Zambia's impending Eurobond lacks Nigerian hubub

My contribution to this month's Business Diary Botswana which now operates out of both Harare and Lusaka as well:

Zambia's plan to issue USD$500MM in sovereign paper to finance infrastructure—Absa analysts wrote last month that the government “intends to forge ahead with plans to issue its maiden Eurobond [in early 2011] once it has obtained a sovereign rating”—comes on the heels of Nigeria's initial foray into international debt markets in late January in which the continent's most populous nation received orders equaling more than two times the amount of debt sold, attracting buyers from 18 countries in Europe, the U.S., Asia and Africa, despite fairly ardent reservations from certain international investment houses and fund managers regarding its fiscal profligacy.  A windfall oil revenue account set up under former President Olusegun Obasanjo, for instance, fell from $20bn to a recent estimate of roughly $300MM, while FX reserves dropped from USD42bn in January 2010 to USD33.1bn by November, marking the second consecutive annual decline (reserves were roughly USD53bn year-end 2008) as the Central Bank of Nigeria (CBN) continued to defend its preferred level of USD/NGN150.  Citing the above, along with increased “political risk” ahead of this April's elections as well as high inflation underpinned by rising food costs and a 2010 fiscal deficit of 6.1% of GDP compared with 4.8% targeted, Fitch Ratings lowered Nigeria's sovereign credit outlook to Negative (BB-) in October, though S&P maintained its B+ “Stable” outlook primarily on the back of the country's strong external debt (2.4% of GDP).  Moreover, the Financial Times noted, “the country's ratio of oil production to oil reserves is very low (2m barrels per day from 36bn in reserves), so it is a safe bet that petrodollars will keep flowing well beyond the 10-year lifespan of the bond.”  With this in mind, the paper's ultimate 7 percent yield looked reasonable in comparison with Ghana's 2017 paper (rated B)—which couponed at 8.5%, now yields 6.3% and is considered the region's defacto sovereign benchmark—and per some analysts may even look “dear” sooner rather than later.  “All expectations are for a rally in the Nigerian Eurobond in the months to come, perhaps when the uncertainty of elections is seen to be less significant,” mused one Standard Chartered banker.  For their part, Nigerian officials couldn't have been happier.  “This is a major success and milestone for the country and economy,” Finance Minister Olusegun Aganga gushed to reporters from his office in Abuja.  “[The country will now have a] transparent and internationally observable benchmark against which international investors can accurately price risk.”    

Relative to the squabble surrounding Nigeria's fiscal soundness, Zambia's impending auction should be somewhat tame as “lofty commodity prices should support the case for a relatively low interest rate” per one commentator in regards not only to Zambia but to Tanzania, a rapidly emerging gold producer.  But this outlook may be particularly true for Zambia, Africa's largest copper producer (responsible for roughly 9 percent of total world exports) given the recent run-up for industrial metals while precious metals such as gold and silver have seemingly paused for breath.  Copper specifically has been buoyed by both demand and supply fundamentals—China's consumption of the metal has tripled in a decade to an estimated 6.8 million tons in 2010, according to CRU, a metals and mining consultant that projects due largely to the accelerating urbanization of central and western China (in addition to the continued development and refinement of ever-burgeoning coastal giants) the country is on pace to almost triple its annual use of copper to 20 million tons in 25 years—more than the world produces today and setting the stage for a potential global shortage of 11 million tons a year by 2035.  And while the People's Bank of China (PBC) has acted increasingly hawkish regarding inflation—“reserve requirement ratio (RRR) increases have triggered fears that the Chinese authorities are about to significantly accelerate policy tightening, which could lead to a sharp slowdown in domestic credit and consequently overall economic growth,” wrote one credit analyst, the overall global macro landscape is such that both demand and supply should be running in somewhat opposite directions for the foreseeable future.  On the demand front the U.S., the world's second largest copper consumer behind China, continues to stabilize as economic data in late January showed that showed the country's GDP grew at a rate of 3.2% for the fourth quarter of 2010 and 2.9% annually, its biggest rise in half a decade.  Moreover, VM Group, a London-based metals, energy, agribusiness and renewals consultancy, wrote to clients recently of the expectation of a supply squeeze in the medium term adding further support to copper's overall return dynamic over the coming year: “Dominating copper's allure are its supply-side shortfalls, which are now well established. Mine supply has not kept pace with demand for many years, nor has it responded with alacrity to the meteoric price rise, implying that structural difficulties exist.”  To that end “the world refined copper market is expected to have a 500,000-metric-ton to 600,000-ton deficit in 2011, even with a significantly weaker demand scenario,” according to metals strategists with JPMorgan Securities Ltd.

Moreover while Nigeria's history of ethnic-fuelled political violence and current macro story (namely inflation) give some investors serious pause, Zambia in contrast is a study in economic soundness and stability.  Absa noted in its year-end Emerging Market Quarterly for instance that FDI inflows—which reached record levels totaling USD4.3bn (27% of GDP) in 2010—more than doubled the total FDI inflow of USD1.8bn in 2009 and should be underpinned in 2011 by further investment—as well as “improved private consumption and infrastructure spending will result in growth of close to 7% in 2011 from an estimated 6.6% in 2010.”  Of note, Chinese investment in Zambia (which has swelled by over 400 percent since 2004) is expected to more than double to $2.4bn in 2011, driven mainly by investments in mining and manufacturing, trade minister Felix Mutati reported last month.  Meanwhile, Vancouver-based First Quantum Minerals Ltd. will invest more than $1bn in a copper mine (with three open pits) and smelter project in Zambia's Northwestern province that will be commissioned by the end of the year, probably produce copper over 20 years and create about 2,000 jobs, per the firm's president Clive Newall, who noted that the company will also build a new hydropower station near the mine to ensure continuous supply of electricity.  And although the upcoming October presidential elections between the MMD's President Rupiah Banda and the opposition PF's Michael Sata should be closely contested, “Zambia has had peaceful elections since becoming a multi-party democracy in 1991,” analysts note.  Inflation, meanwhile, is likely to pick up some due to higher expected energy costs, infrastructure and social spending inherent to the government's continued fiscal expansionary stance as well as the natural effect stemming from stronger domestic demand.  Yet Zambia's fiscal deficit, at just above 3% of GDP in 2010, is among the lowest in Sub-Sahara Africa   And while rising food inflation (which accounts for 57% of the consumer basket) is likely to cause CPI to spike going forward, analysts note that large domestic food stocks mean inflation could remain anchored within single digits, although it accelerated already to 9 percent in January on an increase in grain prices, acting Director of the Central Statistical Office John Kalumbi announced.  Yet the inflation dynamic and the resulting pressure on sovereign borrowing costs is admittedly a nuanced one.  As one report noted, “for outsiders that balance between moderate inflation that stimulates healthy bond yields, and runaway price increases that damage overall economic performance, will be crucial.”  To that end, “there's been a huge amount of policy accommodation in Africa, and understandably, a reluctance to roll that back very quickly,” said Razia Khan, head of Africa research at Standard Chartered in London.  “But at the same time the inflation outlook is not going to be that favorable. The big question is ‘Do domestic yields rise fast enough to compensate for that or not?'  If it's not the case, you're not going to see sizeable investor interest.”  Regardless, the eventual issuance of Zambian sovereign debt is yet another cause for celebration as it will accelerate the maturation of domestic capital markets, in turn making state and ultimately corporate balance sheets all the more autonomous.  And as Ashmore Investment's Jay Dehn reiterated, “sovereign yield curves help corporates to price bonds, [and] in turn [will unlock] Africa's huge medium term growth potential.”