The impact of household debt and saving on long run GDP growth

The impact of household debt and saving on long run GDP growth


Macro Letter – No 70 – 10-02-2017

The impact of household debt and saving on long run GDP growth

Neither a borrower nor a lender be;

For loan oft loses both itself and friend,

And borrowing dulls the edge of husbandry.

Hamlet I, iii – Shakespeare

  • BIS research indicates that household debt to GDP ratios above 80% reduce growth
  • But higher household savings do not appear to lead to higher investment
  • Counter-cyclical fiscal stimulus and fractional reserve lending are much more powerful growth factors than household savings or even household debt

Last week saw the publication of a fascinating working paper by the BIS – The real effects of household debt in the short and long run –the conclusions of the authors were most illuminating, here is the abstract:-

Household debt levels relative to GDP have risen rapidly in many countries over the past decade. We investigate the macroeconomic impact of such increases by employing a novel estimation technique proposed by Chudik et al (2016), which tackles the problem of endogeneity present in traditional regressions. Using data on 54 economies over 1990‒2015, we show that household debt boosts consumption and GDP growth in the short run, mostly within one year. By contrast, a 1 percentage point increase in the household debt-to-GDP ratio tends to lower growth in the long run by 0.1 percentage point. Our results suggest that the negative long-run effects on consumption tend to intensify as the household debt-to-GDP ratio exceeds 60%. For GDP growth, that intensification seems to occur when the ratio exceeds 80%. Finally, we find that the degree of legal protection of creditors is able to account for the cross-country variation in the long-run impact.

The chart below shows the growing divergence between the household debt of developed and emerging market economies:-


Source: BIS

Of the emerging markets, South Korea has the highest household debt ratio, followed by Thailand, Malaysia and Hong Kong: all have ratios above 60%. Singapore is on the cusp of this watershed, whilst all the remaining emerging economies boast lower ratios.

Part of the reason for lower household debt in emerging economies is the collective market memory of the Asian financial crisis of 1997. Another factor is the higher savings rate among many emerging economies. The table below is incomplete, the data has been gathered from multiple sources and over differing time periods, but it is still quite instructive. It is ranked by highest household savings rate as a percentage of GDP. On this basis, I remain bullish on the prospects for growth in the Philippines and Indonesia, but also in India and Vietnam, notwithstanding the Indian Government debt to GDP ratio of 69% and Vietnam’s budget deficit of -5.4% of GDP:-


There are other countries who household sector also looks robust: China and Russia, are of note.

Last month I wrote about The Risks and Rewards of Asian Real Estate. This BIS report offers an additional guide to valuation. It helps in the assessment of which emerging markets are more likely to weather the impact of de-globalising headwinds. Policy reversals, such as the scrapping of the TPP trade deal, and other developments connected to Trump’s “America First” initiative, spring to mind.

Savings and Investment

When attempting to forecast economic growth, household debt is one factor, but, according to the economics textbooks, household savings are another. Intuitively savings should support investment, however, in a recent article for Evonomics – Does Saving Cause Lending Cause Investment? (No.)Steve Roth shows clear empirical evidence that a higher savings rate does not lead to a higher rate of investment. Here is a chart from the St Louis Federal Reserve which supports Roth’s assertions:-


Source: St Louis Federal Reserve Bank

Personal savings represents a small fraction of GDP especially when compared to lending and investment. Roth goes on to analyse the correlations:-


His assessment is as follows:-

Of course, correlation doesn’t demonstrate causation. But lack of correlation, and especially negative correlation, does much to disprove causation. What kind of disproofs do we see here?

Personal saving and commercial lending seem to be lightly correlated. The correlation declines over the course of a year, but then increases two or three years out. It’s an odd pattern, with a lot of possible causal stories that might explain it.

Personal saving and private investment (including both residential and business investment) are very weakly correlated, and what correlation there is is mostly negative. More saving correlates with less investment.

Commercial lending has medium-strong correlation with private investment in the short term, declining rapidly over time. This is not terribly surprising. But it has nothing to do with private saving.

Perhaps the most telling result here: Personal saving has a significant and quite consistent negative correlation with business investment. Again: more saving, less investment. This directly contradicts what you learned in Econ 101.

The last line — commercial lending versus business investment — is most interesting compared to line 3 (CommLending vs PrivInv). Changes in commercial lending seem to have their strongest short-term effects on residential investment, not business investment. But its effect on business investment seems more consistent and longer-term.

This is a fascinating insight, however, there are international factors at work here. This data looks at the US, but the US is a far from closed economy; the current account deficit tells you that. Setting aside cross border capital flows there are even larger forces to consider.

Firstly, in general, when an economy slows, its government increases fiscal spending and its central bank reduces interest rates. Secondly, when short term interest rates fall, banks are incentivised to borrow short and lend long. They achieve this using a fraction of their own capital, lending depositors’ money at longer maturity and profiting from the interest rate differential.

Once fiscal stimulus has run its course and banks have leveraged their reserves to the maximum, the importance of household savings should, in theory, become more pronounced, but if interest rates are low investors are likely to defer investment. If government fiscal pump-priming has failed to deliver an economic recovery, investors are likely to be dissuaded from investing. Despite Roth’s empirical evidence to the contrary, I do not believe that the household savings rate is an unimportant measure to consider when forecasting economic growth, merely that it is overshadowed by other factors.


Household savings may have little impact on GDP growth but Household debt does. In the UK the savings Ratio was 6.6%, whilst the Household debt to income ratio was 152% at the end of 2015. By comparison, at the end of 2014 the US the savings ratio was 5% and household debt to income a more modest 113%. The ratio of the ratios is broadly similar at around 23 times.

With interest rates still close to the lowest levels in centuries and real interest rates, even lower, debt, rather than savings, is likely to be the principal driver of investment. That investment is likely to be channelled towards assets which can be collateralised, real estate being an obvious candidate.

I began this letter with a quote from Hamlet. I wonder what advice Polonius would give his son today? The incentive to borrow has seldom been more pronounced.

US growth – has the windfall of cheap oil arrived or is there a spectre at the feast?


Macro Letter – No 53 – 22-04-2016

US growth – has the windfall of cheap oil arrived or is there a spectre at the feast?

  • Oil prices have been below $60/bbl since late 2014
  • The benefit of cheaper oil is being felt across the US
  • Without lower oil prices US growth would be significantly lower
  • Increasing levels of debt are stifling the benefits of lower prices

In this letter I want to revisit a topic I last discussed back in June 2015 – Can the boon of cheap energy eclipse the collapse of energy investment? In this article I wrote:-

The impact of the oil price collapse is still feeding through the US economy but, since the most vulnerable states have learnt the lessons of the 1980’s and diversified away from an excessive reliance of on the energy sector, the short-run downturn will be muted whilst the long-run benefits of new technology will be transformative. US oil production at $10/barrel would have sounded ludicrous less than five years ago: today it seems almost plausible.

This week the San Francisco Fed picked up the theme in their FRBSF Economic Letter – The Elusive Boost from Cheap Oil:-

The plunge in oil prices since the middle of 2014 has not translated into a dramatic boost for consumer spending, which has continued to grow moderately. This has been particularly surprising since the sharp drop should free up income for households to use toward other purchases. Lessons from an empirical model of learning suggest that the weak response may reflect that consumers initially viewed cheaper oil as a temporary condition. If oil prices remain low, consumer perceptions could change, which would boost spending.

Given the perceived wisdom of the majority of central banks – that deflation is evil and must be punished – the lack of consumer spending is a perfect example of the validity of the Fed’s inflation targeting policy; except that, as this article suggests, deflations effect on spending is transitory. I could go on to discuss the danger of inflation targeting, arguing that the policy is at odds with millennia of data showing that technology is deflationary, enabling the consumer to pay less and get more. But I’ll save this for another day.

The FRBSF paper looks at the WTI spot and futures price. They suggest that market participants gradually revise their price assumptions in response to new information, concluding:-

The steep decline in oil prices since June 2014 did not translate into a strong boost to consumer spending. While other factors like weak foreign growth and strong dollar appreciation have contributed to this weaker-than-expected response, part of the muted boost from cheaper oil appears to stem from the fact that consumers expected this decline to be temporary. Because of this, households saved rather than spent the gains from lower prices at the pump. However, continued low oil prices could change consumer perceptions, leading them to increase spending as they learn about this greater degree of persistence.

In a related article the Kansas City Fed – Macro Bulletin – The Drag of Energy and Manufacturing on Productivity Growth observes that the changing industry mix away from energy and manufacturing, towards the production of services, has subtracted 0.75% from productivity growth. They attribute this to the strength of the US$ and a decline in manufacturing and mining.

…even if the industry mix stabilizes, the relative rise in services and relative declines in manufacturing and mining are likely to have a persistent negative effect on productivity growth going forward.

The service and finance sector of the economy has a lower economic multiplier than the manufacturing sector, a trend which has been accelerating since 1980. A by-product of the growth in the financial sector has been a massive increase in debt relative to GDP. By some estimates it now requires $3.30 of debt to create $1 of GDP growth. A reduction of $35trln would be needed to get debt to GDP back to 150% – a level considered to be structurally sustainable.

Meanwhile, US corporate profits remain a concern as this chart from PFS group indicates:-


Source: PFS Group, Bloomberg

The chart below from Peter Tenebrarum – Acting Man looks at whole economy profits – it is perhaps more alarming still:-


Source: Acting Man

With energy input costs falling, the beneficiaries should be non-energy corporates or consumers. Yet wholesale inventories are rising, total business sales seem to have lost momentum and, whilst TMS-2 Money Supply growth remains solid at 8%, it is principally due to commercial and industrial lending.

