Sub Saharan Africa: Weathering The Storm

LAGOS, Nigeria, Capital Markets in Africa: An uneven recovery in commodity prices, stricter financing conditions and adverse weather patterns have forced many economies in sub-Saharan Africa (SSA) to reassess their structural underpinnings. Faced with rapidly depleting fiscal and foreign exchange reserves, constrained international financing and an understanding that resource prices could remain lower for longer, commodity exporters are at pains to initiate timely and coordinated policy responses to ensure quick, durable and more inclusive levels of growth. The IMF believes that fiscal consolidation, improved domestic revenue mobilisation, careful public investment and sharper governance are necessary preconditions to prevent disorderly adjustments.

However, the slump in commodities prices is as much a boon as it is a burden to SSA.  A host of non-resource reliant economies, particularly in East Africa, are primed for growth on account of a strengthening in their respective terms of trade. Kenya’s medium term economic performance is rooted in its diversified economic base which has cushioned it from the vagaries plaguing the regions mineral and hydrocarbon exporters. Much like Kenya, Tanzania does not have a high export concentration ratio. This has allowed policymakers to focus their efforts on enacting polices that will cushion the economies from a sudden worsening in the economic climate.

Exogenous and endogenous shocks
The global environment is fraught with challenges that could potentially derail SSA’s economic growth path. Key risks worth noting are:

• The potential of a hard-landing in China. A sharp slowdown in China will very likely be accompanied by substantial yuan devaluation. Similar to August last year and January this year, commodity prices will probably take another leg downwards, severely constraining export growth in resource-rich economies like Angola and Zambia.
• The quicker-than-anticipated normalisation of the Fed’s monetary policy and an attendant reversal in yields and/or a resumption of the great dollar rally will be of grave concern to SSA economies with liquid capital markets. Currency volatility is likely to ensue in the event of sharp reversals in portfolio flows in jurisdictions such as Kenya, Zambia and Nigeria.
• The fear of wider exit referenda, following Britain’s departure from the EU, will cause jitters in global markets, dulling the appeal of SSA assets, thereby restricting capital inflows.

Alongside these global risks, idiosyncratic factors such as the political climate, security concerns and weather related events could create a drag on economic performance. For example: 

• Election related disruptions and fiscal slippage present palpable risks to economic growth and financial market stability. At the time of writing, Zambia was in the process of tallying presidential votes. The election was one of the most highly-contested in years and will have a considerable impact on the broader economy. New electoral processes, shifts in political loyalties, the extent of politicking, incidences of intimidation, and a weak economy have raised the stakes. Regardless of the outcome, the successful candidate will need to take a hard line with regard to economic policy reforms to safeguard the economy. Ghanaians are off to the polls in November but the risk of fiscal slippage is minimal given that the government will conduct the elections under the watchful eye of the IMF.
• Security concerns, especially apparent in West and East Africa, could create economic uncertainty. In Nigeria, sporadic militant attacks on petroleum facilities in the Delta have crippled upstream production. In Kenya the danger posed by al-Shabaab has been aggravated by long-running ethnic rivalries over land and the government’s disjointed strategy regarding to the radicalisation of Kenyan youths.
• Certain regions in SSA are vulnerable to the alteration of seasonal climate conditions. La Niña (the cooling of oceanic waters cool below normal) has resulted in wetter-than-normal conditions in Southern Africa and drier-than-normal conditions over equatorial East Africa, disrupting agricultural processes.

Inflation Spiralling Out of Control
Over the past two years, Inflation in most African countries, has taken a turn for the worse on the back of weakening currencies, the continued dependence on imported goods and large cuts in price subsidies as part of fiscal consolidation. For example, Angola’s extreme import-dependence (34% of GDP), and a rapidly weakening currency on the parallel market have resulted in inflation rising to 31.8% in June, the highest level since November 2004. Significant utility price hikes have pushed Ghana’s inflation to a high of 19.2% in 1H16 and it is only. It is only the Southern and East African economies that are expected to have single-digit inflation over the medium term. The rest of our focus economies (Angola, Mozambique, Nigeria, Malawi and Zambia) won’t see single digits until at least 2019, especially as currencies continue to take a hit.

