Nigeria: Wrestling with the Fiscal Deficit

Contemplating Risks ahead of a proposed $500 Million 10 year Bond Issue

Current Ratings:  B+ (S&P downgraded from BB+ August ‘09); Moody’s - NR and BB- _ Stable (Fitch June ’06)

Nigeria Naira (NGN) Official Rate 148.60

GDP at Current Prices 3Q 2009:  NGN 22,729Bn ($151.6Bn)[1]

Gross External Reserves (January 29, 2010):  $42Bn of which $2.1Bn is blocked[2]

CPI Rate December 2009 (Y-O-Y) 12.4%; CPI less food:  9.4%

Monetary Policy Rate (MPR) @ 6.00%

OPEC Oil Basket ($/barrel) 71.40 (01-28-10)

90 Day T- Bill Rate:  2.69% (01-29-10)

Interbank Call Rate 2.46 (29-01-10)

Strengths:

·        Central Bank of Nigeria (CBN) intervention within the banking sector in mid-August and subsequent bank audits have improved risk management controls and financial transparency.

·        CBN response to credit crisis caused Net Domestic Credit (November y-o-y) to explode rising 173% (Y-o-Y) to NGN 7,496,539MM.  Credit provided to the government declined 31% over the same period to NGN 2,493,442MM. 

·        Ample debt capacity as total external debt amounts will likely amount to $7.665BN.  Principal amortizations and interest expense are forecasted to be $1.2Bn for 2010

Risks:

·        Vulnerability to world hydro-carbon prices that generate foreign exchange income has pronounced influence on fiscal balances

·        Poor availability of timely statistical information from Government entities

·        A 2010 Federal Budget that proposes a 31.2% increase in appropriations with little to no concomitant increase in non-oil revenues (VAT, Corporate income taxes, improved customs revenue monitoring)

·        Government intervention in local financial markets in conjunction with infrastructure improvements will exacerbate federal deficit that expects to reach 6.2% of nominal GDP in 2010.

·        Government 2010 Budget projected real GDP growth of 6.1%.  IMF places real growth at 5% asserting that the economy has been hit hard by the global financial crisis, decreasing hydro-carbon production and a banking sector already weakened by over-extended credit to financial intermediaries.

·        Government debt has significantly grown over the 2009 with little abatement expected in 2010. Aggregate Government debt through September 30 2009 has grown 31.8% to Naira 3,058,185 Trillion  ($20.387Bn)

·        President Umaru Yar’Adua’ physical absence from the day to day Federal Government management exacerbates the already lengthy policy making initiatives.  President Yar’Adua has been receiving treatment in Saudi Arabia for a heart ailment since the end of November.  As of this writing both houses of the Nigerian Congress have voted to remove President Yar’Adua and transfer the Presidency to the Vice President Dr. Goodluck Jonathan.  The legality of the transfer, however, is under question.

·        The Nigerian press reports (February 12^th) indicate that support for interim President Goodluck Jonathan was predicated on his promise to disburse $2 Bn from the Excess Crude Account to 12 state governors whose individual states are in fiscal deficit.

Summary:

Nigeria’s rarely lacks the opportunity to be to place itself among the forefront of sub-Saharan economies.  However like Sisyphus, the Nigerian government finds itself stymied, revisiting financial reforms that had been previously addressed.  Financial institutions over-leveraged their balance sheets and failed to implement appropriate CBN recommended risk controls.  The CBN ultimately rescued five banks and intervened with an injection of Naira 420 BN (USD 27MM).  In an effort to rebuild confidence, the CBN may have over-stimulated the money markets.  Since the mid-August bank intervention, inflation has risen steadily.  December CPI has reached 12.4% after showing a period some moderation.

Nigeria’ challenges in 2010 will relate to social welfare issues, such as poverty, infant mortality, and maternal health, which are steadily eroding.  Infrastructure development while prioritized and approved is slow to undertake.  Corruption is both blatant and insidious, conspiring to weaken confidence in the local and regional government. 