US oil production has fallen below 9mln bpd versus a peak of 9.6mln. Rig count last week was 351 down three from the previous week but down 383 from the same time last year. Meanwhile the failure of Saudi Arabia to curtail production, limits the potential for the oil market to rally.

From a global perspective, cheap fuel appears to be cushioning the US from economic headwinds in other parts of the world. Employment outside mining and manufacturing is steady, and wages are finally starting to rise. However, the overhang of debt and muted level of house price appreciation has dampened the animal spirits of the US consumer:-


Source: Global Property Guide, Federal Housing Finance Agency

According to the Dallas Fed – Increased Credit Availability, Rising Asset Prices Help Boost Consumer Spendingthe consumer is beginning to emerge:-

A combination of much less household debt, revived access to consumer credit and recovering asset prices have bolstered U.S. consumer spending. This trend will likely continue despite an estimated 50 percent reduction since the mid-2000s of the housing wealth effect— an important amplifier during the boom years.

…Since the Great Recession, the ratio of household debt-to-income has fallen back to about 107 percent, a more sustainable—albeit relatively high—level.

…The wealth-to-income ratio rose from about 530 percent in fourth quarter 2003 to 650 percent in mid-2007 as equity and house prices surged. Not surprisingly, consumer spending also jumped.

The conventional estimate of the wealth effect—the impact of higher household wealth on aggregate consumption—is 3 percent, or $3 in additional spending every year for each $100 increase in wealth.

…Recent research suggests that the spendability, or wealth effect, of liquid financial assets—almost $9 for every $100—is far greater than the effect for illiquid financial assets, which explains why falling equity prices do not generate larger cutbacks in aggregate consumer spending. Other things equal, higher mortgage and consumer debt significantly depress consumer spending.

…The estimated housing wealth effect varies over time and captures the ability of consumers to tap into their housing wealth. It rose steadily from about 1.3 percent in the early 1990s to a peak of about 3.5 percent in the mid- 2000s. It has since halved, to about the same level as that of the mid-1990s. During the subprime and housing booms, rising house prices and housing wealth effects propagated and amplified expansion of consumption and GDP.

During the bust, this mechanism went into reverse. High levels of mortgage debt, falling house prices and a reduced ability to tap housing equity generated greater savings and reduced consumer spending. Fortunately, house prices have recovered, deleveraging has slowed or stopped, and consumer spending is strong, even though the housing wealth effect is only half as large as it was in the mid-2000s.

Countering the positive spin placed on the consumer credit data by the Dallas Fed is a recent interview with  Odysseas Papadimitriou, CEO of CardHub by Financial Sense – Credit Card Debt Levels Reaching Unsustainable Levels:-

In 2015, we accumulated almost $71 billion in new credit card debt. And for the first time since the Great Recession, we broke the $900 billion level in total credit card debt so we are back on track in getting to $1 trillion.


Source: Bloomberg, Financial Sense

Another factor which has been holding back the US economy has been the change in the nature of employment. Full-time jobs have been replaced by lower paying part-time roles and the participation rate has been in decline. This may also be changing, but is likely to be limited, as the Kansas City Fed – Flowing into Employment: Implications for the Participation Rate reports:-

After a long stretch of declines, the labor force participation rate has risen in recent months, driven in part by an increase in the share of prime-age people flowing into employment from outside the labor force. So far, this flow has remained largely confined to those with higher educational attainment, suggesting further increases in labor force participation rate could be relatively limited.

…Overall, the scenarios show that while more prime-age people could enter the labor force in the coming years, the cyclical improvement in the overall participation rate may be limited to the extent only those with higher educational attainment flow into employment. In addition, the potential increase in the participation rate could be constrained by other factors such as an increase in the share of prime-age population that reports they are either retired or disabled and a limited pool of people saying they want a job, even if they have not looked recently. Thus, while higher NE flow indicates the prime-age participation rate could increase further, it will likely remain lower than its pre-recession rate.


At the 2015 EIA conference Adrian Cooper of Oxford Economics gave a presentation – The Macroeconomic Impact of Lower Oil Prices – in which he estimated that a $30pb decline in the oil price would add 0.9% to US GDP between 2015 and 2017. If this estimate is correct, lower oil is responsible for more than a quarter of the current US GDP growth. It has softened the decline from 2.9% to 2% seen over the last year.

I would argue that the windfall of lower oil prices has already arrived, it has shown up in the deterioration of the trade balance, the increase in wages versus consumer prices and the nascent rebound in the participation rate. That the impact has not been more dramatic is due to the headwinds on excessive debt and the strength of the US$ TWI – it rose from 103 in September 2014 to a high of 125 in January 2016. After the G20 meeting Shanghai it has retreated to 120.

According to the March 2015 BIS – Oil and debt report, total debt in the Oil and Gas sector increased from $1trln in 2006 to $2.5trln by 2015. The chart below looks at the sectoral breakdown of US Capex up to the end of 2013:-

US CAPEX by sector

Source: Business Insider, Compustat, Goldman Sachs

With 37% allocated to Energy and Materials by 2013 it is likely that the fall in oil prices will act as a drag on a large part of the stock market. Energy and Materials may represent less than 10% of the total but they impact substantially in the financial sector (15.75%).

Notwithstanding the fact that corporate defaults are at the highest level for seven years, financial institutions and their central bank masters will prefer to reschedule. This will act as a drag on new lending and on the profitability of the banking sector.

The table below from McGraw Hill shows the year to date performance of the S&P Spider and the sectoral ETFs. This year Financials are taking the strain whilst Energy has been the top performer – over one year, however, Energy is still the nemesis of the index.

Sector SPDR Fund % Change YTD % Change 1 year
S&P 500 Index 2.86% 0.10%
Consumer Discretionary (XLY) 2.23% 5.05%
Consumer Staples (XLP) 4.16% 6.83%
Energy (XLE) 10.20% -19.16%
Financial Services (XLFS) -2.49% 0.00%
Financials (XLF) -1.22% -2.85%
Health Care (XLV) -1.01% -3.31%
Industrials (XLI) 6.41% -0.07%
Materials (XLB) 8.45% -5.78%
Real Estate (XLRE) 1.98% 0.00%
Technology (XLK) 3.60% 5.19%
Utilities (XLU) 10.74% 7.08%

Source: McGraw Hill

The benefit of lower oil and gas prices will continue, but, until debt levels are reduced, anaemic GDP growth is likely to remain the pattern for the foreseeable future. In Hoisington Investment Management – Economic Review – Q1 2016 – Lacy Hunt makes the following observation:-

The Federal Reserve, the European Central Bank, the Bank of Japan and the People’s Bank of China have been unable to gain traction with their monetary policies…. Excluding off balance sheet liabilities, at year-end the ratio of total public and private debt relative to GDP stood at 350%, 370%, 457% and 615%, for China, the United States, the Eurocurrency zone, and Japan, respectively…

The windfall of cheap oil has arrived, but cheap oil has been eclipsed by the beguiling spectre of cheap debt.

US Growth and employment – can the boon of cheap energy eclipse the collapse of energy investment?


Macro Letter – No 38 – 19-06-2015

US Growth and employment – can the boon of cheap energy eclipse the collapse of energy investment?

  • Last year’s oil price falls are still feeding through to the wider economy
  • Oil producing states have remained resilient despite the continued lower price of WTI
  • The wider economy has rebounded after the slowdown in Q1
  • Stock earnings growth is regaining upward momentum

At the end of last year I became cautious about the prospects for the US stock market. The principal concern was the effect a sustained decline in the price of oil was likely to have on the prospects for employment and economic growth.

The Texan Experience

Oil rich Texas represents a microcosm of the effect lower energy prices may be having on employment and growth. This article from December 2014 by Mauldin Economics – Oil, Employment, and Growth – neatly sums up my concerns at the end of last year:-

…we need to research in depth as we try to peer into the future and think about how 2015 will unfold. In forecasting US growth, I wrote that we really need to understand the relationships between the boom in energy production on the one hand and employment and overall growth in the US on the other. The old saw that falling oil prices are like a tax cut and are thus a net benefit to the US economy and consumers is not altogether clear to me. I certainly hope the net effect will be positive, but hope is not a realistic basis for a forecast. Let’s go back to two paragraphs I wrote last week:

Texas has been home to 40% of all new jobs created since June 2009. In 2013, the city of Houston had more housing starts than all of California. Much, though not all, of that growth is due directly to oil. Estimates are that 35–40% of total capital expenditure growth is related to energy. But it’s no secret that not only will energy-related capital expenditures not grow next year, they are likely to drop significantly. The news is full of stories about companies slashing their production budgets. This means lower employment, with all of the knock-on effects.

As we will see, energy production has been the main driver of growth in the US economy for the last five years. But changing demographics suggest that we might not need the job-creation machine of energy production as much in the future to ensure overall employment growth.

…The oil-rig count is already dropping, and it will continue to drop as long as oil stays below $60. That said, however, there is the real possibility that oil production in the United States will actually rise in 2015 because of projects already in the works. If you have already spent (or committed to spend) 30 or 40% of the cost of a well, you’re probably going to go ahead and finish that well. There’s enough work in the pipeline (pardon the pun) that drilling and production are not going to fall off a cliff next quarter. But by the close of 2015 we will see a significant reduction in drilling.

