London - We have long championed the opportunities for emerging markets (EM) investors among countries outside the major indexes like the JPMorgan Global Bond Index - Emerging Markets (GBI-EM). At the same time, we have also stressed the importance of proprietary analysis and due diligence — for EM countries, in general, but especially outside the indexes, where available research is typically scarce.
The recent woes of Ghana serve to drive home that point. Ghana had been an "EM Darling" due to high yields and a fairly stable local currency. However, the EM team has been a skeptic, as our research had revealed poor budget discipline and a deteriorating macro environment.
In particular, the government has been wrestling with a yawning fiscal deficit while dragging its heels in using IMF resources. Additionally, a good deal of the investor base comprises "hot money" holdings of its local-currency bonds, which makes the debt more sensitive to the whims of foreign investor sentiment.
Those hot money investors have been scrambling for the exits, which has helped sink Ghanaian asset prices over the past several weeks, as its sovereign credit spread widened 144 basis points (bps) in October to 910 bps over U.S. Treasurys. The country's local-currency bonds have underperformed peers, with yields on local-currency debt rising 100 bps and its USD-denominated bond yields trading near 11%. The Ghanaian currency, the cedi, weakened by more than 5% against the USD in the past month.
Weaker-than-anticipated growth may make it harder for Ghana to fund its budget deficit, which breached the legislated threshold of 5% of GDP and isn't expected to fall back under that threshold until 2024. Ernest Addison, governor of the Bank of Ghana, acknowledged to Bloomberg that "we can grow ourselves out of the debt, but unfortunately, if we do not get strong growth, then debt sustainability issues will become key." The widening credit spread suggests that investors are doubtful.
The 2022 budget calls for fairly ambitious revenue collection, particularly due to an e-levy, which is already being walked back from 1.75% to 1.50% (or lower) due to political pressure. This makes the revenue collection targets in the budget a bit less realistic and likely. In addition, planned spending for 2022 is expected to increase by 23%. Key drivers of anticipated expenditure growth include capital expenditure, funding of key government flagship programs including the GhanaCares "Obaatanpa" Program, wage bills and interest payments. The debt load continues to grow, and interest payments cost 7.4% of GDP.
In a nutshell, the budget deficit is likely to worsen thanks to overly optimistic revenue assumptions and political pressure for more spending.
Bottom line: We believe that investing in EM countries outside the major benchmarks can be a tremendous source of alpha.* But such a strategy imposes a greater requirement for in-depth understanding — the kind of knowledge that eluded many investors who piled into Ghanaian assets.
* Alpha is the return provided by an investment strategy in excess of the return of the appropriate benchmark or index.