In contrast to most of the world, and especially to developed markets, the general trend for the larger investable markets across the continent is for falling consumer inflation and very low CPI levels compared to the past two years.
In April, CPI fell to 12.5% in Nigeria (a 26 month low), 3.7% in Kenya (lowest since January 2013) and 13.1% in Egypt (lowest since May 2016). Ghana, a country that has traditionally suffered from high inflation saw CPI fall to within the central bank’s target range with a print of 9.6% in April. The currency devaluations in November 2016 and August 2017 in Egypt and Nigeria respectively have been strong contributors to the higher levels of inflation that both these countries experienced recently. A drought in Kenya had resulted in high food prices, which makes up a large portion of the consumer basket. In contrast to this, Morocco (where the Fund has no exposure) saw inflation rise to a multi-year high of 2.7%, with food inflation at 3.7%.
The graph below shows the latest IMF estimates of year-end inflation for African countries with equity markets. We have selected the relevant countries from their database and weighted the inflation rates using the size of each country’s GDP to generate the series.
Source: International Monetary Fund, World Economic Outlook Database, April 2018, Ashburton
The more than 6.0% decline in inflation expected during 2018 should lead to lower interest rates in many countries. This will be positive for equity markets because local pension fund managers who have been investing in high-yielding government bonds and treasury bills should now allocate more of their funds to equities as rates decline.
Despite falling inflation rates most central banks kept rates on hold at their recent meetings, generally citing specific domestic risks. In Nigeria, the Monetary Policy Rate was kept stable at 14%, because the Central Bank of Nigeria foresees significant upside risks to the outlook in the second half of the Fiscal Year, largely related to increased fiscal spending as we approach the elections in February 2019. After reducing interest rates by a cumulative 200 bps this year, the Central Bank of Egypt’s Monetary Policy Committee left interest rates unchanged at its meeting held on 17 May. The need to keep domestic rates high to protect currencies has also dissipated as foreign exchange reserves have grown. In the two biggest economies, for example, Egypt’s import cover of merchandise imports is now more than 9 months with Nigeria’s about 16 months. At the same time, we believe that many currencies are being held artificially weak as central banks continue to buy up US dollars and grow foreign exchange reserves.
We have previously discussed the diversification benefits of investing in African equities, and this divergent trend in interest rate environments further emphasises this. As a reminder, developed markets are more than 80% correlated to emerging markets, whereas they are only 24% correlated to African markets excluding South Africa. For South African equity markets the difference is even more extreme, with the correlation to developed and emerging markets being 77% and 85% respectively, but only 20% to Africa excluding South Africa.
With equity markets in Africa only just recovering to levels of five years ago, but growth continuing for many of the underlying businesses over that period, there is clearly impetus for significant future returns through active management and stock selection. Lower interest rates should provide further support for valuations.
The Fund has maintained its total exposures to Kenya and Nigeria broadly in line with the index, although the underlying holdings vary considerably. The Fund still has its largest exposure to Egypt, where the Egyptian pound has started strengthening. Morocco remains the Fund’s largest underweight as we view the market as expensive.
With many economies across the continent on a recovery path and inflation declining, we expect interest rates to continue declining. This will be positive for equity markets that will also start anticipating the generally improved economic outlook for the continent in 2018 and beyond.
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