Given present supply and demand characteristics, oil in the $40 range is entirely plausible. It may not stay down there for all that long (in the grand scheme of things), but it will reduce the likelihood that loans of the nature and size that were extended the last few years will be made in the future. Which is entirely the purpose of the Saudis’ refusing to reduce their own production. A side benefit to them (and the rest of the world) is that they also hurt Russia and Iran.

Employment associated with energy production is going to fall over the course of next year. It’s not all bad news, though. Employment that benefits from lower energy prices is likely to remain stable or even rise. Think chemical companies that use natural gas as an input as an example.

I am, however, at a loss to think of what could replace the jobs and GDP growth that the energy complex has recently created. Certainly, reduced production is going to impact capital expenditures. This all leads one to begin thinking about a much softer economy in the US in 2015.

Last month’s employment report suggests we may have avoided the downturn from cheaper oil, but uncertainty remains. Earlier this month the Dallas Fed – Robust Regional Banking Sector Faces New Economic Hurdles whilst focusing on the health of the banking sector, worried that the effect of lower oil prices, combined with higher interest rates, may yet wreak havoc in the Eleventh District. Here are some of the highlights:-

Not only have district banks achieved greater profitability than their counterparts nationwide, but their loan portfolios also have grown twice as fast. District banks returned to lending sooner than banks in the rest of the country and experienced more rapid loan growth due to the region’s economic strength.

…Possibly reflecting banks’ quest for yield in a low-interest-rate environment, the so-called three-year asset/ liability gap has been growing, particularly for district banks. This measure subtracts liabilities with maturities greater than three years (certificates of deposit, for example) from loans and securities with maturities greater than three years and divides the difference by total assets. A bigger gap means that banks would be hurt by rising interest rates because their assets are tied up for a longer time relative to their liabilities. Consequently, when interest rates rise, banks’ funding costs could rise while interest income remains stagnant, squeezing profitability.

…The other big concern is potential fallout from recent dramatic oil and gas price declines, which affects Texas banks in particular. In July 2014, the West Texas Intermediate (WTI) spot price exceeded $105 a barrel; by March, it had tumbled to below $50 before bouncing back to near $60 at the start of May. The size and rapidity of the decline raised concerns about the impact on the Texas economy and Texas banks, especially given the experiences of the energy and financial collapses of the 1980s. While the state’s economy has become more diverse and thus less reliant on the oil and gas industry, the price drop has still negatively affected the Texas economy and labor market. Some pockets of the state remain heavily dependent on the energy sector, making local industries vulnerable to spillover effects. And because of community banks’ close ties to the areas they serve, they are more exposed than large banks.

…One measure of potential distress is the so-called Texas ratio, the book value of an institution’s nonperforming assets as a percent of its tangible equity capital and its loan-loss reserves. Essentially, the Texas ratio compares an institution’s bad assets to its available capital. A Texas ratio above 1 (expressed as 100 percent) indicates that probable and potential losses exceed an institution’s immediate loss-absorbing cushion, putting it at greater risk of bankruptcy. There have been two instances of dramatic oil price declines since 1980; one gives rise to concern and the other to hope.

Between June 1980 and September 1986, the WTI price declined 74 percent in real (inflation-adjusted) terms. Roughly 20 percent of all Texas institutions had a Texas ratio greater than 100 percent by year-end 1988. A staggering 706 Texas banks and thrifts failed—including nine of the 10 largest banking institutions—between September 1986 and year-end 1990.9

A more recent oil price decline, in the second half of 2008 and early 2009, was also dramatic, but in a different way. Over a nine-month period beginning in June 2008, the price fell more than 71 percent. Yet less than 1 percent of Texas banks had a Texas ratio exceeding 100 percent and only seven failed in 2008–09. The slight pickup in bank troubles in 2010 is likely attributable to generally difficult financial and economic conditions that year.

From June 2014 through March 2015, the price of WTI fell 58 percent. Nevertheless, not one Texas bank had a Texas ratio greater than 100 percent as of the first quarter and only one bank had failed as of March.

The bottom line: The persistence of low oil prices seems to matter more for banks than the magnitude of falling prices. A precipitous, but short-lived, decline is likely to have only a minor impact on the banking industry. Even a longer-term decline similar to that seen in the 1980s is unlikely to provoke the same scope of disruption now as it did then.

…Mitigating factors also make Texas banks better able to weather falling oil prices. Memories of the 1980s crisis linger, and the 2008–09 financial crisis is also fresh in the minds of bankers and regulators. Apart from regulatory changes, Texas bankers manage their risks more prudently, using better risk diversification. The Shared National Credit (SNC) program is one example. Generally, large loans are held by multiple institutions through the SNC program, allowing individual institutions to spread the risk of large credit exposures. While the SNC program has been around since 1977, it has grown in importance and coverage. SNC industry trends by sector show that commodities credits, including those tied to the oil and gas industry, increased from $395 billion in 2002 to $798 billion in 2014. Regulatory filings and investor conference calls suggest that energy exposure at the larger banks in Texas is now predominantly through these shared credits.

…The low-interest-rate environment and a flat yield curve with relatively little difference in interest rates across various maturities have pressured bank earnings over the past five years. Banks have responded by extending their maturity profile in an attempt to generate more robust returns. As interest rates normalize, regulators will need to monitor banks’ ability to restructure their maturity profiles and adapt to the new environment.

The impact of recent oil price declines on banks also bears watching, particularly in Texas. While banks appear to be managing their energy exposure well—and a relatively short spell of low energy prices is not expected to have a severe, adverse effect on local banks—the importance of energy in certain regions points to the possibility of relatively large localized disruptions. The banking system has navigated a post crisis path to recovery. Conditions have improved markedly, but the industry must remain vigilant to potential risks to its financial health and stability.

According to the Dallas Fed – Texas Economic Indicatorspublished on 4th June, the region is showing mixed performance:-

Region Employment Growth
Austin 7.70%
Dallas 2.20%
El Paso 3.30%
Houston 0%
San Antonio -0.50%
Southern New Mexico -0.90%

Source: Dallas Federal Reserve

For the state as a whole, April employment was 1% higher versus the US +1.9%. The largest fall was seen in Oil and Gas Extraction (-14.4%) followed by Manufacturing (-4%) and Construction (-2.6%). Leisure and Hospitality led employment increases (5.3%) Information (4.6%) Education and Health (2.6%) and Trade, Transportation and Utilities (2.3%).

The importance of Oil and Gas to Texas, from an employment perspective, is small– only 2.5% of the workforce – but the sector’s impact on the rest of the region’s economy is much greater. Many ancillary sectors, including manufacturing, banking and finance rely on energy. The most encouraging aspect of the data above is the 2.3% increase in Trades, Transportation and Utilities. As an employer this sector amounts to 20.2% of the total. For this sector, lower energy prices are like the tax cut John Mauldin alluded back in December.

The Energy Complex and US growth

The recent energy technology boom has increased the oil and gas sector’s importance – please revisit Manhattan Institute – New Technology for Old Fuels – my personal favourite essay on this subject. The share of oil and gas in total employment peaked in the early 1980s at 0.8% it’s now back to 0.5%. Its share of GDP followed a similar path, falling from 4% in the 1980’s to less than 1% at the start of the millennium; it’s now back around 2%. Energy self-sufficiency remains elusive – the US is still a net oil importer and therefore benefits from lower oil prices. The Energy Information Administration (EIA) estimates a $700 per household saving from the decline in gasoline prices in 2015. This should also spur an increase in capital investment. The traditional estimate of a halving of output has increased dramatically; meanwhile energy efficiency has significantly improved. The fall from $105 to $60 – assuming the market remains around the current level – will probably add 0.4% to GDP.

As one might expect, the direct impact of cheaper oil on the energy sector has been negative. The US rig count fell by 850 between December 2014 and March 2015. Many energy exploration firms have reduced headcount and cut capital expenditure. I don’t believe the benefits of technology have been exhausted by the energy exploration firms, especially the shale-industry. The Manhattan Institute – Shale 2.0 – takes up the story and go on to make some policy recommendations:-

John Shaw, chair of Harvard’s Earth and Planetary Sciences Department, recently observed: “It’s fair to say we’re not at the end of this [shale] era, we’re at the very beginning.” He is precisely correct. In recent years, the technology deployed in America’s shale fields has advanced more rapidly than in any other segment of the energy industry. Shale 2.0 promises to ultimately yield break-even costs of $5–$20 per barrel—in the same range as Saudi Arabia’s vaunted low-cost fields.

The shale industry is unlike any other conventional hydrocarbon or alternative energy sector, in that it shares a growth trajectory far more similar to that of Silicon Valley’s tech firms. In less than a decade, U.S. shale oil revenues have soared, from nearly zero to more than $70 billion annually (even after accounting for the recent price plunge). Such growth is 600 percent greater than that experienced by America’s heavily subsidized solar industry over the same period.

Shale’s spectacular rise is also generating massive quantities of data: the $600 billion in U.S. shale infrastructure investments and the nearly 2,000 million well-feet drilled have produced hundreds of petabytes of relevant data. This vast, diverse shale data domain—comparable in scale with the global digital health care data domain—remains largely untapped and is ripe to be mined by emerging big-data analytics.

Shale 2.0 will thus be data-driven. It will be centered in the United States. And it will be one in which entrepreneurs, especially those skilled in analytics, will create vast wealth and further disrupt oil geopolitics. The transition to Shale 2.0 will take the following steps: 1.Oil from Shale 1.0 will be sold from the oversupply currently filling up storage tanks. 2. More oil will be unleashed from the surplus of shale wells already drilled but not in production. 3. Companies will “high-grade” shale assets, replacing older techniques with the newest, most productive technologies in the richest parts of the fields. 4. And as the shale industry begins to embrace big-data analytics, Shale 2.0 begins.

