1bn acquisition of South African-based Massmart (the top wholesaler and low-cost distributor of basic foods and consumer goods, as well as the leading retailer of general merchanise, liquor and home improvement equipment and supplies with 288 stores in 14 countries spread across sub-Saharan Africa) is proof that “Africa is near the top of the agenda for the world’s leading businesses . . . as [its] middle class and urban working class expand rapidly, food consumption is expected to grow strongly, along with sales of other consumer products.” That said, as the article points out by referencing the firm’s travails in Germany, the rewards from such global expansions are never for certain, and hence why the $4bn expenditure should perhaps be thought of more as a cheap call option on the region rather than a definitive, global macro paradigm shift in consumption habits.