The misconceptions of the risks associated with investing in Africa are most acutely expressed within the valuations of local African debt markets, says Mahan Namin, a portfolio manager at Insparo Asset Management.
Current yields are between 12% and 14%, the currency is supported, inflation contained in single-digits, and outstanding domestic debt modest at a forecast 20.2% of GDP by the end of 2012.
From one end of the political risk spectrum to the other, the recent turmoil in Egypt provides a great demonstration of the extent of local support for domestic government bonds and bills within some African states.
It also shows the extent of monetary flexibility central banks are able and willing to deploy.
Egypt’s mass protests leading to the removal of former President Hosni Mubarak on 11 February resulted in massive capital outflows and speculation of a disorderly currency devaluation in the order of between 15% and 20%.
But the central bank had ample motive to prevent a devaluation. It also had the necessary FX reserves (official and unofficial) to be able to sterilise even the worst-case scenario of all foreigners exiting the market at once.
In addition, the banking sector, which already owned 57% of the outstanding stock of T-bills and was about 45% government-owned to begin with, was flush with liquidity and easily able to take up the slack from foreigners becoming net sellers.
Thus despite continued economic uncertainty and major political turmoil, the currency has weakened only by 3% since January.
While the stock market continues to make new lows (now down more than 40% from pre-Arab Spring highs) and the benchmark Egypt 2020 Eurobond has failed to break even on a total return basis, the T-bill market which was yielding about 10.3% in six months, is the only investment that would have made steady and positive returns since the beginning of the year (see chart two).
During the period in which equity markets were closed and real money managers in a panic frenzy, believers in the central bank’s credibility and the resilience of the banking system were able to utilise the NDF to take exposure to the Egyptian pound at implied rates of between 25% and 50%. This was an opportunity too compelling for us to ignore.
Derivatives markets in Africa are at a very early stage of development, but progress is being made rapidly with interest rate swaps markets starting in Nigeria, Kenya, Uganda, Tanzania and Ghana. FX forward markets are becoming ever more liquid and transparent across the region.
These tools will enable investors to hedge out specific risks and take more sophisticated exposure – an integral part of the development and growth of the African local markets.
Corporate issuance outside of South Africa is small and mainly concentrated on a few select issuers within Morocco, Tunisia, Kenya, Nigeria and Egypt.
The potential scope for growth in the local corporate debt market is enormous, if we consider that the total market cap of listed African equity markets outside of South Africa in August was $246.6bn.
Corporate local credit could become one of the biggest asset classes within Africa. Even in its current embryonic state, the local corporate debt market is an essential and highly attractive means of capturing value and tapping into Africa’s exciting growth story.
With continued government commitments to ease foreign investment restrictions and deepen local debt markets, as well as development of the interbank derivatives market and the prospect of growing corporate issuance across the region, the opportunities look set to become increasingly plentiful.