Further, if the U.S. is to fully reap the economic and geopolitical benefits of Shale 2.0, Congress and the administration should: 1. Remove the old, no longer relevant, rules prohibiting American companies from selling crude oil overseas. 2. Remove constraints, established by the 1920 Merchant Marine Act, on transporting domestic hydrocarbons by ship. 3. Avoid inflicting further regulatory hurdles on an already heavily regulated industry. 4. Open up and accelerate access to exploration and production on federally controlled lands.

Nonetheless, in the near-term, states which benefitted from $100+ crude oil and the energy related innovations it spawned, are now feeling the effects of what appears to be a sustained period of lower energy prices. The EIA predicts WTI crude will average $60 over the course of 2015.

The CFR – Energy Brief – October 2013 – predicted that a 50% oil price fall would affect the employment prospects of eight states in particular:-

State Fall in Employment
Alaska -1.70%
Louisiana -1.60%
North Dakota -2%
New Mexico -0.70%
Oklahoma -2.30%
Texas -1.20%
West Virginia -0.70%
Wyoming -4.30%

Source: Council for Foreign Relations

So far, if Texas is any guide, the negative effects of the oil price decline have failed to materialise.

The effect of a 25% rise in crude oil prices is also worth considering:-

State Employment Change State Employment Change
Wisconsin -0.74 Ohio -0.61
Minnesota -0.73 Missouri -0.6
Tennessee -0.72 Illinois -0.59
Rhode Island -0.71 Massachusetts -0.59
Florida -0.71 Delaware -0.58
New Hampshire -0.7 South Dakota -0.57
Idaho -0.69 New York -0.57
Nevada -0.69 California -0.56
Arizona -0.68 Alabama -0.56
Indiana -0.68 DC -0.5
Nebraska -0.67 Kentucky -0.48
Vermont -0.66 Pennsylvania -0.47
Iowa -0.66 Utah -0.38
New Jersey -0.65 Kansas -0.35
Washington -0.64 Mississippi -0.35
Maryland -0.64 Arkansas -0.34
Georgia -0.64 Montana -0.31
Michigan -0.64 Colorado -0.15
Virginia -0.64 New Mexico 0.36
South Carolina -0.64 West Virginia 0.36
Oregon -0.64 Texas 0.6
Connecticut -0.63 Louisiana 0.78
Maine -0.62 Alaska 0.87
North Carolina -0.62 North Dakota 1.01
Hawaii -0.61 Oklahoma 1.16
Wyoming 2.14

Sources: CFR, U.S. Bureau of Labor Statistics and the Wall Street Journal

The effect on the US as a whole is estimated at -0.43%. In other words, a fall in crude oil is good for employment and should also act as a cathartic stimulus to GDP growth.

A final measure of the vulnerability of the US economy to the recent oil price decline is shown by the next table. This shows the substantial diversification away from the energy sector seen in every one of the major oil producing states since the 1980’s:-

Share of Oil and Gas Extraction as a % of GDP
1981 2000 2010
Alaska 49.5 15.1 19.1
Louisiana 35.5 11.1 9.7
New Mexico 26.1 5.2 5.1
North Dakota 20.3 0.9 4.3
Oklahoma 21.6 4.8 9.1
Texas 19.1 5.8 7.8
West Virginia 2.4 1 1.5
Wyoming 37.1 9.8 18.5

Source: CFR, U.S. Bureau of Economic Analysis

Looking at how unemployment has changed across the 51 states over the last 12 months:-

State April April 12-month net change
2014 2015
Alabama 7.1 5.8 -1.3
Alaska 6.9 6.7 -0.2
Arizona 6.9 6 -0.9
Arkansas 6.3 5.7 -0.6
California 7.8 6.3 -1.5
Colorado 5.4 4.2 -1.2
Connecticut 6.8 6.3 -0.5
Delaware 5.9 4.5 -1.4
DC 7.8 7.5 -0.3
Florida 6.4 5.6 -0.8
Georgia 7.3 6.3 -1
Hawaii 4.5 4.1 -0.4
Idaho 4.9 3.8 -1.1
Illinois 7.4 6 -1.4
Indiana 6 5.4 -0.6
Iowa 4.4 3.8 -0.6
Kansas 4.5 4.3 -0.2
Kentucky 7 5 -2
Louisiana 5.7 6.6 0.9
Maine 5.8 4.7 -1.1
Maryland 5.9 5.3 -0.6
Massachusetts 5.8 4.7 -1.1
Michigan 7.5 5.4 -2.1
Minnesota 4.2 3.7 -0.5
Mississippi 7.8 6.6 -1.2
Missouri 6.3 5.7 -0.6
Montana 4.7 4 -0.7
Nebraska 3.4 2.5 -0.9
Nevada 8.1 7.1 -1
New Hampshire 4.5 3.8 -0.7
New Jersey 6.7 6.5 -0.2
New Mexico 6.7 6.2 -0.5
New York 6.5 5.7 -0.8
North Carolina 6.4 5.5 -0.9
North Dakota 2.7 3.1 0.4
Ohio 5.9 5.2 -0.7
Oklahoma 4.7 4.1 -0.6
Oregon 7 5.2 -1.8
Pennsylvania 6 5.3 -0.7
Rhode Island 8.1 6.1 -2
South Carolina 6.1 6.7 0.6
South Dakota 3.4 3.6 0.2
Tennessee 6.5 6 -0.5
Texas 5.2 4.2 -1
Utah 3.8 3.4 -0.4
Vermont 4 3.6 -0.4
Virginia 5.3 4.8 -0.5
Washington 6.2 5.5 -0.7
West Virginia 6.8 7 0.2
Wisconsin 5.5 4.4 -1.1
Wyoming 4.3 4.1 -0.2

Source: Bureau of Labor Statistics

Only Louisiana (+0.9%) North Dakota (+0.4%) and West Virginia (+0.2%) of the top oil producing states, have witnessed increased levels of unemployment. South Dakota (+0.2%) and South Carolina (+0.6%) were the only other states in the union to see unemployment rise. This is not the picture of a faltering economy.

The Federal Reserve Leading Index, whilst it hit a low point of +0.9% in January – down from +2% in July 2014 – has rebounded – April +1.12% – and has remained in positive territory since August 2009. The Conference Board Leading Economic Index increased 0.7% in April to 122.3, following a +0.4% in March, and a -0.2% February. The Conference Board commented:-

April’s sharp increase in the LEI seems to have helped stabilize its slowing trend, suggesting the paltry economic growth in the first quarter may be temporary. However, the growth of the LEI does not support a significant strengthening in the economic outlook at this time. The improvement in building permits helped to drive the index up this month, but gains in other components, in particular the financial indicators, have been somewhat more muted.

The outlook appears steady rather than robust but this has been the pattern of the economic recovery ever since the first round of quantitative easing (QE) in November 2008.

Conclusion and Equity Investment Opportunities

The US economic recovery remains intact. The long run economic benefits of structurally lower energy prices and energy security are slowly feeding through to the wider economy. This is good for the US and, as long as the US continues to run a trade deficit with the rest of the world, it’s good for the US main trading partners too.

After a sharp correction in October 2014 the S&P500 recovered. Since its January lows the market has ground slowly higher:-

S&P500 - 1yr


The table below shows a series of additional valuation measures:-

Indicator Ratio Date Start of Data
Trailing 12 month P/E 20.53
Mean 15.54
Min 5.31 Dec 1917
Max 123.73 May 2009 1875
Shiller Case P/E 27.1
Mean 16.61
Min 4.78 Dec 1920
Max 44.19 Dec 1999 1885
Price to Sales 1.81
Mean 1.4
Min 0.8 Mar 2009
Max 1.81 Jun 2015 2001
Price to Book 2.89
Mean 2.75
Min 1.78 Mar 2009
Max 5.06 Mar 2000 2000


On most of these metrics the market looks relatively expensive but the current level of interest rates is unprecedented. JP Morgan Asset Management predict average corporate earnings to grow by 4% in 2015 – stripping out energy stocks this rises to 11%. They also remind investors that the S&P has seen 10 bear markets since 1926. Eight occurred as a result of economic recessions or commodity price shocks (price increases not decreases) and extreme valuations were a contributing factor only on four occasions. They go on to refute the idea that interest rate increases by the Federal Reserve will derail the bull market, pointing to the positive correlation between rising interest rates and rising equity prices when interest rates start from a low point. They make the caveat that the initial reaction to interest rate increases is negative but in the longer term stocks tend to rise.

At the risk of uttering that most dangerous of phrases – “this time it’s different” – I believe the majority of the rise in equity prices was a function of the reduction in the level of interest rates since 2008. This had two effects; investors switched from interest bearing securities to equities, hoping that capital appreciation would offset the declining income from bonds: and corporations, faced with negative real interest rates, decided to raise dividends and buy back stock, rather than make capital investments when interest rates were artificially low. The chart below shows US 10yr Government Bond yields since 1790:-

US 10 yr Bond Yield Global Financial Data

Source: Global Financial Data

The chart ends in 2013, since when yields have plumbed new depths. Ignoring the inflation shock of the 1970’s and 1980’s it would be reasonable to expect US Treasuries to yield around 3% but that was before the Federal Reserve moved from a stable price target – i.e. around zero – to a 2% inflation target. I think it is reasonable for corporates to assume a long-term cost of finance based on a 3% real yield for US Treasuries plus an appropriate credit spread. Is it any wonder that corporates continue to buy back stock?