The 2010 Budget is predicated on the assumptions that oil production will be 2.088 million barrel per day (mb/d) and that benchmark oil price will be $57/barrel, while Joint Venture cash calls will be $5billion. The Budget expects an average exchange rate of N150 to the US dollar, targeting Gross Domestic Product (GDP) growth rate at 6.1 percent, and putting target inflation rate at 11.2 percent.

Finally, the uncertainty over President Yar’Adua’s health and awaited return as head of the government adds more uncertainty and confusion over the function of the republic. Public expectations that the central government can address the myriad of challenges facing Nigeria are low. [3] The unequal distribution of revenues is causing deep anger that can erupt in serious social unrest.  If these trends are not addressed, Nigeria will remain entangled in the octopus of poor governance and unrealized potential.

Trade Balance

Nigeria’s dependence on oil for over 90% of its foreign exchange earnings makes its capital account vulnerable to the fluctuations in crude oil prices. This, in addition to its high import bills contributed to the fluctuations in the level of reserves over the years and consequently the way the reserves are being managed. During the oil boom of the mid-seventies which has resulted in the build-up of reserves, the external reserves were diversified into an array of financial instruments including foreign government bonds and treasury bills, foreign government guaranteed securities, special drawing rights (SDRs), fixed term deposits, call accounts and current accounts. This provided significant investment income as well as liquidity. However, during the glut in the global oil market which led to collapse in the crude oil prices and consequently a drawdown in the reserves, the reserves were held mainly in current accounts and treasury bills. This underscored the need to diversify the sources of foreign exchange inflow of the country

Debt Sustainability

Nigeria has a low risk of returning to previous distressed debt levels.  Total external debt at the end of 2009 will likely reach $7.665 Bn, a figure representing 13.6% of total exports including services and income.[4] The International Bank for Reconstruction and Development (IBRD) is the single largest creditor having lent roughly $3.8Bn through 2009.  Bilateral creditors which are mostly Export Credit Agencies (ECAs) are owed an additional $1.64Bn.  Commercial bank credits and other private lenders have the least aggregated exposure with $1.2bn.  There are no outstanding Nigerian Government Eurobonds.

Domestic public debt is projected to reach 12 percent of GDP at the end-2009. Deposits at the Excess Crude Account (Nigeria’s windfall oil savings) have provided a substantial cushion to the economy.  The Government has drawn down liberally during 2009.  At the end of 2008 the Central Bank recorded a reserve of $18 billion (almost 10 percent of GDP). On February 8^th 2010 junior Finance Minister Remi Babalola was quoted that the Excess Crude Account’s reserves were now closer to $6.2Bn. The government spent nearly $12Bn to counter the impact of the global downturn on the Nigerian economy.[5]

Government debt has significantly grown over the 2009 with little abatement expected in 2010. Aggregate Government debt through September 30 2009 has grown 31.8% to Naira 3,058,185 Trillion ($20.387Bn)

Source:  Office of Debt Management Nigeria

Abraham Nwankwo, director-general of the Debt Management Office, has stated that Nigeria plans to sell 867.5 billion naira ($5.74 billion) worth of bonds, about a fifth of planned expenditure this year, to fund the budget deficit.[6]   Overall, Nigeria’s debt I predominately domestic issues accounting for 85% of total debt outstanding.  The great majority of international debt is owed to large multi-lateral institutions, in particular the EBRD.   Nwankwo also envisions a return to the international bond market later this year.  The government has proposed to the Parliament a ten year $500 Million USD bond. 

Nigeria’s public debt ratio to nominal GDP (Naira 22,729 Bn – USD 151.5Bn) is comparatively low at 13.45%.  In the past this ratio has been as high as 50% prior to 2005 and the restructuring of Paris Club debt. Nigeria’s financial press has pointed out on several occasions that the proceeds from the debt issuance has not been effectively distributed or monitored despite Government claims to the contrary.

