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African eurobonds hit hard in 2018

Africa Global Funds
July 10, 2018, 9:59 p.m.
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Despite improved economic growth and better fundamentals, African Eurobonds have been hit hard in 2018, with at present 48% of African credits trading with yields over 7%, according to Renaissance Capital.

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Despite improved economic growth and better fundamentals, African Eurobonds have been hit hard in 2018, with at present 48% of African credits trading with yields over 7%, according to Renaissance Capital.

“The credits have largely been sold off because the assets are collectively labelled risky – not because of any deterioration in fundamentals. Even where countries have sold off beyond the African average – for example Zambia – there has been limited change in the fundamentals in 2018, and instead it’s been a story of how investors, under pressure, have re-priced market risk and countries’ vulnerabilities,” said Gregory Smith, Director, Fixed Income Strategist, Emerging Markets, at Renaissance Capital.

The higher-grade (or near investment grade) credits from South Africa, Morocco and Namibia held up better at each level of duration. 
As their credit ratings suggest, they provide a more robust story during a period of re-pricing. “Modest growth keeps us neutral on South Africa and Morocco. We are underweight Namibia based on the IMF’s 2018 forecast for the fiscal deficit (7.7% of GDP) and expectations of sluggish GDP growth,” said Smith.

Zambia’s three eurobonds have been hit the hardest of all African eurobonds. 

“We think the risks of no IMF support should have been priced in from July 2017 (when it became clear that an IMF programme would not be signed). Instead, spreads tightened in 2017 as bond funds recorded inflows. It took the EM wobble from April 2018 to un-nerve investors and dramatic re-pricing followed,” said Smith.

He added that when making an assessment on the value of the credits, investors should think more about Zambia’s complacency; understand the level of capacity; and be measured about concerns of conspiracy. 

“We argue that the current level is still not an obvious entry point for increasing positions. More bad (or badly perceived) news from Zambia, credit ratings downgrades to reflect current risks, or more importantly further outflows from EM fund bond funds could all increase yields further.”

Smith said that investors owning the bonds should hold: “The debt risks are evident, but they are not as stark – relative to other lower-income credit – as current yields suggest. While we do not think this is an obvious entry point, it might be hard to get in if the bonds do rally – something the more bullish should consider.”

The 2018 re-pricing has occurred despite 14 of the 20 African eurobond issuers being forecast (by the IMF) to grow faster in 2018 than the previous year (when eurobond spreads tightened). 

According to Renaissance Capital, 13 issuers are expected to see their current account balance improve, and 17 are forecast to have single-digit inflation in 2018. 

When it comes to keeping a lid on fiscal deficits the record is mixed, but the IMF expects nine of the governments to keep their fiscal deficits below 4% of GDP in 2018. Five countries are forecast to have a fiscal deficit larger than 7% GDP (Egypt, Kenya, Mozambique, Namibia and Zambia), putting further pressure on debt ratios.

“Rising debt is a challenge for most African economies, but we think the situation is less worrisome than how many commentators present it. Recent issuance and events make us less worried about a ‘debt repayment wall’ from 2022 to 2025,” said Smith.

“While it is unclear when the markets will turn positive, we see value in reviewing portfolios. Trimming exposure in some areas could help limit further losses, and efforts to build positions where credits are deemed too cheap could help ensure the full benefits from any rally are captured. We are overweight the growth and reform stories of Senegal, Ivory Coast, Ghana and Egypt in 2018,” he added.

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