The impact of the oil price collapse is still feeding through the US economy but, since the most vulnerable states have learnt the lessons of the 1980’s and diversified away from an excessive reliance of on the energy sector, the short-run downturn will be muted whilst the long-run benefits of new technology will be transformative. US oil production at $10/barrel would have sounded ludicrous less than five years ago: today it seems almost plausible.

US stocks are not cheap, but Q1 earnings declines have been reversed and, whilst growth is muted, the longer term benefits of lower energy prices are just beginning to feed through. At the beginning of the year I was cautious and considering reducing exposure to the US market. Now, I am still cautious, but, if earnings start to improve, today’s valuations will prove justified and further upside may be well ensue. The US bond market is doing the Fed’s work for it – 10yr yields have risen from a low of 1.64% in January to 2.30% today. Whilst the first rise in official rates is likely to act as a negative for stocks, the market will recover as long as the momentum of earnings growth remains positive and energy prices remain subdued.

Nigeria and South Africa – what are their prospects for growth and investment?


Macro Letter – No 37 – 06-06-2015

Nigeria and South Africa – what are their prospects for growth and investment?

  • The IMF forecast South Africa to grow by only 2% in 2015 and 2.1% in 2016
  • Whilst Nigeria is forecast to grow by 4.8% in 2015 and 5% in 2016
  • Both countries are succeeding in diversifying away from resources
  • Corruption remains the greatest political challenge to their prosperity

To begin my analysis of the two largest economies in Africa here is a table of statistics:-

Indicator Nigeria South Africa
GDP 523 USD Billion – Dec 13 351 USD Billion – Dec 13
GDP y/y 3.96 percent – Feb 15 2.1 percent – Feb 15
GDP per capita 1098 USD – Dec 13 5916 USD – Dec 13
GDP per capita PPP 5676 USD – Dec13 12106 USD – Dec 13
Unemployment Rate 23.9 percent – Dec 11 26.4 percent – Feb 15
Population 174 Million – Dec 13 54 Million – Dec 14
Inflation Rate 8.7 percent – Apr 15 4.5 percent – Apr 15
Food Inflation 9.48 percent – Apr 15 5 percent – Apr 15
Interest Rate 13 percent – May 15 5.75 percent – May 15
Foreign Exchange Reserves 4118713 NGN Million – May 15 470400 ZAR THO Million – Apr 15
Balance of Trade 1145749 NGN Millions – Dec 14 (2513) ZAR Million – Apr 15
Current Account ($158 USD Million) – Nov14 (198000) ZAR Million – Nov 14
Gold Reserves 21.37 Tonnes – Nov 14 125 Tonnes – Nov 14
Crude Oil Production 2520 BBL/D/1K – Jan 14 3 BBL/D/1K – Dec 14
Foreign Direct Investment 1030 USD Million – Nov14 1684 ZAR Billion – Nov 14
Government Budget (1.8) percent of GDP – Dec 13 (3.8) percent of GDP – Dec 14
Government Debt to GDP 11 percent – Dec 13 46.1 percent – Dec 13
Capacity Utilization 60.3 percent – Nov 14 81.5 percent – Nov 14
Corporate Tax Rate 30 percent – Jan14 28 percent – Jan 14
Personal Income Tax Rate 24 percent -Jan14 41 percent – Apr 15
Sales Tax Rate 5 percent – Jan 14 14 percent – Jan 15
Population below poverty line 33.1% (2013 est.) 26.2% (2011 est.)
Labour force 48.57 million (2011 est.) 17.89 million (2012 est.)
Labour force by occupation services: 32%; agriculture: 30%; manufacturing: 11% agriculture: 9%, industry: 26%, services: 65% (2007 est.)
Main industries crude oil, coal, tin, columbite, uranium; palm oil, peanuts, cotton, rubber, wood; hides and skins, textiles, cement and other construction materials, food products, footwear, chemicals, fertilizer, printing, ceramics, steel, small commercial ship construction and repair, entertainment, machinery, car assembly mining (world’s largest producer of platinum), gold, chromium, automobile assembly, metalworking, machinery, textiles, iron and steel, chemicals, fertiliser, foodstuffs, commercial ship repair
Ease-of-doing-business rank 131st 39th
Exports $97.46 billion (2012 est.) $101.2 billion (2012 est.)
Export goods petroleum and petroleum products 95%, cocoa, rubber, machinery, processed foods, entertainment gold, diamonds, platinum, other metals and minerals, machinery and equipment
Main Export Partners  India 12.8%  China 14.5%
   United States 11.1%  United States 7.9%
   Brazil 10%  Japan 5.7%
   Spain 7.1%  Germany 5.5%
   Netherlands 7%  India 4.5%
   Germany 5.1%  United Kingdom 4.1% (2012 est.)
   France 4.7%
   United Kingdom 4.5%
   South Africa 4.2% (2013 est.)
Imports $70.58 billion (2012 est.) $106.8 billion (2012 est.)
Import goods machinery and equipment, chemicals, transport equipement, manufactured goods, foodstuffs machinery and equipment, chemicals, petroleum products, scientific instruments, foodstuffs
Main import partners  China 20.8%  China 14.9%
   United States 11.2%  Germany 10.1%
   India 4.5% (2013 est.)  United States 7.3%
   Saudi Arabia 7.2%
   India 4.6%
   Japan 4.5% (2012 est.)
Gross external debt $10.1 billion (2012 est.) $47.66 billion (31 December 2011 est.)
Public debt 18.8% of GDP (2012 est.) 43.3% of GDP (2012 est.)
Credit Rating (S&P) B+ (Domestic) BBB+ (Domestic)
  B+ (Foreign) BBB- (Foreign)
  B+ (T&C Assessment) BBB+ (T&C Assessment)
  Outlook: Stable Outlook: Stable
Foreign reserves $42.8 billion (2012 est.) $54.98 billion (31 December 2012 est.)

Source: Trading Economics, CIA Factbook, IMF, World Bank, S&P

One additional factor to mention from the outset is the importance of China, and not just as an import partner, although South Africa also exports more to China than it does to any other country. Chinese companies have been aggressively bidding for infrastructure projects across the continent, partly in response to over-investment at home. These companies have also been acquisitive, especially in the resource sector, for several years. Across the continent China now accounts for 20% of infrastructure investment. This has grown from next to nothing in 2002. It has been concentrated in transportation – railways, roads and airports – and, to a lesser degree, in energy; although the decline in commodities prices since 2009/2010 has reduced China’ resource security concerns.

Looking ahead, Chinese investment in Africa has the potential to dramatically improve the prospects for large swathes of the continent. Brookings –   Are Chinese Companies Retooling in Africa? elaborates.

Another major investment trend across Africa has been the growth of private participation in infrastructure (PPI) which now accounts for around 50% of the $30bln per annum – up from $5bln in 2003. This investment is concentrated in telecommunications – 64%, electricity – 18.6% and seaports – 9.8%. Nonetheless, the estimated infrastructure investment gap – $93bln – remains a significant impediment to productivity growth.


Nigeria has just emerged from a general election, the most credible since its return to constitutional government in 1999. The new president, Buhari and his APC party, secured a substantial victory on an anti-terrorist and anti-corruption mandate; it’s worth noting that Muhammadu Buhari is a devout Muslim, his campaign slogan was “new broom”.

The country has overcome some challenges but, as this article from Brookings – Nigeria’s Renewed Hope for Democratic Development – makes clear, there is much still to be done:-

…there is an extensive list of challenges awaiting Buhari and the APC government. They include: ending the Boko Haram insurgency; promoting the socio-economic advance of the largely Muslim and impoverished northern region; overhauling the criminalized petroleum sector; improving the core infrastructures of electricity, water supply, and public transport; drastically reducing corruption in state institutions; and rapidly increasing jobs in agriculture, agro-processing, and light industry.

Chatham House – Nigeria’s New President Pits Hope Against Harsh Realities, takes up the theme:-

This would-be economic powerhouse and Africa’s biggest crude oil producer is running low on fuel. While Nigeria exported around 2.08 million barrels of oil a day in the first quarter of 2015, its three refineries operate at 20 per cent capacity at most. So Nigeria imports its petrol to run cars and diesel to power private generators for homes and businesses. National grid power generation is negligible relative to demand. 

The traders that import refined products are paid by government in cash or crude oil via the byzantine Nigerian National Petroleum Corporation (NNPC). Most foreign suppliers had long stopped supplying on credit as they are owed $1.5 billion in arrears dating back to 2011. Local traders and wholesalers claim to be owed N200 billion in subsidies and are withholding supplies pending some form of settlement.

…In a country that remains dependent on crude exports for fiscal revenue and product imports to function, the cabal-controlled opaque deals that keep the economy running are perhaps at the heart of the corruption that makes people’s lives unnecessarily harsh every day in Nigeria.

But given the parlous state of the economy after crude oil prices halved in six months in 2014, the depreciation of the national currency, the erosion of foreign reserves to under $30 billion, (perhaps four months of external payments), and the political and popular sensitivities around fuel importation and the fuel subsidy, the new government may not have chosen the fuel traders and how to reform the NNPC as the first challenge to tackle. But the traders have forced the issue.

…With ambitions including economic diversification, institutional reform and improving welfare to millions of Nigeria’s poorest, President Buhari and the APC will see their efforts stymied in 2015 by empty state coffers.

Yet it is not the availability of money but the management of it that may effect change in Nigeria. Years of high oil prices and strong GDP growth have not translated into the development, job creation and poverty reduction that they should have. Instead Nigeria is one of the fastest-growing markets for luxury aircraft and champagne, while it ranks 152 out of 187 countries in the Human Development Index.

