It was good to, once again, visit the countries where we invest, exchange views with local officials, and capture the qualitative aspects of our investment theses. We were a group of seven/eight investors, meeting with the usual suspects (government officials, private-sector representatives, officials of international organizations and local journalists) in Ghana, Kenya, and Zambia on March, 31 and April, 1.
Contrary to many predictions, the pandemic hasn’t ravaged Africa. Vaccination rates are lower than in developed markets, but the vast majority of the population follow health precautions (masks, hand washing, social distancing, fist bumping). The number of COVID cases is low, roadside market activity is brisk, children are in school and shops are open. Traffic is intense, although not as chaotic as before the pandemic. Even in Nairobi!
Nevertheless, activity has been affected and, in many countries, GDP still hasn’t recovered to pre-pandemic levels. We saw many new buildings in all three countries but, worryingly, only one crane was in operation.
Ghana
We visited Ghana to better understand the country’s fiscal outlook. Despite recent curbs to government spending, the picture that emerged was concerning. Most measures, such as cuts in ministers’ and top officials’ salaries, have not had a significant impact, nor will a ban on car imports by government ministries. Secondly, politically sensitive and non-discretionary expenditures, like wages for public-sector employees and interest payments, accounts for 53-55% of total expenditures.
This leaves transfer payments and capital expenditure as the main expenses that the government can cut or delay. But cutting transfers at a time when the country is getting back on its feet after a pandemic could increase social discontent. Some transfers, like school vouchers, are statutory (i.e. linked to specific taxes) so not easy to cut, and lowering capex impacts growth. The recently-approved e-levy will not raise revenues by much.
An IMF program would be one solution to rein in the deficit, but the government vehemently opposes this. Instead, it appears to be considering a US$2 billion syndicated loan.
To date, Ghana’s budget deficit has mostly been financed by domestic investors. But bond yields have risen in recent months and a 2.50% increase in the Bank of Ghana (BoG)’s policy rate, to 17%, in March has made local financing even more onerous. Uncertainty also exists over the local market’s capacity to absorb more debt. Banks have been buying local bonds but this has created a “crowding out” problem that is affecting growth. Recent data from the BoG indicates that activity is stalling.
The BoG impressed all of us with its commitment to its inflation target. Its monetary policy committee met earlier than scheduled in March, right after a 15.7% inflation reading for the 12 months to February was published. This reading implied that the bank’s real policy rate had turned negative for the first time in years, and prompted it to raise rates from 14.5% to 17%. Bank staff highlighted how rising commodity prices had triggered an increase in inflation and that they wanted to avoid second-round effects. To lower inflation, they said they were aiming to keep aggregate demand in check, hence the increase in the policy rate.
One of us asked whether it would be helpful for the BoG to be lenient in its anti-inflation stance, to lower the government’s financing costs. But staff were vocal in rejecting this approach and said that their resolute stance could be an incentive for the government to act on the fiscal front. They also stated that a repetition of the monetary financing of government in 2020, to the tune of GHS10 billion or 1.5% of GDP, is not on the cards (my view: “Never say never”).
The Ghanaian cedi’s depreciation is partly controlled by the BoG’s deployment of its foreign currency reserves, and BoG staff seemed comfortable with reserves at their current levels, of around US$9.5 billion.
One third of imported fertilizers comes from Russia, and higher fertilizer prices will not only widen the current account deficit but also impact agricultural production. Nevertheless, Ghana’s current account is only expected to widen to 4.2% of GDP this year, compared to a previous forecast of 3.7%.
Investment conclusion: This visit did not change our outlook for Ghana. At best, the country can muddle through 2022 because the government has no major foreign-currency redemptions coming up. But the fiscal outlook remains precarious, and it appears that the authorities will only negotiate an IMF program when they see no alternative. Until then, the Ghanaian government’s financial position will probably continue to deteriorate, especially given the current global environment. We see little scope for improvement so, even at current bond prices, our current underweight allocation to Ghanaian bonds is appropriate.
The Presidential Palace in Ghana's Capital of Accra
Giancarlo Perasso.
Kenya
Kenya’s economy has rebounded strongly after the pandemic. Its government agreed on an Extended Fund Facility (EFF) program with the IMF in the summer of 2020 but that program is backloaded, in my view (more on this below). The government’s budget deficit was 8.2% of GDP in fiscal 2020/21 and is expected to reach 8.1% of GDP in the current fiscal year. Debt/GDP of around 67% identifies Kenya as being “at high risk of debt distress,” according to the IMF. The authorities forecast Kenya’s current account deficit to widen from 5.4% in fiscal 2020/21 to 5.9% of GDP this fiscal year, despite strong remittances and an improved tourism outlook.