The Office of Debt Management indicates that sub-national borrowing (Nigerian state borrowing) has also grown to Naira 20.788Bn.  While individual state borrowing is limited, there are indications that State Governments are expanding their exposure to domestic creditors, underscoring the need for improved monitoring of sub-national debt.

Oil Production and the Niger Delta Strife

Nigeria’s proven oil reserves are estimated to be 36 billion barrels of predominately low sulphur content.   Natural Gas reserves are thought to be over 100 trillion cubic feet.[7]  Despite the potential, oil and gas production has been steadily falling (see graph).  Nigeria draws a good portion of its on shore oil and gas from the Niger Delta region where there has been serious security issues effecting production. Nigeria has largely ignored OPEC production quotas set a t1.65MM bbls/day, removing quotas as a reason for falling production. Production has averaged about 2MM bbls/day million barrels a day in recent months—20 percent below its 2005 peak and well below estimated capacity of 2.8 MM bbls/day.  Nigeria is expected to export $52.5Bn worth of crude oil in 2010 down some $22 Bn from 2008.

Security in the Niger Delta region continues to limit the ability of the both the oil firms and the Government to extract revenues.  The Government’s lack of a coherent plan to address oil smuggling and to implement a fair distribution of the region’s wealth to the local population has contributed to the decline in security and thus the ability to grow oil revenues.   The major oil firms operating in the Niger Delta have, according to corporate websites [8]acted independently of the Government to facilitate local community development.  

Fiscal Balances

The 2009 fiscal budget was poorly implemented.  The government will likely record a larger than expected shortfall of $2.2Bn.  From the beginning the 2009 budget ran into difficulty. The Government presented the budget in early December 2008 for Congressional debate.  In mid-December the Senate hastily passed an expanded 2009 budget shortfall that the House of Representatives did not endorse.  By mid-April 2009, President Yar’Adua requested a review of the 2009 budget in light of projected fall in oil revenues and OPEC mandate quotas.   

The government had approved a NGN836.9Bn 2009 budget deficit representing 3.2% of GDP. In reality the deficit grew to 9.1% of GDP.  The deficit would have been even worse if the Government had not drawn down from the Excess Oil Credit Account (that is the windfall earnings between actual and budgeted oil revenues).  A junior finance minister estimated the drawdown to be $12Bn.[9]

The 2010 Federal budget will have to address several immediate and wide ranging concerns.  The banking crisis and subsequent loss of faith in the financial sector has affected private credit outlays.  The government stepped in to facilitate with loan guarantees and ramped up expenditures.  The Budget Office has proposed a Naira 4,079,654,724,257 ($27.2Bn) appropriation.  The appropriation is a 31.5% increase over the 2009 approved budget of Naira 3.102Trn.  The budget is built around real GDP growing by 6% and a weighted average crude oil price of $57bbls/day.  Oil production is forecast Expected 2010 government revenues are Naira 2.517Trn, leaving a financing gap of Naira 1.562Trn ($10.4Bn) or 38.29% of Government expenditures.  The 2010 Budget envisions distributing Naira 180.28Bn or Statutory Transfers, Naira 517.07 Bn for debt service, Naira 2,011Bn for non-debt related expenditures and Naira 1,370Bn for capital expenditures.

The Government will have to invoke several options in order to plug the deficit hole.  President Umar Yar'Adua, in his budget speech, gave hints on what the public can expect from the tax regime. "Government is also forging ahead with key public-sector financial management reforms, with greater emphasis on increasing non-oil revenue through the reform of the Customs Service and the Federal Inland Revenue Service, as well as the audit of independently generated revenue." Clearly President Yar’Adua will be relying on the government agencies that have not met important standards previously.

Effective national growth policies are predicated on targeted expenditures to worthy projects that will sustain employment and enhance the efficiency of the economy, Nigeria suffers from a lack of transparency.  Timely and accurate information on government websites are not available, leaving outside monitors to make broad assumptions.  Comparative data from the National Statistics Bureau is outdated.  Information from the Budget Office is designed more to confuse and obfuscate.  Ascertaining the effectiveness of fiscal expenditures applied to infrastructure projects: rail transport, power generation, roads, telecommunications, port facilities, is not available on any government website. 

