By Thys Louw, Assistant Portfolio Manager
We recently attended the International Monetary Fund (IMF) spring meetings in Washington D.C. We had the opportunity to engage with various policymakers, investors and IMF representatives across frontier markets. The experience left us with the impression that the recent performance divergence across frontier local and hard currency markets could continue given the spectrum of fundamentally differing credit stories.
Signs of strength and stability
These are countries generally under an IMF programme or alternatively where we have seen a dramatic and sustained improvement in imbalances which we expect to continue over the next 6-9 months. Countries in this group included Ghana, Egypt, Nigeria, Ivory Coast, Georgia and Mongolia.
Ghana remains supported by an IMF programme, and benefits from strong group of competent technocrats within its government. Growth looks like it will remain strong, while increased oil production will help limit the impact of any increase in growth related imports on the current account. In addition, declining interest rates will also help the deleveraging process.
- What to watch out for – GDP rebasing which could see 20% revision in GDP making debt to GDP look more benign; Ability to raise non-tax revenues
Egypt remains a favourite among investors and the IMF alike. It is performing well under the IMF’s US$12bn programme and ‘green shoots’ of growth are appearing.
The primary fiscal (government annual budget) balance is expected to move towards a 2% surplus in 2019, while exports from the Zohr gas field will help sustain improvement in the current account.
- What to watch out for – Micro-reforms to help kick-start the private investment cycle; Risks of social unrest in case youth unemployment is not addressed
After a tough few years, the worst seems to be over for Nigeria, at least in the short term. With oil prices above US$65 and oil production stable, the country is now running a sizeable current account surplus. Meanwhile, declining inflation will allow the central bank to ease rates over the coming year. Although structural issues remain, the country now has the opportunity and firepower to support the economy.
- What to watch out for – General elections in February 2019; Unrest in the Niger delta hurting oil production
Signs of improvement
There were several countries where after a period of deterioration in credit metrics we are starting to see signs that data might start to surprise to the upside once again. Countries in this group included Argentina, Costa Rica, Oman and Angola
After a solid stretch of policy and economic performance, Argentina shook investor confidence at the end of last year with a sudden change of inflation target, resulting in an 18% depreciation in its currency.
At the meetings, policymakers clearly expressed that they had learned lessons from how they communicated the policy change. Meanwhile, a weaker currency and stronger growth numbers could easily trigger better fiscal performance than expected and support lower issuance.
In the short term, we expect to see the central bank try and re-anchor inflation expectations, while seasonal flows could also support the stabilisation in the current account.
- What to watch out for – Central bank stance on inflation and exchange rate; Progress on wage negotiations with unions
With the election of President Carlos Alvarado, we are finally starting to see moves to rein in the fiscal deficit which has plagued the country. Recent reforms introduced are expected to cut almost 2.5% off the deficit, while the IMF team seemed to think that this was just the first step towards the 3.5% figure needed to stabilise debt to GDP ratio. Although a move in Congress towards the centre-right bodes well for any package being approved, we will need to monitor the situation closely once the new Congress takes its seat on the 1 May.
- What to watch out for – Constitutional Court and new congress stance on proposed fiscal reform package; Progress on wage negotiations with unions
Signs of reform fatigue
After a period of improvement in economic data, a few countries are starting to show some signs of weakness. This will need to be addressed in the short term to avoid a build-up in vulnerabilities. Countries in this category included Ukraine and Senegal.
Ukraine’s performance under its current IMF programme has started to wane. This is in part due to local resistance of some of the tougher proposed measures such as increasing gas prices by 40% as well as establishing an Anti-Corruption Court.
Fundamental performance has remained relatively good, with inflation continuing to moderate and the strong current account balance moving reserves above US$18bn. However, given the refinancing risks that remain, Ukraine still require the IMF support.
- What to watch out for – Willingness of government to address outstanding IMF issues (Anti-corruption court, gas price hikes); Plan post expiry of program in March 2019
Signs of fragility
Some countries face debt sustainability issues which are not being adequately addressed and show some signs of fragility. Vigilance is required, as without sufficient action by authorities these countries could face severe difficulties in the future. Countries in this category included Pakistan, Zambia, Ecuador and Venezuela.
With deteriorating fiscal and current account balances, Pakistan is quickly heading back to a situation where it will require an IMF programme to stabilise its finances. It only just escaped from IMF support 18 months ago, yet with an election coming up, we have seen little intent to address the deteriorating level and quality of fiscal balances, deal with the current account deficit or address the overvalued exchange rate.
- What to watch out for – Stance from new government post general election in July 2018, changes to currency policy as pre-cursor to engagement with IMF
The credibility of Zambian policymakers continued to erode when the government failed to deal with the issue of large contracted loans, which endanger debt sustainability. They have also failed to propose sufficient fiscal reforms to offset this proposed debt load.
In the meantime foreign currency reserves continue to decline and now sit at only two months of import cover, as external debt payments erode external buffers even at higher copper prices
- What to watch out for – Debt sustainability analysis to be released from Zambian authorities; New IMF Article IV on Zambia; Foreign Exchange Reserve levels
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