Roses and thorns among Africa’s do­mes­tic bonds..

Zambian Business Times - - FRONT PAGE - • Mandimika is an economist and a sub-Sa­ha­ran Africa fixed-in­come strate­gist at Rand Mer­chant Bank

Zam­bia and Kenya cited as thorns in the bas­ket

Dovish cen­tral banks and re­strained in­fla­tion make Nige­ria and Ghana good con­tenders In the last few months much has been writ­ten about the over­whelm­ing de­mand ex­pe­ri­enced by African eurobond is­suers. Nige­ria, Kenya, Egypt and more re­cently Ivory Coast have all come out smil­ing, hav­ing is­sued bonds at low rates that were unimag­in­able just a few years back.

While "ku­dos" might be the ap­pro­pri­ate re­sponse to these is­suers’ con­quests in for­eign lands, it’s im­por­tant to keep an eye out for po­ten­tial lo­cal op­por­tu­ni­ties. Un­like their at­ten­tion-seek­ing spoilt cousins (eurobonds), lo­cal cur­rency bonds have been steadily gain­ing trac­tion given the gen­eral im­prove­ments in the global econ­omy and, more im­por­tantly, the com­mod­ity price-linked cycli­cal eco­nomic re­cov­ery.

Syn­chro­nised global growth and a re­bound in com­modi­ties have spurred risk-on sen­ti­ment, al­low­ing in­vestors to give lo­cal cur­rency bonds a sec­ond look in the search for yield.

While pos­i­tive sen­ti­ment is al­ways use­ful, it is im­por­tant to note that it is no­to­ri­ously fickle, hence the need for macroe­co­nomic poli­cies to of­fer a solid plat­form for growth.

The im­prove­ments in fun­da­men­tals have largely been cycli­cal, ow­ing to im­prove­ments in com­mod­ity prices. Nige­ria and Ghana have par­tic­u­larly rel­ished the com­mod­ity price div­i­dend, be­ing large com­mod­ity ex­porters them­selves.

Bond yields have been ar­ti­fi­cially low, in a man­ner not re­flec­tive of the risks in Kenya at the mo­ment

To be fair, these two West African giants have at­tempted to di­ver­sify their economies, but Ghana is fur­ther down the road than Nige­ria.

"Big Brother", the IMF, has cer­tainly played a key role in en­sur­ing fis­cal re­straint across the con­ti­nent. Since the end of the com­modi­ties su­per cy­cle in 2014 we have seen the pres­ence of the IMF grow­ing — as it nat­u­rally does when fi­nances are tight for most ma­jor com­mod­ity ex­porters. Say what you will about the IMF, but coun­tries such as Ghana have re­ally ben­e­fited from this sup­port.

The cedi has been rel­a­tively sta­ble, while in­fla­tion and fis­cal ex­pen­di­tures have been kept in check — all com­po­nents that make lo­cal cur­rency bond in­vest­ing at­trac­tive.

The Africa lo­cal cur­rency as­set class is akin to a sweet-smelling, thorny rose. Sweet-smelling in that there is a vast ar­ray of pos­i­tive real yield op­por­tu­ni­ties, but thorny be­cause there is a need to be dis­cern­ing when pick­ing the losers and win­ners.

We tend to favour Nige­ria and Ghana for one sim­i­lar rea­son: dovish cen­tral banks. For both economies, in­fla­tion is on a down­ward tra­jec­tory ow­ing to both base ef­fects and feedthrough from their cur­ren­cies, which have strength­ened over a multi-quar­ter ba­sis.

On a year-on-year ba­sis, Nige­ria’s in­fla­tion has fallen by al­most three per­cent­age points, from 17.2% to the cur­rent 14.3%, while the naira has strength­ened over the same pe­riod.

Eco­nomic growth has been on the mend, hav­ing re­cently emerged from a re­ces­sion, and is now ex­pected to reg­is­ter growth of 2% in 2018

How­ever, this level of growth is not suf­fi­cient to en­sure pos­i­tive growth of GDP per capita as the pop­u­la­tion is poised to in­crease by 2.7%.

The pos­i­tive sen­ti­ment in Nige­ria must be taken with a pinch of salt as the econ­omy is still struc­turally de­pen­dent on oil pro­duc­tion. If global com­mod­ity mar­kets sneeze, Nige­ria will surely catch a cold.

How­ever, for as long as "black gold" re­mains favourably priced, off­shore in­vestors will con­tinue to come in droves, which has caused the yield curve to com­press from about 16.5% in late 2017 to just over 13% at present. We see fur­ther room for gains in 2018.

Ghana has also seen its yields fall in dra­matic fash­ion for sim­i­lar rea­sons to Nige­ria — yields have com­pressed from around 18% in late 2017 to about 15% to­day. Un­like Nige­ria, Ghana has a much more di­ver­si­fied ex­port bas­ket, with gold, co­coa and more re­cently oil all con­tribut­ing to ex­port rev­enues.

More­over, the cur­rent IMF ex­tended credit fa­cil­ity pro­gramme (due to ex­pire at the end of 2018) has given off­shore in­vestors rea­sons to be bullish on Ghana­ian bonds as the pro­gramme of­fers a pol­icy an­chor.

As we ap­proach the third quar­ter of 2018, Ghana’s in­vestor base will be­gin to ask if the coun­try will be able to cap­i­talise on the good­will it has built up over the past three years un­der the watch­ful eye of Big Brother. As in­vestors look to re­solve this is­sue, we could see some risk pre­mium built into bond valu­a­tions. Cau­tion is war­ranted as we move to­wards the tail-end of 2018.

The thorns within our bas­ket are Zam­bia and Kenya, for vastly dif­fer­ent rea­sons. Zam­bia has fallen out of favour with most off­shore in­sti­tu­tional in­vestors given the con­tin­ued back and forth be­tween the gov­ern­ment and the IMF.

The sta­tus quo is that the IMF has re­jected the Zam­bian au­thor­i­ties’ bor­row­ing plans as these would put their debt-to- GDP met­rics deeply in the red. To make mat­ters worse, for­mer fi­nance min­is­ter Felix Mu­tati was reshuf­fled from his po­si­tion dur­ing the ne­go­ti­a­tions with the fund, which con­sid­er­ably di­min­ished any hope of a prag­matic and mar­ket-friendly deal.

Given the stale­mate, in­vestors are shift­ing to­wards other op­por­tu­ni­ties, par­tic­u­larly those out­lined above.

Kenya’s is­sues are more self-in­flicted than those of Zam­bia. In Septem­ber 2016 the gov­ern­ment in­sti­tuted a law stip­u­lat­ing that in­ter­est rates charged to bor­row­ers should not ex­ceed 400 ba­sis points above the pol­icy rate — that is 13.5% given the cur­rent bank rate of 9.5%.

The chal­lenge is that the gov­ern­ment has not been will­ing to ac­cept fund­ing costs in ex­cess of the cap, im­ply­ing that bond yields have been ar­ti­fi­cially low, in a man­ner not re­flec­tive of the risks in­her­ent in Kenya at the mo­ment.

Pick­ing the win­ners and losers is one thing. The key is to un­der­stand the reg­u­la­tory and mar­ket nu­ances when in­vest­ing in these coun­tries.

Fac­tors such as cur­rency liq­uid­ity, ex­change con­trols, se­condary mar­ket bond liq­uid­ity and set­tle­ment pro­ce­dures make the ter­rain froth with chal­lenges and risks. If done right, this as­set class has the po­ten­tial to de­liver healthy re­turns.

Roses and thorns

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