In our meetings with the authorities, however, we did not detect any urgency to address these macroeconomic imbalances. The reason is simple: elections are scheduled for August 2022.
Rising commodity prices have impacted Kenya and, while inflation remains contained, the effects on its government budget and current account could be significant. Fuel prices have crept up recently, after government subsidies had kept them stable since October 2021. The government also subsidizes fertilizer, and more subsidies could be in the pipeline. One of our interlocutors mentioned a potential expenditure increase of one percentage point of GDP due to an increase in subsidies before the end of fiscal 2021/22.
Likewise, Kenya’s current account deficit is at risk of unexpected widening. The country is an oil importer and imports most of its fertilizer from Morocco. Morocco, in turn, depends heavily on Russian inputs for its fertilizer production. The risk of not importing the usual amount of fertilizers, which would negatively impact agricultural production, is non-negligible. On a positive note, American vaccine firm Moderna is planning to open a US$500 million pharmaceutical plant in the country.
So far, local investors and concessional finance have met most of the Kenyan government’s financing needs. Bank of Kenya is increasingly involved in strengthening the local bond market, but it does not appear keen to attract more foreign investors to the local market: “We are happy with the absence of foreign investors,” we were told.
As for financing the deficit in coming months: the authorities mentioned that the World Bank has agreed to disburse a US$750 million loan in respect of the current year’s budget and that the government plans to raise another US$1.2 billion in international markets. It is unclear whether the government will tap international markets by issuing a Eurobond or by negotiating a syndicated loan.
As mentioned above, the IMF’s EFF program in Kenya is backloaded. The Fund’s review last December projects major fiscal adjustment in fiscal 2022/23 and 2023/24, when “unidentified tax policy measures” should be implemented, worth 0.9% and 0.8% of GDP, respectively. Yet, we heard nothing, in our meetings, about what these measures might entail. The authorities’ sense of complacency was palpable, in my view.
Investment conclusion: Kenya’s authorities are avoiding major adjustments ahead of a general election in August 2022. It remains to be seen what measures, if any, it will take after the elections. For now, our underweight position in Kenyan bonds is appropriate, given current prices.
Traffic in Downtown Nairobi, Kenya
Giancarlo Perasso.
Zambia
We visited Zambia to evaluate progress in applying the G20 Common Framework for Debt Treatments beyond the DSSI (Debt Service Suspension Initiative), for the first time in a country that also has Eurobonds outstanding. Staff-level agreement was reached in December 2021. The authorities are aiming at IMF Board approval, by June, of a US$1.4 billion program, equal to Zambia’s IMF quota. However, this target looks increasingly ambitious given the unclear position of Chinese creditors. Negotiations could therefore drag on a while, prolonging the current uncertainty.
Our most relevant takeaway was the more helpful attitude of Zambia’s new government officials, after the opposition victory in last August’s elections. There could scarcely be a bigger difference, compared to the previous administration. Officials are more open, focused and willing to engage with the country’s creditors.
Another example of major change in the government’s stance is its treatment of the mining sector. Long gone are the days of constantly changing tax rates and regulation in the copper sector, which prevented investment in this key economic sector. Representatives of the mining sector declared themselves delighted with the new situation, and investments should be forthcoming. That expenditure would provide a welcome boost to the Zambian economy, which the authorities forecast to grow at a low 3.4% this year.
The government also linked fuel prices to international prices in December 2021, with a monthly adjustment, and it will reintroduce fuel taxes, which were removed last summer. The authorities are revising fertilizer subsidies, which have been a major drag on its budget in recent years. And they are working on raising fuel taxes, planning to increase them by one percentage point of GDP, from the current 8.2%.
As a result of these improvements, the government’s deficit should be contained to 2.3% of GDP this year, compared to 3.5% last year. (One should factor in Zambia’s default on its external debt last year.)
Unsurprisingly, Bank of Zambia (BoZ) highlighted the inflationary risk of oil prices during our visit. Its officials appeared confident about the bank’s reserves, at US$2.8 billion, but they recognized the volatility of the Zambian kwacha’s exchange rate as a concern. Interestingly, they mentioned that foreign investors have returned to the local bond market and now hold 28% of the Zambian government’s domestic debt.
The impact of rising food prices on Zambia should be contained, as the country is self-sufficient. Clearly, rising prices for oil imports will have an impact. But there should not be a shortage of fertilizer this year, since the country has already purchased what it needs from Saudi Arabia. According to the authorities, the weather is a more important factor in determining the country’s agricultural output.