Currency woes – Dollar liquidity low
Currency weakness has increased significantly over the last two years, driven mostly by the decline in commodity prices that have affected the overall dollar supply in commodity-export dependent nations. Currencies that are highly dependent on the FX earnings from commodities have felt the pain over the last few years, in particular Angola, Nigeria and Zambia. Countries that have come off relatively unscathed have been Kenya and Tanzania as a result of their diversified economies and the low level of dependency on just one type of commodity. Currencies from these countries are mainly driven by seasonal factors for example, in our portfolio of countries, the following reason (the countries are listed in the order of the currency with the most weakness to that with the least weakness taken from 2014 onwards):

• Ghana: Major budget imbalances
• Mozambique: Debt crisis and dollar strength
• Zambia: Budget imbalances
• Nigeria: Oil price dependence; moved from a peg to a  managed float
• Angola: Oil price dependence
• Tanzania: Seasonal factors
• Kenya: Seasonal factors

(The policy responses of the central banks of Ghana, Mozambique and Zambia have erred on the side of minimum direct intervention in the currency markets. This has resulted in their respective currencies being some of the most volatile in the region in 2014 and 2015).

Monetary policy reaction to rising inflation
The monetary policy reaction of our portfolio of economies has differed. Policy tightening has been the name of the game for all our countries except Kenya. The biggest hiking cycle we have seen is Ghana’s with a 1250bp rate increase since 2012 due to inflation spiralling out of control on the back of a weak cedi, together with the IMF’s conditions including a continued tight economic policy. Other countries like Mozambique had to make quick and significant hikes in the last few months due to the significant currency weakness feeding into prices. Kenya’s receding inflationary pressures, a strong first quarter GDP growth print and relative calm in the domestic foreign exchange market have provided ample justification for the central bank to lower its policy rate.

We expect the following policy movements over the next year.  

• Angola: Hikes
• Ghana: Unchanged
• Kenya: Cuts
• Mozambique: Hikes
• Nigeria: Hikes
• Zambia: Hikes

General government budgets are under pressure
The burden on monetary policy has in many cases been aggravated by a lack of fiscal consolidation. This has been evident in most resource-rich countries where fiscal balances have deteriorated, despite expenditure adjustments, owing to persistent revenue shortfalls. Of our 10 focus economies, 5 are expected to post budget deficits in excess of 5% of GDP in the 2016 fiscal year. The ability to fund these budget deficits are often hindered by shallow domestic capital markets forcing many sovereigns to seek funding offshore.

SSA is swimming against a tide of rising debt
African sovereigns have borrowed freely from international markets over the last eight years, spurred by a global search for yield. Economies boasting favourable growth prospects amassed considerable external debt to support ambitious spending plans, often at prices that insufficiently captured the enormity of sovereign risk. 

The region’s US dollar-denominated debt binge might have persisted had the collapse in commodity prices not exposed structural vulnerabilities in a number of economies. Ambitious development plans have been thwarted by a lack of sustainable revenue streams and reduced fiscal space, compelling a host of countries to take on additional external debt. The added burden has amplified refinancing risks, especially in highly-leveraged economies like Ghana and Zambia.

Faced with elevated real interest rates, modest levels of GDP growth and diminishing investor interest, many sovereigns are swimming against a rising tide of debt, similar to the torrent experienced in the 2000s. Talk of IMF led structural-adjustment austerity programmes for embattled nations, similar to those adopted in the 1980s, is increasingly being bandied about. Zambian authorities and the IMF are likely to conclude negotiations between 4Q16 and 1Q17.

Although public debt levels are well below their peak, the ability of African sovereigns to fulfil debt obligations without having to draw down on international reserves has roused concern among private creditors.

Offshore financing less forthcoming as funding conditions tighten globally.
Investors have become far more circumspect with regard to Africa credit as evidenced by the widening in yield spreads between SSA Eurobonds and comparable US treasuries since May 2015. Yields on sovereign bonds (outside of South Africa) are trading well above their historical averages, reflecting a seismic shift in investor behaviour. Relative-value trades are few and far between as markets battle weakening fundamentals.

In a less severe global environment, elevated yields might entice foreign investors on a purely tactical basis. Yet, Africa’s macroeconomic landscape has become less conducive to Eurobond trade on account of domestic constraints, poor governance and rising US Treasury yields.

Despite these conditions, sovereigns will continue to favour Eurobond funding over concessional debt due to the sizable loan amounts and the less stringent nature of agreements.

By Neville Mandimika, Celeste Fauconnier and Nema Ramkhelawan Bhana, Africa Analysts, Rand Merchant Bank

This article features in the September edition of INTO AFRICA Magazine, which focuses on reviews of Africa’s economies in the first half of 2016.