Despite deteriorating economic fundamentals, Africa’s financial markets made a remarkable recovery in 2020. Mark Dunley-Owen discusses the price distortion in sovereign bond markets and explains how we are positioning the Africa ex-SA Bond Fund to withstand the potential fallout.
In March, we quoted Ghana’s finance minister describing the COVID-19 pandemic as Africa’s “break the glass moment”. Governments across the continent were calling for the suspension of debt servicing costs on public debt. Rolling African sovereign defaults were feared. We described the road ahead as “bumpy”.
We were wrong. The Standard Bank Africa ex South Africa Sovereign Bond Index gained 47% since its March low, ending the year higher than it started in spite of the pandemic. The cost of borrowing for many African countries fell during the year, ending near or below historic lows. The price on Nigeria’s 10-year Eurobond started the year at 103, sold off to below 70 in March and ended the year at 108.
We expected attractive returns to be made from the lows of a panic, but the speed and scale of the recovery of financial markets surprised us. This recovery is in stark contrast to economic fundamentals. Debt is higher, while in many cases the revenue to support the debt is lower. Demand remains muted in key sectors ranging from tourism to retail. The oil price remains unfeasible for many African producers. Nigeria’s currency and bond markets are dysfunctional. Egypt and Ghana spend more than half of their government revenue on interest. South Africa’s debt to GDP is climbing towards 100%, a level unthinkable a year ago. Zambia defaulted on a Eurobond interest payment, and the full extent of what it owes remains hidden.
Deteriorating fundamentals should be mirrored in financial markets. Instead, global liquidity trumped everything else in 2020. Central banks gave out unprecedented money and promises, distorting global asset prices away from underlying fundamentals. Developmental institutions initially supported governments with cheap money, epitomised by Kristalina Georgieva, the managing director of the International Monetary Fund, urging: “Spend. Keep the receipts. But spend.” Private sector money followed as the largesse of fiscal and monetary stimulus made it clear that risk had been underwritten by the regulators.
This is unlikely to end well for bonds. Prices and fundamentals cannot remain disconnected forever. Borrowers must eventually generate sufficient cashflow to repay their debt. Those that can’t, including many African borrowers, will find other ways such as inflationary erosion of debt or, in extreme cases, default. Much as hope followed panic, we expect reality to become apparent over the coming months and years.
Within the Allan Gray Africa ex-SA Bond Fund, we continue to favour dollar-denominated bonds from more diversified countries such as Kenya, Egypt and Ghana, and cash-generative corporates such as Seplat. We increased local currency exposure to 16% of Fund by buying Namibia, Uganda and Ghana local currency bonds at yields and currency levels that offer attractive probable returns. Duration remains conservative. Cash was increased to 11% of Fund as we wait for more suitable prices.