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There’s no paucity of warnings about the unintended consequences of the Bernanke Federal Reserve’s unprecedented monetary policy. After all, four years of zero interest rates followed by at least three rounds of freestyle easing have injected trillions into global capital markets. Are high-yield bonds now too junky? Should banks actually be penalizing customers for giving them too much in the way of super-cheap deposits? What of the widening of the gap between the Have-Nots and the Kardashians?
But how cool would it be if the era of QE3 is unintentionally doing Africa, the world’s most developmentally stunted region, a huge favor?
So posits Larry Seruma, a Uganda-born portfolio manager with Nile Capital Management in his draft white paper “Why QE3 will be a Boon to Africa’s Frontier Markets.” “Massive monetary measures such as QE3,” writes Seruma, “have the impact of forcing investors out of their comfort zone and into riskier assets.” When the Fed accumulates Treasuries and mortgage-backed securities, he explains, the private sector receives cash in the form of short-term bank reserves, which it needs to invest in search of higher returns.
In some emerging markets, that cash now can be put to work in sovereign debt earning 9 percent yields. The problem is that mainstream emerging markets such as Brazil have the First World problem of worrying about the effects of too much hot money sluicing into their economies. In 2011, foreign direct investment in Brazil hit a record $68 billion, double 2010’s inflow. As a result, Brazil’s currency appreciated by 39 percent against the U.S. dollar, hurting the appeal of its exports and forcing the government’s hand to keep its currency affordable and hold hot money in check.
“But,” writes Seruma, “if emerging markets like Brazil are trying to moderate the hot-money tsunami, where will it go? Stocks and bonds of frontier markets with the highest economic growth rates are positioned just downstream from the emerging markets. They need and welcome capital to support infrastructure growth, resource development and expanding consumer markets.”
Indeed, international investors have loved Africa this year, sending borrowing costs to record lows for some nations. In July, Gabon’s 10-year bond, maturing in 2017, sported a yield of 4.45 percent while Spain was paying 6.22 percent. In mid September, Zambia sold its first 10-year dollar-denominated bond, raising $750 million; the deal was so oversubscribed that there were $12 billion of orders. Zambia’s bond yielded 5.625 percent vs. Spain’s then-5.78 percent. According to Capital Economics, the yields on global debt issued by Nigeria, Namibia, Senegal, and Ivory Coast have fallen by an average 2.5 percentage points this year through October.
That enthusiasm was initially stoked by high interest rates that were the result of central banks having hiked rates until very recently to fight double-digit inflation, says Caglar Somek, global portfolio manager with Caravel Fund, a frontier investor that has positions across the subcontinent. “Therefore,” he says, “real interest rates spiked and attracted foreign investors. But recently we have seen inflation peak and taper off, with bond yields falling.” It’s no coincidence that investor ardor for Africa has spilled into the booming stock markets of Uganda, Rwanda, Nigeria, Kenya, and Namibia, whose indexes are up an average of 33 percent in local currency terms this year. Africa, he points out, was the only region whose gross domestic product growth was most recently revised upward by the International Monetary Fund. “We like the growth dynamics.”
According to the IMF and World Bank, economic growth in Sub-Saharan Africa is forecast to accelerate to 5.7 percent in 2013, multiples of what is expected out of Europe and North America. Twenty-three African countries are on track to hold multiparty elections in 2012, compared with the existence of only three continental democracies as recently as 1989.
Kenya, East Africa’s biggest economy, has brought in General Electric (GE) as it budgets as much as $50 billion over the next 20 years to meet a 14 percent annual increase in electricity demand, according to the country’s Energy Regulatory Commission. GE has inked similar development deals with Nigeria and Ghana, is pursuing power-generation projects in Tanzania and health-care equipment rollouts in Ethiopia and Rwanda. The American conglomerate is also supplying oil and gas companies in Angola, where it’s looking to expand into power generation. All of the above are a direct function of governments’ access to affordable debt capital.
Seruma cites a McKinsey prediction that from 2008 to 2020, revenue for infrastructure companies in Africa will grow from $72 billion to over $200 billion. He adds that the number of cell-phone subscribers in Africa has ballooned from 283 million only five years ago to what is expected to be 735 million by the end of this year. The McKinsey Global Institute calculated that Africa had a combined spending power of $860 billion in 2008. That’s on track to rise to $1.4 trillion by 2020, as more Africans increase their consumption of discretionary goods and services.
For an example of how the confluence of ultra-low Western interest rates and Africa’s unusually high growth have compelled capital into the region, Seruma points to Nigeria. “A country such as Nigeria,” he writes, “has the size and GDP growth rate to put foreign capital to productive use.” Nigeria is Africa’s largest country (167 million people) and the seventh-largest country in the world. By 2025, writes Seruma, its population is projected to surpass Brazil’s; its GDP is now growing by 6.7 percent, more than triple Brazil’s rate. Still, he writes, “with a coupon of 13 percent, Nigeria’s six-month T-bills are yielding above the rate of inflation, producing a positive real rate of investment return, compared to negative real rates in most developed market sovereign debt.”
Nigeria was recently added to the JPMorgan (JPM) Emerging Market Government Bond Index, a development that has knocked down its borrowing costs and is expected to increase capital flows to the volatile economy by an estimated $1.5 billion.
Is all this new money destined to stay in Africa, where it is sorely needed to finance the building of bridges and dams? Or will it bolt when better risk opportunities beckon? The stakes are huge for a continent that is the landmass equivalent of China, India, Japan, Mexico, the U.S., and Europe combined.
Seruma echoes many continent watchers in believing that a fundamental shift in international capital allocation is underway. “QE1 and QE2,” writes Seruma, “have demonstrated the power of hot-money capital flows to drive emerging market price appreciation. Now, QE3 is poised to help Africa’s frontier markets emerge into the expanding consciousness of global investors.”