Investment conclusion: Zambia’s outlook remains uncertain, but the authorities’ change in attitude and their commitment to finalizing an IMF agreement is commendable. Zambia is a credit worth watching, with a potentially positive trajectory. We are comfortable with our positions in this issuer’s bonds, given our expectation that their recovery value could be higher than current prices.
Now-Obsolete Mobile Phone Booths Used for Banking Transactions in Downtown Lusaka, Zambia.
Giancarlo Perasso
More Insights
Securitized Products
High-Quality Securitized Products - An Optimal Diversifier for LDI Portfolios May 31, 2022
The comments, opinions, and estimates contained herein are based on and/or derived from publicly available information from sources that PGIM Fixed Income believes to be reliable. We do not guarantee the accuracy of such sources or information. This outlook, which is for informational purposes only, sets forth our views as of this date. The underlying assumptions and our views are subject to change. Past performance is not a guarantee or a reliable indicator of future results. ESG investing is qualitative and subjective by nature; there is no guarantee that the criteria used or judgment exercised by PGIM Fixed Income will reflect the beliefs or values of any investor. Information regarding ESG practices is obtained through company engagement or third-party reporting, which may not be accurate or complete, and PGIM Fixed Income depends on this information to evaluate a company's commitment to, or implementation of, ESG practices. ESG norms differ by region. There is no assurance that PGIM Fixed Income's ESG investing techniques will be successful.
Source(s) of data (unless otherwise noted): PGIM Fixed Income, as of May 17, 2022.
PGIM Fixed Income operates primarily through PGIM, Inc., a registered investment adviser under the U.S. Investment Advisers Act of 1940, as amended, and a Prudential Financial, Inc. (“PFI”) company. Registration as a registered investment adviser does not imply a certain level or skill or training. PGIM Fixed Income is headquartered in Newark, New Jersey and also includes the following businesses globally: (i) the public fixed income unit within PGIM Limited, located in London; (ii) PGIM Netherlands B.V., located in Amsterdam; (iii) PGIM Japan Co., Ltd. (“PGIM Japan”), located in Tokyo; (iv) the public fixed income unit within PGIM (Hong Kong) Ltd. located in Hong Kong; and (v) the public fixed income unit within PGIM (Singapore) Pte. Ltd., located in Singapore (“PGIM Singapore”). PFI of the United States is not affiliated in any manner with Prudential plc, incorporated in the United Kingdom or with Prudential Assurance Company, a subsidiary of M&G plc, incorporated in the United Kingdom. Prudential, PGIM, their respective logos, and the Rock symbol are service marks of PFI and its related entities, registered in many jurisdictions worldwide.
These materials are for informational or educational purposes only. The information is not intended as investment advice and is not a recommendation about managing or investing assets. In providing these materials, PGIM is not acting as your fiduciary. Clients seeking information regarding their particular investment needs should contact their financial professional. These materials represent the views and opinions of the author(s) regarding the economic conditions, asset classes, securities, issuers or financial instruments referenced herein. Distribution of this information to any person other than the person to whom it was originally delivered and to such person’s advisers is unauthorized, and any reproduction of these materials, in whole or in part, or the divulgence of any of the contents hereof, without prior consent of PGIM Fixed Income is prohibited. Certain information contained herein has been obtained from sources that PGIM Fixed Income believes to be reliable as of the date presented; however, PGIM Fixed Income cannot guarantee the accuracy of such information, assure its completeness, or warrant such information will not be changed. The information contained herein is current as of the date of issuance (or such earlier date as referenced herein) and is subject to change without notice. PGIM Fixed Income has no obligation to update any or all of such information; nor do we make any express or implied warranties or representations as to the completeness or accuracy or accept responsibility for errors. All investments involve risk, including the possible loss of capital. These materials are not intended as an offer or solicitation with respect to the purchase or sale of any security or other financial instrument or an y investment management services and should not be used as the basis for any investment decision. No risk management technique can guarantee the mitigation or elimination of risk in any market environment. Past performance is not a guarantee or a reliable indicator of future results and an investment could lose value. No liability whatsoever is accepted for any loss (whether direct, indirect, or consequential) that may arise from any use of the information contained in or derived from this report. PGIM Fixed Income and its affiliates may make investment decisions that are inconsistent with the recommendations or views expressed herein, including for proprietary accounts of PGIM Fixed Income or its affiliates.
The opinions and recommendations herein do not take into account individual client circumstances, objectives, or needs and are not intended as recommendations of particular securities, financial instruments or strategies to particular clients or prospects. No determination has been made regarding the suitability of any securities, financial instruments or strategies for particular clients or prospects. For any securities or financial instruments mentioned herein, the recipient(s) of this report must make its own independent decisions.