Concluding Remarks:

Nigeria appears to be in for a rough ride in 2010.  Fiscal expenditures are growing significantly necessitating a strong government attempt to allocate funds judiciously and to increase the ability to raise revenues.  At the current expenditure trend rate Nigeria will likely issue significantly more internal debt which may have a crowding out impact should non-government entities need to raise funds.  Nigeria is not yet in a fiscally perilous situation.  However, the Government response to falling oil revenues and poor revenue gathering  

John T. Sullivan

Kerry Emerging Global Opportunities LLC

February 15, 2010

E-mail: jtpsullivan@gmail.com

---

[1] Source: Ministry of Finance, Nigeria

[2] Source:  Central Bank of Nigeria

[3] Poll conducted by The Guardian   January 6-9^th 2010

[4] Central Bank of Nigeria, International Institute of Finance

[5] Nigerian Guardian February 8^th 2010

[6] Bloomberg interview February 12^th 2010

[7] U.S. Department of Energy EIA estimates

[8] See Shell UK – Nigeria http://www.shell.com/home/content/nga/responsible_energy/shell_in_the_society/

[9] The Guardian ibid

VIETNAM: STRONG FOURTH QUARTER GROWTH BELIES FISCAL CHALLENGES, TRADE IMBALANCES AND THE DECLINE IN FOREIGN DIRECT INVESTMENT

Contemplating Risks ahead of $1 Billion 10 year Bond Issue


Current Rating: BB _ Negative (S&P Sept ’06); Ba3 _ Negative (Moody’s July ’05) and BB- _ Stable (Fitch June ’02)


10 yr CDS spread: 272.6 bps (Bloomberg Jan. 8, 2010); 5yr CDS spread: 228 bps (Bloomberg Jan. 8, 2010)


Vietnam Dong Official Rate 17, 942 (Ministry of Finance Jan. 8, 2010) Banks quote 18,500


GDP at 1994 Constant Prices: VND 515,909Bn ($ 23.75Bn)


• Economic Growth capped by inability to generate incremental electrical power
• High Government Expenditures on a variety of subsidies exacerbate fiscal imbalances. Financing gap is approximately 6.9%
• Actual Foreign Direct Investment has slowed despite higher incidence of Ministry of Planning and Investment approvals
• Trade Balance continues to deteriorate. High valued imports consistent with rapidly developing nation outstripped the value of oil exports. The second and third largest contributors to the export industry, textiles and footwear, have decline nearly 9%.


Recent Trends

The General Statistics Office of Vietnam (GSO) reported on January 5th that Vietnam’s GDP in the fourth quarter grew a remarkable 6.9% (y-o-y) leaving the country with an overall 2009 real growth rate of 5.32%. The GSO statistics show that the services industry lead the way growing at an annual rate of 6.63%, followed by industry and construction at 5.52% and agriculture, fisheries and forestry rounding out the data with a 1.83% addition. The latter half grow in 2009 can in part be attributed to the government’s intervention. The government enacted a series of economic stimulus measures, including an interest rate subsidy program for qualified capital outlays, and a general tax reduction policy through the postponement of corporate and personal taxes.

The growth figures when broken down quarter by quarter illustrate a progressive turnaround from one of the weakest quarterly results (3.14% y-o-y) occurring in the first quarter of 2009. In the 2nd quarter GDP grew by 4.46% followed by 6.04% in the third quarter. At the onset of the fourth quarter the State Bank of Vietnam devalued the national currency, the dong (VND) by 3.41% to VND 18,480 to the $. In addition, the SBV raised base interest rates by 100 basis points to 8%.