Back in April 2014 the Nigerian Statistics Office rebased GDP for the first time in 20 years, the result was a near doubling of the size of their economy, as this article from the Atlanitic – How Nigeria Became Africa’s Largest Economy Overnight, expalins:-

In computing its GDP all these years, Nigeria, incredibly, wasn’t factoring in booming sectors like film and telecommunications. The Nigerian movie industry, Nollywood, generates nearly $600 million a year and employs more than a million people, making it the country’s second-largest employer after agriculture. As for the telecom industry, consider that there are now some 120 million mobile-phone subscribers in Nigeria, out of a population of 170 million. Nigeria and South Africa are the largest mobile markets in sub-Saharan Africa, and cell-phone use has been exploding in the country:

Nigeria mobile subsribers

Nigerian Communications Commission (Datawrapper)

Incorporating the film and telecom industries into Nigeria’s GDP made a huge difference in the services sector, rendering the country’s economy not just bigger but more diversified:

Nigeria GDP estimate

 National Bureau of Statistics (Datawrapper)

This is not the first time an African country’s GDP has risen after rebasing, Ghana saw a 60% increase in 2010. The World Bank and IMF estimates for growth in many frontier markets may prove self-fulfilling prophesies if other frontier economies rebase in a similar manner. Nonetheless, these countries are growing rapidly and present a plethora of investment opportunities in the process.

Between 2000 and 2008 African GDP growth averaged 4.9%, twice the pace of the previous decade. Last August, ahead of the US-Africa Summit, saw the publication of the Cato Institute – Sustaining the Economic Rise of Africa – they gave an excellent summation of the state of the region:-

 …between 1990 and 2010, the share of Africans living at $1.25 per day or less fell from 56 percent to 48 percent, while the continent’s population almost doubled in size. If the current trends continue, Africa’s poverty rate will fall to 24 percent by 2030. Since 1990 the per-capita caloric intake in Africa increased from 2,150 kcal to 2,430 kcal in 2013. Between 1990 and 2012, the proportion of the population of African countries with access to clean drinking water increased from 48 percent to 64 percent. Many African countries have also seen dramatic falls in infant and child mortality. Since 2005, some African countries, such as Senegal, Rwanda, Uganda, Ghana, and Kenya, have seen child mortality decline by an annual rate exceeding 6 percent.

Nonetheless, the continent still lags significantly behind the rest of the world in its income levels and also in many indicators of human well-being. For example, Africa scored a mere 0.502 on the United Nation’s 2014 Human Development Index, measured on a scale from 0 to 1, with higher values denoting higher standards of living. By comparison, the United States scored 0.914, Latin America 0.74, and China 0.719.

The extent of trade protectionism, for example, is large, especially when compared with other regions in the world. Average applied tariffs in Africa remain comparatively high, and the extent of trade liberalization on the continent has not matched that experienced in the rest of the world. While between 1988 and 2010, the average applied tariff in high-income countries in the Organization for Economic Cooperation and Development fell from 9.5 percent to 2.8 percent, Africa saw a reduction from 26.6 percent to 11 percent. That is not a negligible decrease but it still leaves the continent with unnecessarily high tariff protection, which hinders trade.

Cato went on to highlight what Africa needs:-

Needs Examples
The Rule of law Land title, commercial contact enforcement
Improvement in governance Oversight of government contracts
Reduction of red tape Regulatory reforms
Infrastructure investment Electricity generation, transportation
Regional Economic integration Free-trade agreements

Here are the IMF – Selected Issues papersDecember 2014 – South Africa and April 2015 – Nigeria  – which look in more detail at several of these issues.

Whilst Nigeria is not exactly a paragon of virtue when it comes to corruption – ranking 136th out of 175 countries on Transparency International’s Corruption Perceptions Index – this 2011 article from the Economist – Africa’s hopeful economiespoints to real signs of progress, both in Nigeria and across the continent as a whole:-

Her $3 billion fortune makes Oprah Winfrey the wealthiest black person in America, a position she has held for years. But she is no longer the richest black person in the world. That honour now goes to Aliko Dangote, the Nigerian cement king. Critics grumble that he is too close to the country’s soiled political class. Nonetheless his $10 billion fortune is money earned, not expropriated. The Dangote Group started as a small trading outfit in 1977. It has become a pan-African conglomerate with interests in sugar and logistics, as well as construction, and it is a real business, not a kleptocratic sham.

…Severe income disparities persist through much of the continent; but a genuine middle class is emerging. According to Standard Bank, which operates throughout Africa, 60m African households have annual incomes greater than $3,000 at market exchange rates. By 2015, that number is expected to reach 100m—almost the same as in India now.

…Since The Economist regrettably labelled Africa “the hopeless continent” a decade ago, a profound change has taken hold. Labour productivity has been rising. It is now growing by, on average, 2.7% a year. Trade between Africa and the rest of the world has increased by 200% since 2000. Inflation dropped from 22% in the 1990s to 8% in the past decade. Foreign debts declined by a quarter, budget deficits by two-thirds.

…Africa’s population is set to double, from 1 billion to 2 billion, over the next 40 years. As Africa’s population grows in size, it will also alter in shape. The median age is now 20, compared with 30 in Asia and 40 in Europe. With fertility rates dropping, that median will rise as today’s mass of young people moves into its most productive years. The ratio of people of working age to those younger and older—the dependency ratio—will improve. This “demographic dividend” was crucial to the growth of East Asian economies a generation ago. It offers a huge opportunity to Africa today.

Dangote Group may not be a “kleptocratic sham” but it is protected from foreign competition by import tariffs which enable it to make a 62% margin on domestic sales. The Economist article goes on to apply a string of caveats – after all, every silver-lining must have its dark cloud, especially for those trained in the “dismal science”- the authors conclude:-

Africa is not the next China. It provides only a tiny fraction of world output—2.5% at purchasing-power parity. It is as yet not even a good bet for retail investors, given the dearth of stockmarkets. Mr Dangote’s $10 billion undeniably makes him a big fish, but the Dangote Group accounts for a quarter of Nigeria’s stockmarket by value: it is a small and rather illiquid pond.

For corporations wishing to succeed in Africa, Nigeria remains a key market. With roughly 20% of Sub-Saharan Africa’s 930 mln people and population growth of 2-3% per annum, this is a market one can’t ignore. The Economist – Business in Nigeria – takes up the story:-

In 2001 MTN, a fledgling telecoms company from South Africa, paid $285m for one of four mobile licences sold at auction by the government of Nigeria. Observers thought its board was bonkers. Nigeria had spent most of the previous four decades under military rule. The country was rich in oil reserves but otherwise desperately poor. Its infrastructure was crumbling. The state phone company had taken a century to amass a few hundred thousand customers from a population of 120m. The business climate was scarcely stable.

MTN took a punt anyway. The firm’s boss called up colleagues from his old days in pay-television and found they had 10m Nigerian customers. He reasoned that if they could afford pay-TV they could stump up for a mobile phone. Within five years MTN had 32m customers. The company now operates across Africa and the Middle East. But Nigeria was its making and remains its biggest single source of profits.

In the 1980’s, after an oil price collapse threatened to under-mine government finances, I ended up doing business in Nigeria with a subsidiary of Unilever (ULVR). Outside of the Oil and Mining sector, it was one of a very few multi-nationals still operating in the country, however, there had been an, almost catastrophic, deterioration in the operations of the division with which I dealt. This decline had taken place over the two decades since Nigerian independence: it reflected the endemic problems of doing business in the country. Managers privately told me, the principal reason they had not closed down was because this was the only practical way to recoup losses sustained in lending the government money.

Finally Unilever, along with a handful of other firms, are reaping the benefit of their long term investment. According to UN forecasts the population of Nigeria will overtake the population of the US by 2045, as soon as 2020, according to research from Oxford Economics, the population will have topped 200mln making Nigeria the fifth largest country in the world, overtaking Pakistan and Brazil – they should have a very bright future.

Near-term growth has slowed as a result of weaker GDP – 3.96% in Q1 2015 vs Q4 2014 at 5.94%, Q3 2014, 6.23% and Q2 2014 of 6.54%. The marginal effect of a falling oil price is still substantial – especially for the export market 95% of which is in petroleum and petroleum products.

The construction sector has remained robust, growing at around 10% – lower than in 2013 but still impressive. Information and Communications has also shown stability, growing at 8% per annum.

South Africa

South Africa has triple Nigeria’s per capita GDP, it is also endowed with better developed institutions. This does not, however, guarantee prosperity. This article from last week’s South African Independent on Sunday – South Africa’s triple challengemakes that clear:-

We are frequently reminded by the political establishment of South Africa’s triple challenge of poverty, inequality and unemployment. This weighs heavily on the social, political and economic fabric of the country.

This is why the unemployment and economic growth data just released points to South Africa sinking into crisis. Official unemployment, at 26.4 percent, rose to a 12-year high. Growth slumped to 1.3 percent for the first quarter this year, below expectation.

The official unemployment rate is one of the highest in the world. The measure masks a low economic participation rate and excludes discouraged work-seekers. In other words, people who want work but have stopped looking for work due to being discouraged are not counted among the unemployed. If a higher participation rate was factored in and discouraged work-seekers were included in the data, the unemployment rate would be nudging towards 50 percent.

…The economy is not big enough to absorb everyone into it. The solution is a bigger economy. For that, the economy needs growth. Not difficult. But growth has ground down to 1.3 percent and looks set to slow further. At the recent Monetary Policy Committee meeting, the SA Reserve Bank warned the inflation risks were to the downside but the risks to economic growth were on the downside.

