- Interest rates are expected to drift lower as the Bank of Tanzania seems to be in a good position to ease
In late July 2014 Global Evolution visited Tanzania as part of an East Africa trip. During the trip they met with Central Bank officials, Ministry of Finance officials, local banks and pension funds, IMF and independent consultants. A summary of the investment notes from this trip follow.
The difficult task to open up the capital market
We currently see the monetary framework as the weak link in the Tanzanian economy as the monetary policy seems caught in a transitory phase as it migrates from a monetary aggregate targeting regime to an interest rate regime. This is expected to strengthen the relationship between the yields on T-bills/T-notes and the interbank rate. Under the current monetary framework the central bank is extremely focused on the quantity of reserves and set up levels for expected future reserve levels.
In the light of this intense focus on reserve accumulation and management of hard currency flows the deregulation of Tanzania’s capital account will be interesting to follow. Today, in order to protect the Tanzanian Shilling from hot money/speculative investors, foreign investors are not allowed to buy local financial assets. However, according to plans this will gradually change. From September 1, 2014 investors from the East African Community (EAC) will be allowed to invest in Tanzanian fixed income while other investors from the rest of the world are not expected to get access before 2016. We clearly had the feeling that several amendments will have to be made to the current regulatory framework that has strict restrictions attached. EAC investors will be the first to test these restrictions;
- A maximum 40% of a bond series can be purchased by non-residents while the level for equities will be 60%
- In primary bond auctions foreigners cannot buy tenors shorter than 1yr
- Foreign investors are obliged to hold a position for 1 year as a minimum unless sold to another non-resident investor
We find the above restrictions very unappealing for foreign investors as you basically will have to lock up your position with little chance of being able to sell for 1 year. The central bank sees the current regulatory framework and the restrictions as a way to protect the shilling from huge swings in the capital account. Still, we think the worry is overdone. If capital markets were genuinely opened we believe that capital market dynamics automatically would adjust. In fact, we rarely see huge moves in the capital account in other frontier countries and - if opened - Tanzania would likely be rewarded for pursuing prudent fiscal and monetary if so deserved. Like the rest of East Africa Tanzania suffered from drought in 2011. This caused inflation to spiral and the shilling to weaken. However, contrary to Kenya and Uganda that significantly raised policy rates and attracted portfolio flows that helped stabilize currencies and slow inflation, Tanzania continues to struggle with the aftermath of the 2011 drought. Today’s elevated level of real yields (5yr bonds around 15% with inflation at 6.4%) seems to be the only feasible solution for the central bank to support the currency while running a substantial current account deficit (since 2011 the CAD has ranged between 12.4% and 16.9% of GDP).
Oil and gas potential
In 2013 GDP growth was 6.9% expected to accelerate to 7.1% in 2014 led by services, construction and manufacturing. Tanzania has been able to generate impressive growth rates over the past decade and keeping promising gas discoveries in mind nothing suggest that growth will slow in the foreseeable future. Tanzanian gas reserves are estimated at 35tn cubic feet according to recent reports and exploration is ongoing. Today several major energy companies are involved in Tanzania. Generally speaking, the government faces some tough decisions on how to capitalize on the gas potential. Should the state profit only from production sharing, revenue agreements, royalties and general corporate income tax or simply enter as a strategic investor? Often the last option is preferred by governments as a way to obtain more control with exploration but we tend to disagree. In Tanzania gas exploration and development costs are estimated to as much as USD 20- 40bn over the coming years and if the government decide to become a strategic investor (let's assume a 10-15% share), the government's financing needs and debt stock will increase. Instead the government could opt for royalties and corporate taxation only.
Going forward, we expect interest rates to drift lower as the Bank of Tanzania seems to be in a good position to ease. In our opinion this should lead to a bull flattening of the local yield curve. Unfortunately foreign investors cannot get access yet so we are basically left on the sideline. As to the opening of the capital account for EAC investors starting September 1 we sensed a rather muted excitement not least from professional investors in Nairobi. Still, if Tanzania succeeds to attract EAC investors we think the current regulation will create a segmentation of the market that could see 40% of outstanding debt trading offshore in Nairobi and the remaining 60% trading domestically in Tanzania.
From an exchange rate perspective we believe the shilling will continue to depreciate modestly thereby keeping REER unchanged. There is a chance though that the opening of the capital account can attract sufficient inflow to strengthen the shilling but as mentioned above inflows are likely to be modest in our opinion. Furthermore, more recently forward rates have collapsed so we do not see much scope for investment opportunities in the offshore forward market. This leaves the potential launch of a Eurobond as the most promising investment opportunity.
Global Evolution, an asset management firm specialized in emerging and frontier markets debt, is represented by Capital Stragtegies in the Americas Region.
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