In 2007, Tullow Oil made the announcement that uplifted a whole nation. The company had discovered 1.5bn barrels of oil in an offshore field off the Ghanaian coast. In the first three years of production, the government had earned an average of USD 469 million per annum in royalties. Given that the country also exports gold and cocoa, the economic prospects looked promising and investors began scouting for opportunities across the economy.

Although the economic fundamentals looked sound, the depreciation of the Ghanaian Cedi earlier this year has led investors to re-examine the country’s outlook. At the beginning of the year, the Cedi was trading at 2.35/USD, but by August it had fallen by a stunning 64% to trade at 3.85/USD. This story is not limited to Ghana. Several other African currencies have struggled this year including the Kenyan Shilling, which has needed Central Bank support to retain its value.

The fall of these currencies may lead one to infer that these economies have structural weaknesses. Any analysis must start with each country’s balance of payments (BOP), which tracks transactions between a country and its trading partners.  The BOP is made up of three accounts: current account (exports/imports), financial/capital account (flow of funds for investment) and the official reserve account. The official reserve account, which records transactions made by the Central Bank, does not move significantly year-on-year, which leaves the current and financial account for closer examination.

Theoretically all these countries supply the world with something, which should provide a consistent supply of foreign currency. Ghana exports gold, oil and cocoa; while Kenya exports tea, coffee, flowers and tourism. However, both of these countries operate current account deficits (their imports exceed their exports). Although Ghana produces oil, it is a net oil and gas importer as it imports gas for power generation. Kenya has had a difficult year as terrorist attacks have crippled the hospitality industry and the oversupply of tea has resulted in a 44% decline in tea prices. These markets are similar in that they are over reliant on a few economic sectors for foreign exchange. The result has been the current account deficits.

The Ghanaian current account deficit as a % of GDP is forecast to be 12.4% at the end of the year and Kenya 11.2%. To restore the current account balance, currency depreciation is needed or a positive financial account movement through foreign investment is necessary.

Kenya’s sovereign bond was a resounding success for the government and has also been beneficial to the Central Bank of Kenya (CBK). CBK bought the dollar proceeds from the government and has subsequently used it to support the local currency. Both debt and equity flows into/out of the country make up the financial account, which is another source of hard currency.

Reliance on the financial account to support the currency should be viewed as a short-term measure.  Equity flows into emerging markets are typically short-term in nature, given that most countries have limited exchange controls as an incentive to attract investments.

With global investors showing an appetite for emerging markets bonds, countries looking for a quick fix can issue USD-denominated sovereign bonds. It’s no wonder that in the midst of the current challenges, Ghana has hinted at issuing its third Eurobond. However borrowing from abroad may not be sustainable as debt-to-GDP levels continue to grow. The long-term solution to address the current account imbalance is to rethink trade policies, which take time to design and actualise. Recent investments by some of these countries seem to suggest that policy-makers are actively redressing trade imbalances.

Although Ghana is an oil producer, the World Bank reports that it spends USD 1 million per day on crude oil imports, which are utilised by its power plants. To address this need for foreign currency, the government commissioned the Atuabo gas plant which is described by Ghana’s President John Mahama as a ‘game-changer’. The plant will utilise gas from the oil fields thus eliminating the need to import crude oil.  The Ghanaian government has noted that the country will save USD 500 million annually in crude imports and reduce the cost of power to businesses. However, analysts forecast that gas supplies to the plant from the oil fields will only be guaranteed in 2017 when two new oil fields come online.

Kenya

Kenya has also made strides in improving its current account deficit. The new government’s push to produce 5,000MW of power by 2017 is yielding results. By December 2014, the government projects that the total power output will have risen by 800MW from 1,600MW to 2,400MW. The majority of this new power produced is from geothermal sources, and is expected to be used as base-load, electricity available at all times, which will replace the expensive thermal power. Thermal power is reliant on crude oil and Kenya expects to save USD 325 million per annum through these changes.

For investors, the long-run fair value of a currency is a concern.  For Kenya and Ghana, private consumption is predicted to be the primary driver of long-term growth, and not exports. These countries will thus continue to encounter structural changes, which will see their currencies gradually depreciate, requiring market intervention by the official monetary authorities.  Investors will need to bear this in mind as they consider African investments.

– Brian Maina
Analyst, RisCura Fundamentals

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