The combination of weak economic prospects, along with higher inflation, means unemployment is set to rise even further.

… The underperformance of South Africa has been self-inflicted. It struggles under its triple triple.

First Triple: poverty, inequality and unemployment.

…if South Africa had full employment, then poverty and unemployment would be dramatically diminished as issues. However, by not emphasising this perspective, policy is focused on inequality and poverty but is not resolving unemployment.

The national budget is a case in point where the “rich” (success) are penalised through a very “progressive” tax take. Inequality is reduced by pulling down the top end of earners (in reality right down to the working class).

Poverty is tackled through a very aggressive redistribution spending policy. Through this whole process, unemployment is neglected and perpetuated. Policy focus on poverty alleviation has the effect of transferring economic resources to consumption, which is in complete contrast to poverty reduction that transfers resources to investment.

…This shift of resources to consumption has resulted in the second triple, which has become a major constraint and stumbling block to resolving the first triple.

Second Triple: the triple deficit.

The budget deficit in recent years has led to a multiple downgrade of the credit rating. On the face of it, the government “needs” more taxes to balance its books. Yet households, the core of the tax base, are also in deficit. The cost pressures in recent years and availability of credit has led to households spending more than they have earned. The ability to meet a higher tax bill is simply not there. The tax base is both narrow and shallow.

The high unemployment rate also places pressure in a higher dependency ratio on each salary and wage earner. And the government has very ambitious spending plans and faces at least four expenditure threats where each one can take South Africa to a solvency crisis. These are: the public sector wage bill; National Health Insurance; State Owned Enterprises’ need for capital; and the nuclear deal. So far, indications are that the government is going to commit to all four.

The third deficit is the current account deficit. This has been widening to record levels, especially since 2008. Of particular concern is that the current account deficit has been widening while the economy has been slowing and the currency has been weakening. This is a major concern as it means the country is losing competitiveness at an alarming rate.

Part of the reason for the loss of competitiveness comes down to the third triple:

Third Triple: the triple mistake.

The first mistake is labour unrest. No one invests in labour unrest, and investment is essential to grow the economy. South Africa must find a way to resolve labour disputes without unrest. Labour relations is where South Africa languishes near the bottom of the World Economic Forum’s Global Competitiveness survey. The unemployment crisis needs attraction of investment into labour, not away from it.

The second major mistake is the regulatory tsunami that has hit the business sector. The economy is being attacked by policymakers not nurtured. Companies trying to contain costs in a low growth environment have resources diverted to compliance, leaving less to grow their businesses. The biggest problem is that the regulatory burden requires economies of scale in order to be compliant. This is manageable by big business but debilitating for the SME sector. And it is the SME sector that is the engine of job creation. South Africa should be seeking to make South Africa an easier place to invest and do business not more difficult.

…The third mistake South Africa is making is in taxes. Economic expansion cannot happen without investment. Investment cannot be sustained without savings. The investment rate is currently 19 percent of GDP. This will buy a long-term growth rate of 2 to 3 percent.

Excessive debt, both public and private, a low savings rate and a low investment to GDP ratio – it sounds remarkably like the problems of many developed economies. Before dismissing the above article as a little localised hyperbole it’s worth considering this leader from last week’s Economist – Africa’s second-largest economy is in a huge mess:-

There is little in the way of bright news about South Africa’s economy—and not just because power cuts are plunging neighbourhoods into darkness several times a week. According to figures released on May 26th, annual GDP grew by a mere 1.3% in the first three months of this year, a crawl compared with the 4.1% achieved in the fourth quarter of 2014. Unemployment is soaring. Even using a narrow definition, it stands at 26.4%, the highest since 2003.

“The numbers are saying ‘something has to be done, and done quickly’,” says Pali Lehohla, South Africa’s statistician-general. But where to begin? Power shortages under Eskom, the failing state utility, have dampened manufacturing, drought has hit agriculture and tourism, a rare boon, has been hampered by much-criticised new visa requirements. Rating agencies have warned that South Africa is dancing dangerously close to junk status, though no immediate downgrade is likely.

…Strikes are hurting mining. Talks between unions and gold-mine bosses are due to begin in early June. But with unions opening the bargaining by demanding that basic pay for unskilled mineworkers be doubled, prospects of an early settlement seem poor. Last year similar demands at platinum mines sparked five months of labour unrest. A strike by 1.3m public-sector employees has been averted, but only at the cost of a 7% wage increase, with the money coming from emergency funds.

The weak economy is stoking social unrest and public violence. Foreigners, seen as competition for scarce jobs, were targeted in a recent spate of xenophobic attacks that left at least seven people dead. The IRR, a think-tank in Johannesburg, says that protests have nearly doubled since 2010. Many relate to the provision of basic services such as water and electricity. Inequality remains high. A report by the Boston Consulting Group, a consultancy, placed South Africa 138th of 149 countries for its ability to turn the country’s wealth into well-being for its people.

So far the government of President Jacob Zuma has shown little sign of being able to improve matters. The African National Congress, the ruling party, is bogged down in internal political battles, not least over whether to pursue capitalist or socialist economics. The government’s much-touted National Development Plan, a market-friendly strategy to encourage investment and growth, is largely ignored. Even by the ANC’s own standards, it is failing: only 2% growth is expected in 2015 when the economy needs to expand by at least 5% a year to reduce unemployment.

The country doesn’t score that well on corruption either, ranking 67th out of 175 countries on the Corruption Preceptions Index.

Likewise the Deliotte’s CFO Survey is less than encouraging. Many South African CFO’s expressed anxiety about the future. New investment is overwhelmingly directed towards expanding into other, higher-growth, parts of the continent. Of those companies with no presence elsewhere in Africa, 80% said they wanted to build such a presence within the next year – West and east Africa were their favoured destinations.

Capital Markets and Investment Opportunities

Africa is largely dependent on private capital flows as this May 2015 article explains – Brookings – Private Capital Flows, Official Development Assistance, and Remittances to Africa: Who Gets What?:-

The data also show that private capital flows to sub-Saharan Africa over the period of 2001-2012 have mostly benefited two countries—South Africa and Nigeria—which accounted for 45 percent and 13 percent of total private flows to sub-Saharan Africa, respectively. These two countries have attracted the most flows in part because they are the largest in sub-Saharan Africa, together making up more than half of the region’s GDP.

…Portfolio flows have also been increasing recently, though they remain concentrated in South Africa: That country received 96 percent of the portfolio flows to the region in 1990-2000. However, in 2001-2012, the issuance of sovereign bonds by a number of countries and increased interest by investors has led to a more diversified recipient base for portfolio flows. South Africa’s share of the total fell to 59 percent, whereas Nigeria’s increased to 24 percent, and other countries like Mauritius (14 percent) emerged on the scene.

…From 1990 to 2000, half of total FDI to sub-Saharan Africa went to South Africa (29 percent) and Nigeria (21 percent). This trend has not changed: Between 2001 and 2012, the top 10 recipient countries received 85 percent of the total FDI inflows to the region.

…In terms of volume, Nigeria was the largest recipient of remittances in the region from 1990 to 2012.

I want to turn my attention to more liquid opportunities.

Bonds – South Africa

The SARB – Quarterly Bulletin – March 2015 – sums up the recent price action in South African government bonds:-

South African bond yields moved generally lower from early 2014, in line with US bond yields. Local yields receded further in January 2015, supported by an improved inflation outlook and abundant international liquidity following the announcement of an expanded asset-purchase programme by the ECB and continued quantitative easing out of Japan. Bond yields edged higher in early March 2015 as a reversal in the oil price, the announcement of higher levies on fuel and rand depreciation impacted on inflation expectations. Most money-market interest rates have displayed little movement since the middle of 2014, remaining well-aligned with the repurchase rate of the South African Reserve Bank (the Bank) that had been held steady over this period.

The SARB has left base rates unchanged at 5.75% since July 2014 as a result of the stabilisation of the Rand and falling oil prices. Inflation expectations had been on the downside but as SARB Governor Lesetja Kganyago stated in the 21st May MPC statement:-

The challenges facing monetary policy have persisted, and, as expected, the downward trend in inflation which was mainly attributable to the impact of lower oil prices, has reversed. Headline inflation is expected to breach temporarily the upper end of the target range early next year, and thereafter remains uncomfortably close to the upper end of the target band for most of the forecast period. The upside risks have increased, mainly due to further possible electricity price increases. The exchange rate also continues to impart an upside risk to inflation as uncertainty regarding impending US monetary policy continues. Domestic demand, however, remains subdued while electricity constraints continue to weigh on output growth and general consumer and business confidence.

As the chart below suggests, 10yr Bond yields have risen from their January lows. The upward trend appears to be established, the current 10yr yield is 8.51% which is not far from the January 2014 high of 8.8%. I suspect this level will be breached but not to a substantial extent because the rising interest rate environment will undermine, already weak, growth expectations. If yields approach 9.25% I think this offers a buying opportunity. For the present, remain short. For most retail investors this means using South African bond index futures, but remember, only your P&L will be exposed to currency fluctuations.