Addressing Electricity and power demands

The Ministry of Industry and Trade (www.moi.gov.vn) posted a rather “illuminating” statement on the website of Vietnam Electricity (www.evn.com.vn). According to the Ministry, demand is increasing by 10-20 per cent per year as a result of the nation’s drive for rapid economic growth. However traditional sources of energy like oil, gas and coal are quickly being exhausted, making an effective energy policy key to sustainable development. Vietnam Electricity (EVN) statistics show that 50 to 60 percent of Vietnamese enterprises are using obsolete or worn-out technologies despite having comparatively new equipment. The shortages coupled with the lack of efficiency will restrict economic development.

At the end of 2009, Vietnam Electricity is generating only 15,000MwH. With a population close to 87.5 million and an economy struggling to grow, Vietnam will have to serve the growing power needs of its people. At present Vietnam would rank in the lower power generation quartile per capita. The Vietnamese government has responded with a plan to raise total capacity by 48,000MwH (over three times current levels) by 2015. In 2010, EVN anticipates that it will add an additional 3,000MwH with new power plants coming on line. The ambitious math relies heavily on hydro generation (1/3), and coal (over ½). The balance will be provided by natural gas. The coal plants will likely rely on both domestic and imported coal stocks. A Harvard Kennedy School of Government and Fulbright case study of EVN (December 2008) asked two rather poignant questions: (1) what mix of electrical generating capacity will reliably supply the demand in Vietnam at the least cost; and (2) how can this be contracted for or constructed?
That is, what prices need to be charged under what terms?


Federal Budget Deficit

The Ministry of Finance reported that the government recorded a VND 35,810Bn deficit for the year to date (September 30th). The deficit amounts to 6.94% of 2009 GDP (constant prices). At 3rd quarter end the State Budget (planned versus actual) will overshoot by 3-5% assuming straight line analysis. The principal areas of potential differences are: social expenditures overshooting by 16.8% to VND 170.2Trn and social subsidies by 16.87% to VND 59Trn. The Ministry of Finance does not further breakdown these figures.

The government needs also to address its ability to generate more revenue. At current rates government revenue will undershoot the planned budget by 2.5% with a projected VND 355Trn. VAT revenue is projected to run 6.7% below the budget. The projected VAT at year-end will likely be around VND 99.8Trn if trends were maintained. The estimate is vulnerable as the economy grew significantly during the fourth quarter of 2009.

Reliance on the Overseas Donor Community

Vietnam has been able to plug part of its budget deficit through assistance from the international donor community. The donor community had pledged over $ 8Bn to assist Vietnam through the global credit crisis. During the December 2009 Consultative Group Meetings held in Hanoi, the donors reviewed the general business climate and the further need to assist in macro-economic expansion. For the last five years Vietnam has benefited from annual international aid packages that rose from $3.7Bn in 2005 to over $6Bn in 2008. The clear support of this community is necessary to sustain Vietnam’s fiscal targets.


Foreign Direct Investment

For any economy that is seeking to grow the ability to diverse and attract investment from abroad is an imperative. This observation is particularly true if the economy is in early stages of growth where both capital and technology are scarce. When capital is scarce or there is a dominate source, the ability to grow may be truncated in the course of development. For these reasons, The Socialist Republic of Vietnam’s recent foreign direct investment (FDI) statistics are worrisome.

Vietnam (General Statistics Office - GSO) reported that realized FDI year to date as of November end was an estimated $9Bn, a 10.4% decline from 2008 (same period). The future pipeline of approved and licensed FDI is shockingly deteriorating. Again year to date figures from the GSO suggest that FDI approved projects declined by 72% to $ 19.7Bn over the same period as 2008.

The State has augmented the overall capital investment by appropriating VND 112,800Bn ($ 6.31Bn @ pre- devaluation VND 17,869) in the 2009 State Budget. As September 30th, the Ministry of Finance reported that VND 78,975Bn had been spent on investment development, 96% of which is new infrastructure construction. This amount is a 40.5% increase over the previous year. The State’s participation rate in total investment amounts to 42.8% of GDP. Total real GNP (1994 constant prices) is measured at $ 27.92Bn The GSO does not break down the beneficiaries let alone the efficacy of the infrastructure investment.

