Frontier Debt’s Exacting Exploration Excitement

Following consecutive years of double-digit gains above the core sovereign bond benchmark, and with crowded trades in the main emerging market local and external instruments, investment houses pre-virus were touting fundamental frontier allocations based on diversification and underlying country improvements. They argue that risk re-pricing can partially offset illiquidity, although the credits have not been tested in crisis and remain outside standard ETFs, Last year’s big winners were Egypt and Ukraine, while Kazakhstan and Kenya lagged the JP Morgan EMBI and GBI-EM indices. A major debt and equity rebounder predicted for 2020 is Pakistan with another IMF program, with inflows into domestic Treasury bills yielding almost 15% as the currency stabilizes. Economic growth will be 2-3% on fiscal and current account adjustments, as double-digit inflation drops from prior depreciation and bad farming results. The balance of payments gap should halve to 2.5% of GDP with import compression, as reserves are bolstered by fresh foreign direct and portfolio investment. The exchange rate stance has moved from pegged to flexible and at 155/dollar currently is roughly fair value. International reserves remain negative on a net basis but Fund injections aim to restore balance, with the government coalition in slight majority in parliament. Tax revenue may reach 15% of GDP this fiscal year on a wider base and with spending cuts almost eliminate the primary deficit. Energy reform will entail costs over time, and anti-money laundering compliance is outstanding to avoid FATF sanctions. Geopolitics is not in the equation, with India again stoking tensions in Kashmir and denying Muslims future citizenship under a proposed law. Daily T-bill market turnover is over $300 million, with frequent auctions and narrow bid-ask spreads compared with frontier rivals, on 10% withholding tax according to JP Morgan research.

In Africa Ghana and Nigeria are back in favor after foreign investors were subject to access and rule changes resulting in the latter’s local index exclusion. Ghana’s twin deficits are under stricter control heading into end-year elections, with a several billion dollar financial sector cleanup consolidating banks and holding executives accountable for crimes and mismanagement. The crackdown suspended bank shares on the stock exchange prompting removal from the MSCI frontier rung, and potential reinstatement awaits the index provider’s next review. Inflation is in single digits as the central bank is poised to lower 15% interest rates. The current account gap is put at 4% this year, but the currency should be steady on external bond inflow momentum and calmer capital flight after successful poll transitions. A good medium term yield curve is offset by thin trading, but authorities are trying to launch derivatives for further liquidity. In Nigeria the reserve drain has bottomed at around $35 billion, and the central bank has turned its attention from currency intervention to reigniting credit and economic growth. It recently barred domestic buyers from high-yield open market operation (OMO) paper so that banks eventually have more room to extend loans especially to non-oil smaller business. Pension funds and corporations shifted their portfolios into other government instruments, and foreign investors now holding half the amount will be the main OMO target to whet their broad fixed income appetite. The naira after previous convulsions should only fall toward 370 over the coming months as import and dealing grips relent from past seizure.