Bonds – Nigeria

Nigerian 10yr Government bonds have behaved in a very different manner to South Africa over the last seven years, as the chart below reveals:-

south-africa-nigeria government-bond-yield

Source: Trading Economics, Central Bank of Nigeria and South African Treasury

A portfolio of these two bonds would offer an attractive Sharpe ratio. Short South Africa and Long Nigeria 10yr might be another strategy to consider, you may get positive carry, but Nigerian inflation has been substantially higher over this period. Here is a chart:-

south-africa-nigeria inflation-cpi

Source: Trading Economics, National Bureau of Statistics Nigeria and Statistics South Africa

The Central Bank of Nigeria – MPC May 2015 Communique 101 – provides a wealth of information, here are some highlights:-

The Committee expressed concern about the weakening economic momentum but recognized the relative similarity in the condition to the evolving economic environment in virtually all oil exporting economies, suggesting the need for acceleration of various ongoing initiatives to diversify the economic base of the country.

The Committee noted that the uptick in inflationary pressures, year-to-date, was largely traceable to transient factors such as high demand for transportation, food and energy, especially in the period around the general elections as well as the Easter festivities. It also noted the roles played by system liquidity and the pass-through effects of the recent depreciation of the naira exchange rate. When the transient causes are isolated, the Committee observed the decline in month-on-month inflation across all the measures in April as headline inflation moderated to 0.8% from 0.9% in March; core inflation moderated to 0.6% from 0.8% and food inflation moderated to 0.9% from 1.0%.

The Committee reiterated its commitment to price stability noting that given the already tight stance of monetary policy and the transient nature of the incubators of the current inflationary trend, which are outside the direct control of monetary policy, the space for maneuver remains constrained, necessitating the intervention of fiscal and structural policies to stimulate output growth.

…the Committee stressed the need for proactive measures to protect the reserve buffer to safeguard the value of the domestic currency and engender overall stability of the banking system. It was, however, noted that monetary policy is gradually approaching the limits of tightening and would, therefore, require complementary fiscal and structural policies.

…Consequently, the MPC voted to:

(i) Retain the MPR at 13 per cent with a corridor of +/- 200 basis points around the midpoint;

(ii) Retain the Liquidity Ratio at 30 per cent; and

(iii) Harmonize the CRR on public and private sector deposits at 31.0 per cent.

10yr Bond yields have fallen from more than 17% in mid-February to 13.7% today. I believe that the hawkish policy of the Central Bank of Nigeria will insure that inflation falls further. Now the election is over, bond yields will continue to decline as foreign capital flows into the country. As recently as July 2014 yields were at 12% – I think they will go lower even than this despite yield curve inversion. The one major risk to this otherwise promising scenario is a rating agency downgrade. S&P downgraded Niara bonds to +B as recently as March, the election result helps but the new government need to deliver on their promises of reform.

To access the Nigerian bond market you need to contact one of the primary dealers – here is the link to the Nigerian Debt Management Office. You will have to deal with the issues of exchange controls, an alternative would be to be a fixed rate receiver through a Niara interest rate swap. The list of dealers may be a place to start but I suspect this is a strictly institutional option.

Stocks – South Africa

The SARB – Quarterly Bulletin – March 2015 – describes recent developments in South African equities:-

Despite the subdued growth in the economy over the past year, domestic share price entered 2015 on a positive note, recovering from the losses incurred in the second half of 2014 to reach all-time-high levels in March 2015. The domestic share market benefited from sustained accommodative monetary policies in the advanced economies, while lower international oil prices and the depreciation of the rand also boosted some share prices. Corporate funding through the issuance of shares in the primary share market rose considerably in 2014, consistent with the high level of share prices and rising number of companies listed on the JSE Limited.

…The performance of equity funding on the JSE was strong in 2014. Equity capital raised in the domestic and international primary share markets by companies listed on the JSE amounted to R153 billion in 2014, which was 65 per cent higher than the amount raised in 2013. Equity capital raising activity was concentrated in companies listed in the financial and industrial sectors, which dominated equity funding in 2014 with shares of 35 and 41 per cent respectively. Dividing the industrial sector further, as shown in the accompanying graph, more than half of the industrial sector’s equity funding in 2014 was accounted for by companies in the consumer goods subsector. Proceeds were utilised mostly for acquisitions, both abroad and domestically.

Robust funding in the primary share market was consistent with the high level of share prices and rising number of companies listed on the JSE, as new listings exceeded delistings in 2014 for the first time since 2008. The number of company listings came to 329 on the main board at the end of February 2015, while 60 were listed on the Alternative Exchange (AltX) and 3 on the development and venture capital boards. The most prominent method of raising capital was the waiver of pre-emptive rights where shares were issued for cash to the general market or specific investors. Equity financing amounted to R43 billion in the first two months of 2015.

Secondary market trading has remained stable but the P/E ratio, at around 18 times, is above its long term average (1990-2015) of 14.4. The P/E ratio has only broken above 20 once, back in 2010, during the rebound from the global recession – though it came close to these levels in 1993.

The Johannesburg (JSE) and the Nigerian Stock Exchange (NSE) are currently working towards developing a partnership that would benefit both exchanges. In this collaboration, among other things, South African companies would be able to list on the NSE and Nigerian companies on the JSE.

South Africa has the most sophisticated financial markets in Africa, it also acts as a conduit for foreign investment to the rest of the continent. The main stock index – the FTSE/JSE 40 – has traded steadily higher since 2009:-


Source: Trading Economics and JSE

However, this does not take account of the currency risk of investing in the Rand. An alternative is the iShares MSCI South Africa ETF – EZA. Here are the top 10 components:-

Company Symbol % Assets
Naspers Ltd Class N NAPRF.JO 19.44
Mtn Group Ltd MTNOF.JO 9.83
Sasol Ltd SASOF.JO 6.51
Standard Bank Group Ltd SBGOF.JO 5.27
Firstrand Ltd FSR.JO 4.81
Steinhoff International Holdings Ltd SNHFF.JO 4.41
Sanlam Ltd SLMAF.JO 3.46
Aspen Pharmacare Holdings Ltd APNHF.JO 3.43
Remgro Ltd RMGOF.JO 3.28
Bidvest Group Ltd BDVSF.JO 2.63

Source: Yahoo Finance

iShares MSCI South Africa

Source: Yahoo Finance

It is clear from the chart above that South Africa’s main stocks are struggling due to the difficult domestic economic situation, which has led to continuous bouts of currency weakness and bond rating agency downgrades.

For domestic or hedged investors the market trend remains positive, but for international investors the carry costs of hedging undermines the attraction of this market.

Stocks – Nigeria

Nigerian stocks have recovered from weakness earlier this year. The Central Bank put most of the recent performance down to improvements in earnings, sentiment and the successful conclusion of the election.

nigeria-stock-market 2010 - 2015

Source: Trading Economics and NSE

Given the heavy weighting to Dangote in this index (25%) perhaps a more diversified investment would be the Global X MSCI Nigeria ETF (NGE) here are the top 10 constituents:-

Nigerian Breweries PLC 16.41
Guaranty Trust Bank PLC 11.54
Zenith Bank PLC 8.93
Nestle Nigeria PLC 7.06
Ecobank Transnational Inc 4.72
Lafarge Africa PLC 4.66
First Bank Of Nigeria PLC 4.64
Dangote Cement PLC 4.63
Guinness Nigeria PLC 4.48
Stanbic IBTC Holdings PLC 4.37

Source: Yahoo Finance and MSCI

The advantage of the ETF is that you don’t have to deal with the problem of Nigerian exchange controls, however you should keep a close eye on the currency which continues to depreciate against the US$. The technical picture is unclear, I have no direct exposure to Nigeria but it remains on my list of stock markets with significant long-term potential. The current P/E ratio is around 16 times, not cheap like China last year, but worth watching.

NGE 2 yr chart

Source: Yahoo Finance


The South African Rand (ZAR) is a freely traded international currency. Daily turnover is roughly 1.1% of the global total – mostly traded in London. The Nigerian Niara (NGN) is subject to exchange controls. It is possible to trade non-deliverable forwards, but liquidity reflects the relative lack of tradability. The chart below compares the two currencies against the US$ since 2007:-

ZAR and NGN vs USD - 2007-2015

Source: Trading Economics

Since H2 2011 the ZAR/USD rate has been weakening. This trend looks set to continue. This is how its recent movements are described in the SARB – Quarterly Bulletin – March 2015 – they highlight the developments during 2014:-

The nominal effective exchange rate of the rand declined, on balance, by 2,8 per cent in 2014, compared with a decline of 18,6 per cent in 2013. The trade-weighted exchange rate of the rand increased, on balance, by 0,3 per cent in the fourth quarter of 2014 following a decline of 2 per cent in the third quarter. The rand did, however, regain some momentum, rebounding by 4,0 per cent in October 2014 supported by a positive Medium Term Budget Policy Statement and portfolio investment inflows. The domestic currency weakened by 0,3 per cent in November 2014 amid South Africa’s credit rating downgrade from Baa1 to Baa2 by Moody’s rating agency as electricity challenges became more acute. In December 2014, the trade-weighted exchange rate of the rand weakened further along with other emerging-market currencies and declined by 3,2 per cent. Sentiment towards emerging-market currencies, including the rand, was generally weighed down by the persistent weakness of the euro area, a slowing Chinese economy and an unexpected Japanese recession.

The USD/NGN has been declining by steps as the Central Bank of Nigeria, in a futile attempt to halt the depreciation, depletes its gross reserves. These have fallen to $28bln from more than $50bln in less than two years. Now that the elections are behind them the currency should be less vulnerable. During mid-April overnight rates hit 90% but have since returned to a more normal range – still a volatile series. It’s unlikely they will drop below 9% with the current hawkish MPC. This makes Long NGN Short ZAR an attractive trade – carry will be around 300bp. However, this should be viewed as a trading position. The Central Bank of Nigeria will probably have to defend the NGN again, when they fail the USD/NGN rate will rapidly head for 230.