Trade Imbalances likely to pressure VND further

Rapidly growing nations are likely to run trade balance deficits. Imports of high valued machinery and refined petroleum products are an indication of anticipated growth requirements. Vietnam does not differ in this respect. The country’s imports of machinery and spare parts make up the most significant import category. Vietnam imported $12.369Bn of machinery and spare parts, representing nearly 18% of the value of all imports. Last year machinery and spare parts amounted to $13.712Bn. The GSO does not breakdown the type or quantity of the machinery.

Vietnam is expected to run a 2009 trade deficit of $12.246Bn, a figure close to total machinery and parts imports. In 2008 the trade deficit amounted to $17.5Bn with similar concentrations of high valued imports (machinery, refined petroleum and steel). As Vietnam continues to develop, the trade deficit will expand as Vietnam has little infrastructure capacity to substitute these imports.

The export side of the equation is problematic. Current year export revenues are projected to fall to $56.58Bn from $62.91Bn earned in 2008 (GSO). In 2008 Vietnam exported textiles with a value of $ 9.1Bn, competing with oil exports of $10.45Bn. In 2009, Vietnam’s second and third largest export industries textile and footwear fared poorly, declining by $1.328Bn to $ 13.8Bn from the previous year ($15.147Bn). Vietnam’s exports with the exception of oil are not high valued. Vietnam’s offshore oil industry exported $ 6.21Bn of product only to import refined petroleum valued at $6.159Bn. Clearly, exporting textiles, footwear and assembled electronics will not cover the value of advanced machinery, steel or automobiles.

Conclusions

Vietnam is undergoing a period of rapid development spurred on by strong credit growth (SBV) through loan subsidies. The economy is regaining some strength with 4th quarter GDP growth recorded at 6.9%. The GSO statistics aggregates broad categories of contributors to growth. One weakness of the GDP figures is that it is not possible to fully investigate the accuracy of these numbers. The first quarter of 2009 was one of the weakest on record. By the fourth quarter post-devaluation the economy was recording a 6.9% (y-o-y) rise.

Vietnam can be a dynamic economy if the proper infrastructure in put into place. Electricity demand currently outstrips supply impeding the ability to grow. The government will likely use the proceeds of any bond issue to address this. However, the government must also insure that the use of these funds will be closely supervised to prevent leakages.


John T. Sullivan
E-mail: jtpsullivan@gmail.com
January 10, 2009

WHITHER COLOMBIA? STAGNATING CONSUMPTION – GOVERNMENT TAX REVENUES TO SHRINK

·        Real consumption (ex-transport and energy) fell 3.06% Y-o-Y in September.  Extrapolating from statistics provided by Colombia’s Departamento Administrativo Nacional de Estadística (DANE) point to a continued fall in consumption in October and November.  The key period will be December which is the lead up to the Christmas and New Year holidays.

·        Colombia’s consumer inflation rate for November continues to fall with Y-o-Y change being 2.41% well below the official targeted range of

·        Producer Price Y-o-Y inflation fell  3.87% in November versus a more dramatic October decline of -4.08%

·        National unemployment (October 2009 – DANE) is measured at 11.5% which was a slight improvement over the three month average (August to October) of 11.8%.  Under-employment remains a serious social issue as individuals claiming to desire a change because of fewer hours, indeterminate schedules, part time work rose to 11.3% from 9.4% in October 2008.  Worse yet, individuals claiming that they had not found suitable full time work because of lack of opportunity rose to 32.2 from 27.1% in October 2008.

·        2^nd quarter 2009 Real GDP continued to perform poorly falling a further 0.51% on top of a 1^st quarter decline of 0.45.

·        Consumption taxes (IVA) fell during the first six months by 3.9% to COP$ 8,576MM from a comparable period of COP$ 8,922MM in 2008.  As a percentage of GNP consumption taxes has fallen from 1.9% (2008) to 1.7% (2009).

