[TOP STORY] Inflation’s impact on markets in the rest of Africa

SIMON BROWN: I’m chatting with Rami Hajjar, fund manager at [the Allan Gray Africa ex-SA Equity Fund]. Rami, I appreciate the time today. Let’s kick off [with] inflation on the rest of the continent. We’re talking Africa excluding SA. How are we seeing inflation impact on markets and the rest of the continent?

RAMI HAJJAR: I think it’s important first to distinguish between two types of inflation. There’s a demand-pull inflation, which normally comes when growth is strong. And then there’s cost-push inflation, which follows a supply shock. What we’re seeing today is cost-push inflation, following a global supply shock that’s leading to a jump in food and energy prices.

The problem with this type of inflation is that local central banks have less capacity to deal with it, and at the same time higher prices are leading to lower purchasing power, so lower demand and lower growth. That’s one impact.

Another impact is that central banks are forced to raise interest rates just to keep pace with developed markets and to manage inflation expectations, higher rates also, meaning ……01:26 policy is also leading to lower growth.

But there’s one more aspect that’s very important, especially in Africa ex-SA and in other emerging markets. It’s that inflation is also putting pressure on the budget. How? It’s because a lot of the governments subsidise basic commodity goods such as in Africa – especially like bread, flour, maize, petrol prices – as the price of those has gone up substantially.

Now the governments are faced with two choices, either keep subsidising – and that comes at the cost of the budget – or let prices go up. That comes obviously with the risk that has a lot of political implications, let me say, and we are seeing that today in Sri Lanka, we’ve seen that historically in Egypt, and other countries are at risk. We’re seeing that also in other frontier markets in India. We’ve seen that in Ghana, we’re seeing that in Tunisia, we’re seeing everywhere riots happening because of inflation.

SIMON BROWN: I take that. I actually hadn’t thought of that. Of course, a lot of those subsidies, as you said, put pressure on the budget and puts the government between a rock and a hard place.

The risk to emerging market economies? There’s a lot of talk out there around potential recessions in developed markets. We had two negative GDP quarters from the US. We delve into whether that is or isn’t a recession, but the Bank of England is worried about the UK, for example. That must pose a risk to emerging markets generally, particularly into the rest of the continent.

RAMI HAJJAR: Sure. So I would say in general, yes, the slowdown or recession in developed markets will cause a slowdown in emerging markets. But, to be more specific, I would say, ‘it depends’, because some emerging markets are already growing strongly, so they’re coming off a high growth base. Those emerging countries, including some of the African ones, will not necessarily fall into a recession as technically defined. Some of them also are benefiting from the high commodity-price environments – those that are commodity exporters of commodities that are seeing a rally.

On the other hand, you have vulnerable countries that are coming off a low growth base, or are more exposed to trade with developed markets, or are net commodity importers – those will surely suffer more. But actually what I worry about mostly, more than the growth aspect, is that many countries are looking vulnerable from a debt perspective and the current environment of tighter global monetary conditions, lower risk appetite, higher rates and depreciating currencies is putting a lot of these countries in Africa and outside Africa at higher risk of debt distress.

Then [those] crises, if they occur, are normally associated with a much more severe downturn than a regular global-induced growth slowdown. So we are seeing that already in Sri Lanka today and other countries are at risk.

SIMON BROWN: I see that the recession would be dependent on, as you say, different economies responding differently. But debt perhaps is the bigger issue. You mentioned currencies as well, and certainly we’re seeing some currency weakness in the rest of the continent. It is again, I imagine, going to be pockets that are experiencing different types of currency impact.

But generally that currency weakness, is that [on] concerns around debt, is that more perhaps just around dollar strength?

RAMI HAJJAR: It’s a few things. First of all, it’s pressure on the balance of payments that many countries are experiencing. So that is a deteriorating trade balance, meaning rising import bills that have drained hard currency reserves in many countries. So, fundamentally speaking, this means lower supply of foreign exchange in the country while the demand for foreign exchange at best has remained the same. But in actual terms in many countries it has gone up because some countries have seen a lot of foreign investors exiting. Now that’s one impact.

The other impact is an important one. It’s the reversal of what we call the carry trade, where investors seek higher-yield investments in riskier countries because of low yield at home. That’s also been impacting currency, and obviously there is sentiment always at play, and today risk aversion. Sometimes if a country is deemed to have a low capacity to deal with the shock, investors lose confidence in the local currency. The worst form of that is a self-fulfilling attack on a currency, leading to a currency collapse. Examples are Sri Lanka and other countries which are seeing this sort of dynamic.

SIMON BROWN: You mentioned sentiment, and we’ve talked in the last couple of minutes around challenges facing the rest of the continent. There are some, and they are absolutely real. But I’m imagining there’s the other side of the coin and in fact there are probably some really good opportunities for an investor such as your fund.

RAMI HAJJAR: There are always plenty of good-quality companies with solid fundamentals, especially in the Africa universe. Their valuations today, where they stand, especially if we compare them to developed markets, are at very depressed levels, which makes me, given the quality of the companies we own – let’s talk about the Allan Gray fund, the quality of the companies we own – we generally invest in companies that are insulated against such downturns, such volatility that we’ve seen today. That makes me very excited about the medium-term to long-run returns in our universe and specifically in our fund.

SIMON BROWN: I take that point. Even in darkest times there’s opportunity. And your point around valuations – the S&P is back to its long-term average valuation. That to me is a bit of a head-scratch.

We’ll leave it there. Rami Hajjar, fund manager at Africa ex-SA Fund at Allan Gray, I really appreciate the time.