Sub-Saharan African (SSA) countries that are reliant on short-term capital flows to finance large current account and budget deficits are most at risk from tightening global liquidity conditions, with Kenya, South Africa and Ghana among the most vulnerable, ratings agency Fitch has said.

In a newly released report, the agency estimated that the current account deficit less foreign direct investment (FDI) for Kenya and South Africa would be 10.5% and 4.6% of gross domestic product (GDP), respectively, for the 2013 fiscal year, with the deficit 80% and 30% funded, respectively, through short-term capital flows into bonds and equities.

The report found that Ghana was also exposed, with an expected budget deficit of 10.3% of GDP for the 2013 fiscal year, funded largely by 68% domestic debt issuance, of which foreigners held around 26%.

“On average, however, SSA will be less vulnerable to eventual US Federal Reserve Bank (Fed) tapering and monetary tightening than more mainstream emerging markets, owing to lower external financing requirements and the largely nonconcessional nature of their foreign debt.

“SSA is also shielded by financial markets, which are not as globally integrated, and improved reserve cover. Stronger growth prospects, supportive of FDI, will also provide a needed buffer,” the agency said in a statement.

As a result, Fitch said it did not expect eventual Fed tapering to place significant pressure on SSA countries' domestic and external financing capacity, as an improvement in credit fundamentals over the past decade should make most relatively resilient.

It added that central reserves had risen in the last ten years on the back of improved balance-of-payments positions, less currency market intervention and more exchange-rate flexibility, with domestic financial institutions providing a steady source of demand for local debt.

“South Africa, Kenya and Ghana are not alone among SSA in having large current account and budget deficits, but vulnerability is mitigated in other countries. For example, in Mozambique, much of the current account deficit is financed through FDI, while Rwanda receives substantial concessional funding,” Fitch noted.

Foreign participation in smaller markets, such as Uganda and Zambia, had largely been driven by movements in domestic interest rates, making these markets less vulnerable to Fed tapering.

In addition, fears that higher yields may dissuade first-time SSA Eurobond issuers from entering the market appeared to be misplaced, with Fitch expecting first-time issuances to continue as countries took advantage of what were still historically low yields to fund infrastructure deficits.

“While yields are likely to rise further and faster once the Fed eventually starts hiking rates, the significance of regular Eurobond issuances in Africa will largely depend on how successful governments are at using the proceeds. The track record here is still largely unproven,” the agency said.