The turnaround of the Colombian economy will be impeded if personal consumption is not able to generate a recovery.  Real consumption (ex-transport and energy) has declined 3.06% y-o-y in September.  Real Consumption accounts for approximately 65% of GNP (constant 2000 pesos; source DANE)

Total vehicle sales for the Third Quarter of 2009 declined significantly from the same period last year.  Nationally produced vehicles sales were down 25.7%.. Imported vehicles were down 22.7%.  The two worst performing categories were domestic cargo transport and domestic recreational camping vehicles down 54% and 87% respectively from a year earlier.

                                Source:  DANE; ENEI

In tandem with the decrease in consumption, both real producer and consumer prices have fallen.

 

                                           Source:  DANE

The 2009 inflation rate has fallen from 7.178% in January to 2.72% in October.  Extrapolating from this data, the trend will likely continue for the balance of the year. 

                            Source:  DANE; ENEI

 Examining the repercussions, the Colombian government needs to provide an impetus to domestic demand.  Fiscal spending has certainly increased, exacerbating the national government’s fiscal deficit which added COP$4.2Bn  The process of re-flating the economy through fiscal stimulus may take longer than anticipated.  The movement of money that translates into increased consumer expenditure is distorted by the seasonally consumption.  Colombia’s consumers spend most in December, corresponding to the Christmas holidays. Historically consumption drops off in January and February before recovering.

Would fiscal stimulus spending and actually grow GDP, setting Colombia on the path to recovery? One can argue that a fiscal stimulus masks the weakness of an economy by distorting the allocation of money to preferred government recipients.  In Colombia’s case it will be too early to draw any concrete conclusion until after January 2010 when the effect of .the seasonal increase in consumption has passed.

Extend and Pretend - US Regional Bank Day of Reckoning

The Wall Street Journal published an article on December 8th entitled "What Zions Consider a Loss". the article was placed on the back page of the "Money & Investing" section. The point of the article by Peter Eavis is that Zions capital structure and therefore its Tier 1 capital adequacy ratio is benefiting from a lax accounting and regulatory environment. Management, likely to be the CFO and bank's Treasurer, have marked difficult to price, impaired securities at prices management considers fair. This procedure has been called "marked to model". Among the trading community we have christened it "mark to myth". What is important to shareholders and to the "brokered money community" (large deposits of money placed at the bank through brokers)is that Zions and other banks like it do not have a sudden earnings hiccup. Under present accounting regulations, Zions management is able to delay any immediate recognition of losses. Thus there is no impact on the earnings statement for the moment. Management is able to claim that any dramatic drop in market prices is overdone. Asset price recovery will occur at some future date. There is an imposed time limit of several quarters before biting the bullet.

On January 1st 2010, the new FASB regulations #166 and 167 will hopefully address the “mark to myth” presently used. Under the #166 and #167 banks will have to mark their impaired securities to “fair value”.

I am skeptical. One has only to go to the FDIC website and look up the Uniform Bank Performance Report (http://www.ffiec.gov/UBPR.htm) to ascertain the wave of potential pain that resides in our banking system. I would specifically draw attention to the Peer Group Data Reports. “Off Balance Sheet Items and Derivatives Analysis” are listed for each bank as are “Non accrual and Restructured Loans”. Many of the “Off Balance Sheet Items” are the CDOs, CLOs and other Asset Backed Securities referred to in the article.

There is a tremendous amount of restructuring work to be done. The potential for another financial credit bust has not dissipated.

