The global macro environment over the past year has proved to be challenging for emerging market debt. A large part of that could be attributed to developments in the US and other developed markets. The bond yields of advanced economies have been surging and the dollar is near a two-decade high following a series of interest rate increases by the Federal Reserve and other major central banks. Their mission is to quell inflation that’s stayed stubbornly high. The upheaval in the energy and commodities markets following Russia’s invasion of Ukraine and the after effects of Covid continue to be disruptive for many economies.
However, with challenges come opportunities. Emerging markets still offer yields that are significantly higher than developed markets and we believe in doing the groundwork at all times to spot attractive entry points and opportunities. During my visit, I met with top policy makers as well as representatives of multilateral institutions and other stakeholders in the economy to evaluate the relative merits of the two countries.
Firstly, let’s take a look at politics as that inevitably shapes policies. Nigeria, Africa’s largest economy, is gearing up for presidential elections in early 2023. Any change in leadership will be a welcome development given that the current administration led by President Muhammadu Buhari lacks a reform agenda. No candidate has a clear edge as of now. Although Africa’s most populous nation has complex regional, religious, and tribal dynamics, it has a well-established convention of smooth transfer of power. The election outcome is expected to be fair and is unlikely to be contested as the country has adopted a new voting technology that is difficult to rig.
Ghana, on the other hand, is hobbled by a hung parliament for the first time in its history and elections are two years away. But it has a functioning government, and the growth outlook is positive. The parliamentary process is democratic, and the underlying institutions are robust in the context of Africa.
When we invest in hard currency EM bonds, as active managers, we consider a host of metrics including the level of fiscal deficit and national debt as well as the amount of foreign exchange reserves to assess their ability to service debts.
Nigeria’s budget deficit has been between 5% and 6% of GDP for the past five years. Of this, the oil subsidy alone accounts for 3% of GDP. Such a high fiscal deficit can’t be sustained in the long run. Foreign exchange reserves total $38 billion but unencumbered reserves could be less than half of that. Nigeria is a large oil producer and is a member of OPEC, but it doesn’t benefit from high oil prices as the output is much lower than its 1.8mb/day quota due to underinvestment. Exports through rampant oil theft and sale on the black market reduce the availability of dollars in the formal economy.
On the positive side, Nigeria’s total national debt as a share of its economy is about 40%. The number could exceed that if contingent liabilities are also accounted for but we see little chance of a default over the next 18 months even in an extremely bearish scenario.
Ghana’s economic position is much more difficult. The pandemic has widened its budget deficit to 8%-12% of GDP, which has increased the debt to GDP to ratio to 85%. The currency has slumped, and foreign exchange reserves have dwindled to just $3.5 billion. Ghana’s ability to access capital markets to shore up its reserves is closed for now. Talks with the International Monetary Fund (IMF) to get some financing is underway. The nation has asked for $3 billion. As with any country, IMF may ask Ghana to promise some reforms to improve debt sustainability.
For Ghana, there’s little option but to bite the bullet to gain market access. Among the reforms it could commit to, we could list: a credible plan to drastically cut government spending and restructure local debt as well as external debt. Reducing the size of the bloated government expenditure could be popular among the population. The procedure to restructure the local debt is simpler than revamping external debt but has to be done in a measured way to avoid any disruption. About 40% of banking assets are invested in government bonds and any haircut could have an impact on their capital ratios.
Pros and cons
Overall, we expect Nigeria to fare better than Ghana. A change in government after elections next year would be a positive for Nigeria as there is a possibility the fuel subsidy will be removed, which in turn will reduce budget deficit and national debt. Ghana, on the other hand, faces an uphill task in demonstrating it can get its act together to push through reforms.
Many EM investors are allocated to Nigeria yet it’s not easy to put a big overweight on the country because of the lack of transparency on usable oil reserves and the central bank policy instils no confidence for the long term. There are positive catalysts brewing, however. Post the trip, our view hasn’t materially changed but we have more conviction on maintaining exposure.
In Ghana, the main challenge however is the first hung parliament. For rapid progress on debt restructuring and budget consolidation a highly motivated and competent government is required. It would be too optimistic to expect the government to be able to deliver these policies effectively and quickly. We prefer thus to maintain an underweight bias. For the moment we will maintain however some exposure across our portfolios investing in sovereigns as there is a possibility of some positive surprises.
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