Conflicts of Interest: PGIM Fixed Income and its affiliates may have investment advisory or other business relationships with the issuers of securities referenced herein. PGIM Fixed Income and its affiliates, officers, directors and employees may from time to time have long or short positions in and buy or sell securities or financial instruments referenced herein. PGIM Fixed Income and its affiliates may develop and publish research that is independent of, and different than, the recommendations contained herein. PGIM Fixed Income’s personnel other than the author(s), such as sales, marketing and trading personnel, may provide oral or written market commentary or ideas to PGIM Fixed Income’s clients or prospects or proprietary investment ideas that differ from the views expressed herein. Additional information regarding actual and potential conflicts of interest is available in Part 2A of PGIM Fixed Income’s Form ADV.
In the United Kingdom, information is issued by PGIM Limited with registered office: Grand Buildings, 1-3 Strand, Trafalgar Square, London, WC2N 5HR. PGIM Limited is authorised and regulated by the Financial Conduct Authority (“FCA”) of the United Kingdom (Firm Reference Number 193418). In the European Economic Area (“EEA”), information is issued by PGIM Netherlands B.V., an entity authorised by the Autoriteit Financiële Markten (“AFM”) in the Netherlands and operating on the basis of a European passport. In certain EEA countries, information is, where permitted, presented by PGIM Limited in reliance of provisions, exemptions or licenses available to PGIM Limited under temporary permission arrangements following the exit of the United Kingdom from the European Union. These materials are issued by PGIM Limited and/or PGIM Netherlands B.V. to persons who are professional clients as defined under the rules of the FCA and/or to persons who are professional clients as defined in the relevant local implementation of Directive 2014/65/EU (MiFID II). In certain countries in Asia-Pacific, information is presented by PGIM (Singapore) Pte. Ltd., a Singapore investment manager registered with and licensed by the Monetary Authority of Singapore. In Japan, information is presented by PGIM Japan Co. Ltd., registered investment adviser with the Japanese Financial Services Agency. In South Korea, information is presented by PGIM, Inc., which is licensed to provide discretionary investment management services directly to South Korean investors. In Hong Kong, information is provided by PGIM (Hong Kong) Limited, a regulated entity with the Securities & Futures Commission in Hong Kong to professional investors as defined in Section 1 of Part 1 of Schedule 1 (paragraph (a) to (i) of the Securities and Futures Ordinance (Cap.571). In Australia, this information is presented by PGIM (Australia) Pty Ltd (“PGIM Australia”) for the general information of its “wholesale” customers (as defined in the Corporations Act 2001). PGIM Australia is a representative of PGIM Limited, which is exempt from the requirement to hold an Australian Financial Services License under the Australian Corporations Act 2001 in respect of financial services. PGIM Limited is exempt by virtue of its regulation by the FCA (Reg: 193418) under the laws of the United Kingdom and the application of ASIC Class Order 03/1099. The laws of the United Kingdom differ from Australian laws. In South Africa, PGIM, Inc. is an authorised financial services provider – FSP number 49012. In Canada, pursuant to the international adviser registration exemption in National Instrument 31-103, PGIM, Inc. is informing you of that: (1) PGIM, Inc. is not registered in Canada and is advising you in reliance upon an exemption from the adviser registration requirement under National Instrument 31-103; (2) PGIM, Inc.’s jurisdiction of residence is New Jersey, U.S.A.; (3) there may be difficulty enforcing legal rights against PGIM, Inc. because it is resident outside of Canada and all or substantially all of its assets may be situated outside of Canada; and (4) the name and address of the agent for service of process of PGIM, Inc. in the applicable Provinces of Canada are as follows: in Québec: Borden Ladner Gervais LLP, 1000 de La Gauchetière Street West, Suite 900 Montréal, QC H3B 5H4; in British Columbia: Borden Ladner Gervais LLP, 1200 Waterfront Centre, 200 Burrard Street, Vancouver, BC V7X 1T2; in Ontario: Borden Ladner Gervais LLP, 22 Adelaide Street West, Suite 3400, Toronto, ON M5H 4E3; in Nova Scotia: Cox & Palmer, Q.C., 1100 Purdy’s Wharf Tower One, 1959 Upper Water Street, P.O. Box 2380 - Stn Central RPO, Halifax, NS B3J 3E5; in Alberta: Borden Ladner Gervais LLP, 530 Third Avenue S.W., Calgary, AB T2P R3.
© 2022 PFI and its related entities. 2022-3204