Frontier markets to withstand Fed tapering
As Fed tapering gathers momentum, frontier markets in Africa are not as vulnerable as their emerging market heavyweights, but those with higher current-account deficits will feel the pressure.
Last year was characterized by the rotation into equities from debt, and from emerging markets into developed markets, as the news took hold that Fed tapering will continue to play out as the west pulls itself out of the economic abyss.
As portfolio flows have reversed back to their developed counterparts, countries such as Turkey, Russia and South Africa which run current- and fiscal-account deficits – and are thus vulnerable to reduced global liquidity – have seen their currencies take a tumble.
The rouble remains just above record lows at 35 roubles to the dollar on Thursday, and on Monday the rand hit a five-year low at 11.25 against the dollar, remaining around this figure for the week.
However, while emerging markets have taken a hit, sub-Saharan African (SSA) markets, excluding South Africa, have managed to avoid much of the fallout, outperforming in most asset classes, according to Standard Bank data.
“Although there has been limited bond price appreciation during 2013, Africa’s higher yields, lower correlation with US treasury yields and better-performing currencies delivered returns of 9.3% for our AF8 10-year bond index [which includes Botswana, Egypt, Ghana, Kenya, Mauritius, Nigeria, South Africa, Tanzania, Uganda and Zambia] ,” say analysts at Standard Bank, referring to data gathered for 2013.
“This compared to a negative 11.6% for our EM10 10-year bond index [consisting of South Africa, Turkey, Brazil, Russia, Mexico, Israel, Indonesia, Poland, Hungary and India]. We see a similar outcome on a multi-month basis.”
The relatively closed financial systems of African economies, excluding South Africa, means they are less vulnerable to portfolio outflows, and, in general, foreign holdings in these countries are low, says Stephen Charangwa, portfolio manager at Silk Invest based in London.
“This said, hard-currency bonds, which are often held by foreign investors, will be more volatile than local-currency bonds,” he says. Nevertheless, Rwandan government debt issued in April is still trading close to par.
However, as the global economy adjusts to US Fed tapering, markets are likely to become less forgiving about the financing of budget and capital-account deficits, says Yvonne Mhango, SSA economist at Renaissance Capital. Some SSA countries will be more vulnerable than others.
“The SSA countries that will be hardest hit by this turn in sentiment are those with poor public finances, such as Ghana, and weak external finances like Zimbabwe,” she says. “If we assess the strength of SSA’s financing on these parameters, Nigeria looks much more favourable than Kenya, Ghana and Zimbabwe.”
In Ghana, central bank foreign-exchange reserves reached $5.6 billion in November, only slightly up from $5.35 billion at the end of December 2012, with import cover at uncomfortable levels of around three months.
“Investors [will] continue to choose Nigeria over Kenya or Ghana, because of the former’s stronger fundamentals – a CA surplus and smaller budget deficit,” says Mhango.
“However, we think the attractiveness of Nigeria over Kenya will narrow, as Nigeria’s shine is dulled by fiscal laxity due to preparations for the 2015 polls and the uncertainty of monetary policy post the tenure of current central bank governor Sanusi Lamido Sanusi.”
She adds: “At the same time, we see Kenya’s external position strengthening on the back of a narrowing current-account deficit and a boost in financial inflows from forthcoming Eurobond proceeds.”
Nigeria is famous for its pre-election spending binge, especially at the state level, fanning fears the central bank will fail to rein in inflation and correct imbalances.