15 Sept 2022
High-yield hard currency debt markets across the globe have come under significant pressure in recent months, with African markets caught in the eye of the storm. In addition to rising developed market yields, increased global recession fears and thinning liquidity, concerns around food security and external indebtedness have weighed heavily on African markets amid a general souring of investor sentiment.
Overall, Africa’s economies entered 2022 in reasonable shape. Although we’ve seen an increase in debt levels, liquidity buffers were high and the majority of countries were engaged in fiscal and domestic reform programs. But the current environment – characterised by a ‘sudden stop’ in foreign investor flows into Africa’s debt markets – has accelerated the need for those reforms as economies will need to reduce external financing needs and increase domestic savings and resilience. And the IMF may need to revive some of the support measures implemented post-COVID, in tandem with countries also focussing on securing more multilateral support, as we discussed recently.
With this as the backdrop, we expect to continue to see a greater dispersion between economies and, therefore, debt market performance across the region. Countries that are willing and able to consolidate fiscal finances, even in the face of tighter financial conditions, are likely to see relative strength, and it is these that we favour.
To understand which countries are most vulnerable to tighter global liquidity conditions, we use a proprietary credit vulnerability model. This looks at current economic, fiscal, external and institutional factors of each country relative to peers and history and then combines this with a consideration of external liquidity vulnerability (reserves and gross external financing needs). According to this, countries that are most vulnerable (those with large short-term gross financing needs and weaker credit fundamentals) include Egypt, Ghana and Kenya. However, we believe market pricing has already reflected these risks to a great degree. Liquidity conditions are likely to improve on the margin for Egypt, Tunisia, Ghana, Kenya as all of these are on or working towards an IMF program. Most foreign investors have left, meaning the financial-account drain (i.e., impact from tightening financial conditions) will be lower as there is little foreign capital, and currencies have adjusted significantly. But the picture is diverse and careful selection will be needed to identify sustainable alpha opportunities across the investment universe.
As we wrote last year, the economic growth premium enjoyed by frontier markets, such as many African markets, stems from both the demographic make-up of these countries (younger populations with more people moving into the workforce each year) and structural dynamics (e.g. moving from an agriculture-driven to a services economy). Given this backdrop, it is not unusual for investors to see sudden, positive shifts from this significant part of the EM debt universe. A recent example is Kenya, where – contrary to fears among the investor community - the Supreme Court upheld the result of the Presidential election, highlighting a significant improvement in Kenya’s democratic process since previous elections. Similarly, last year we described how the peaceful transfer of power to Zambia’s new president – the country’s first president with a background in business – underscored the country’s democratic credentials and heralded an exciting new era for investors in Zambian debt.
More broadly, a theme which will only continue to grow is that of ESG investing within Africa; several governments are currently working to set up the right frameworks to allow ESG issuance. Given the huge amounts of capital needed for the global transition to a more sustainable path, this will be an important area for both governments and investors to focus on.
With a combination of short-term challenges and structural shifts likely to increase disparity across the African debt opportunity set, we think an active investment approach is vital.