Peru's Economy 4th Quarter 2009

Peru: Can Private Sector Growth Be Achieved Without Relying on Fiscal Stimulus and Monetary Easing? – Taking the Fat Out
Pros:
• Stable, flexible monetary policy
Cons:
• Over reliance on fiscal stimuli and near zero real interest rates
• External Trade strongly dependent on world mineral demand
• Bank lending outside of larger corporate credits has not manifested itself
• Electric power generation is flat
• Stagnating manufacturing sector
• Delays in government sponsored infrastructure investment hampering growth prospects
Peru’s economy is showing signs of a tepid, uneven recovery. Economic activity (January – September) is being lead by a combination of government stimulus expenditures and monetary easing. Government related expenditures are up 16.8% in the 3rd Quarter (y-o-y) followed by Financial Sector gains of 10.89%, according to recent INEI data (October 2009). The Central Bank has cut reference interest rates from 6.5% at the beginning of the year to the present level of 1.25%, a 525 basis points change. The Board of the Central Bank has held the current reference rate since its August 6th meeting. Bank Reserve Requirements have been loosened Annualized inflation has declined sharply from 6.53% (January 2009) to 0.71% (October 2009). The current inflation rate is well below the 2% target (1% flex either side) set by the Central Bank in March (Inflation Report 2009). Despite these observations Peru’s annualized 3rd Quarter GDP fell a further 0.4 compared to 3rd Quarter 2008. The 3rd Quarter 2009 follows a lackluster 2nd Quarter annualized fall of 1.1%. The Central Bank (Weekly Report #47 – November 27 209) reported that 3rd Quarter domestic demand fell an annualized 4.8% following a 2nd Quarter fall of 5.1%. Public consumption continued to be the strongest 3rd Quarter category performer, rising to 9.8% following a similar 2nd Quarter annualized performance of 7.8%. Public consumption’s contribution to GDP is weighted (2008) only 3.8%. Private sector consumption continued to be a pale ghost of its former self rising only an annualized 1.5% during the 3rd Quarter. In 2008 private consumption along with export trade were the two engines of Peru’s growth, respectively growing 5.9% and 1.6%.

Looking beyond the horizon and into the first two quarters of 2010, Peru’s economy presents a mixed bag. Peru’s next general elections are scheduled for April 2011. The anticipated political jockeying may restrict the effectiveness of fiscal policy measures as political parties dilute targeted expenditures. Looking at the current high rate of government participation in the economy, one can likely extrapolate.
Proinversion Peru, the government’s infrastructure and investment promotion agency, is tasked with overseeing privatizations and concession awards for transportation, ports, airports, communications, sanitation, and eight to ten other public-private categories (www.provinversion.gob.pe). In 2009, over forty projects have been identified for a public-private partnership. As of October 1, fifteen projects have been awarded with definitive investment contributions from the government and the private sector. The largest among these ($650MM) has been a concession to provide hydro-electric power plants and distribute electricity at fixed tariffs.
The construction, generation and delivery of electricity are critical to Peru’s private sector development. The latest report (October 2009) from the Department of Energy and Mines (Estadistica_Octubre-2009_Actualizando- Peru.pdf) indicate that production levels of 2783 Gwh just barely cleared the required 2307Gwh sold to the private sector. Highest daily demand figure was 4088 Mwh which is virtually unchanged from the previous year October 2008 ( 0.01%). Strikingly, the Peruvian economy including its manufacturing sector was in a better condition than current figures (down 9.07% y-o-y)

Peru’s exports are concentrated in its mineral sector. Fortunately world prices for gold, silver, copper, zinc and lead have been rising. What is not widely watched is that the value and volume of non-commodity related exports have dropped. According to ENAPU , export related container traffic measured in TEUs (Twenty-foot Equivalent Units) is down nearly 16% out of Peru’s principal port of Callao. In addition, import related traffic is down nearly 13% using the same measurement.
Since the beginning of 2009, Peru’s equity market (Lima General Index, heavily weighted in favor of metals and mining firms) has risen 104.6%; EMBIG risk factor has narrowed from 215 basis points to 183 basis points (November 27th) and lastly the sol has appreciated to PEN 2.88 ( PEN 3.13 at the beginning of the year). One can only conclude that the market and Peru’s macro-economics have reached a stage of disconnect.



John T. Sullivan

December 6, 2009