Investing in South Africa – risky business or not?

The odds are for foreigners’ perceptions of the risk pertaining to investing in South Africa to improve, as global economic growth and commodity prices could be bottoming.

“However, both internal and external factors could influence perceptions in the other direction,” says Prieur du Plessis, Plexus Group chairman. “Any further deterioration in the global economy will increase risks, resulting in further capital outflows and a concomitant pressure on emerging market currencies.”

“The upcoming election and pronouncements, as well as any changes in fiscal and monetary policies, could also result in South Africa’s risk rising relative to other emerging economies.”

South Africa needs foreign investment to promote a healthy economy, strong financial markets and a stable currency. While South Africa has some measure of control over the internal actions, outside factors cannot be controlled.

“To measure the inferred risk of investing in South Africa, one can look at the differential or gap between South Africa’s long-term interest rate and that of first world countries,” says Du Plessis. “In times of crisis, when the perceived risk of investing in South Africa increases, the bond yield spread increases.”

Crises can be either region or country specific, such as the 1976 Soweto uprising, President PW Botha’s Rubicon speech and the declaration of a state of emergency in 1986. They can also be external, such as the Asian crisis in 1997/1998 and the 9/11 terrorist attack in the USA. Risks also increase when a country’s financial affairs are not in order.

“When global growth declines and demand for commodities decreases, the risk of investing in commodity-based emerging economies such as South Africa increases,” says Du Plessis. This is evident in the significantly increased South African spread since 2007.

The converse is also true, as risk declines with improved expectations for better global growth and the resultant increase in commodity prices.

According to Du Plessis there is also a strong inverse correlation between the bond yield spread of emerging economies and metal prices. “When metal prices increase, the bond yield spread of emerging economies declines due to the prospects of improved growth for these economies as a result of higher metal prices.”

South Africa is classified as an emerging economy, so there is a close correlation between the country’s bond yield spread and emerging markets in general. However, South Africa’s spread moves out of line with that of other emerging economies at times. This occurred in 2006 when South Africa’s spread increased long before the spread of other emerging economies. According to Du Plessis, this could be ascribed to the political turmoil in Zimbabwe, which foreigners viewed as negative for the whole region.

The South African spread also improved in 2008 before that of other emerging economies after the demise of US company Lehman Brothers, when it became evident that local banks were not exposed to the credit crisis to the same extent as some other emerging economies.

According to Du Plessis, government bonds will in general not be a good asset class to be invested in when global growth eventually improves, due to rising yields and lower prices.