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Can South Africa bank on its emerging market status?

29 October 2010 Gareth Stokes
Gareth Stokes, FAnews Online Editor

Gareth Stokes, FAnews Online Editor

Billions of rand of foreign investment capital has flooded into South African equity and bond markets through 2010. Fund managers in the US, UK and other developed economies cannot resist the yield on offer at the southern tip of Africa. The nominal yield

Economic forecasting is a mugs game. The minute you think you’ve got a handle on GDP growth, inflation, interest rates or currency crosses an unexpected event occurs, leaving your careful calculations in tatters. Earlier this week we attended Old Mutual Investment Group South Africa’s (Omigsa) quarterly assessment of the global and domestic economic environment. Senior economist Johann Els was on hand to talk us through The Emerging Market Boom and its Impact on South Africa.

The developed versus emerging debate

The best way to get to grips with South Africa’s immediate economic prospects is to observe the major macroeconomic rifts between the developed and emerging world. Growth prospects in the United States, Europe and Japan are “chalk and cheese” when compared to those in emerging countries like Brazil, India, China and Russia (the BRICS) and most of Africa. While the world’s economic superpowers talk about growth rates of between 1% and 3%, emerging economies are still producing numbers in the early double-digits.

The outlook for interest rates and inflation are totally different too. The United States economy is showing absolutely no signs of inflationary pressure right now. The threat to its economy – as it was in 2003 – centres on deflation – or a period of price contraction. “Deflation is a bigger risk to the developed world than inflation,” said Els. And it’s a real threat! Some of the US Treasuries (bonds) issued recently offer negative interest rates. In other words: investors are prepared to “pay” the US government to keep their money “safe”... The only sensible response to near zero inflation is for the US to embark on another round of quantitative easing. They’ll print more money to get industry off the ground and hope inflation ticks up slowly over time.

South Africa – firmly aligned with the emerging economy camp – has no such concerns. Instead we’re celebrating the fact inflation is finally under control. Over the past few periods consumer price inflation has slipped nicely into the Reserve Bank’s 3% to 6% target range. Although economists agree we’re at the bottom of the cycle they don’t expect significant inflationary pressures over the next 12 to 24 months. Some experts are using this data as motivation for a further interest rate cut. There’s an outside chance of this happening, though Omigsa believes the next rate move will be gradually higher, starting late 2011.

One man’s pleasure is another man’s pain

While we enjoy the lowest interest rates and inflation in recent history, the developed world is praying for upward inflationary pressure to resume. An economy needs inflation to grow… And investors need inflation to fuel the returns on their investments. Inflation and interest rates play a major role in domestic market returns AND how funds flow between countries. Because US-based investors cannot earn a return on their local cash – cash is trash in Europe, Japan and the US – they’re channelling it to emerging market economies by the bucket load. Emerging market debt and equity will remain popular because investors are willing to ignore risk in favour of yield.

South Africa has been a major beneficiary of yield seeking cash flows in recent months, a fact suggesting the developed world has confidence in our fiscal policymakers. There’s also some evidence offshore asset and fund managers are making South Africa part of their “permanent” offshore allocation. This trend will hopefully shelter the rand in the event the “hot” money is withdrawn from the market.

Incidentally there’s some merit to government’s recent lobbying for South Africa to be listed alongside the BRICs as an emerging market superpower. The rand has been tracking the Brazilian currency with amazing accuracy – and our markets have echoed Brazil’s over 10-years. The return on the FTSE/JSE All Share index going back a decade is 244%, while Brazil is 295% higher. The US Standard & Poors 500 index has declined 28% over the same period!

Editor’s thoughts: South Africa is reaping the benefits of 10 or more years of fiscal discipline. We’ve implemented the correct strategies and allowed Treasury and the Reserve Bank to dictate policy as appropriate. Provided we steer clear of policy blunders the country should convert some of the “hot” cash currently sitting in our bond and equity markets into the long-term investment capital which really makes an economy fly. Do you think government’s recent obsession with nationalisation and greater state intervention in the economy will chase potential investors away? Add your comment below, or send it to gareth@fanews.co.za

Comments

Added by Bidnis Man, 03 Nov 2010
The hot money will leave when real yield drops. Like it did when the rand hit R14 to the dollar. The permanent allocation will be too small and we will have economic upheaval from the changing forex prices. A stable foreign exchange rate is more important to a country than either a low one or a high one as it allows businesses to establish themselves who are dependant on export or import. Constantly changing causes business failure which causes enemployement which causes political tension.
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