Global tide of money is receding, and SA is swimming naked
The main reason for the sell-off in South African assets lies beyond the country’s borders, write Mehul Daya and Neels Heyneke
There is a perception that the sell-off in the rand (and other SA financial assets) is because "Ramaphoria" has turned into "Ramaphobia", leading to capital outflows from our shores amid subdued economic growth, structural impediments such as the country’s twin deficits and policy uncertainty around key issues such as land reform and the mining charter, unfortunately this is not the complete story.
While these factors are certainly worrying, it is important to note that the current turmoil in emerging markets has been across the board, from the strongest emerging-market economies in Asia (China, India, South Korea) to the weakest emerging-market economies like Turkey, Brazil and South Africa.
This is important to note as we believe there is a far bigger force materialising other than idiosyncratic, country-specific factors.
The bigger force we are referring to is the tide of money, which has been shaping the outlook for emerging markets through capital inflows and outflows for many years. As long as the tide of money engulfed emerging-market shores, currencies appreciated and interest rates fell, leaving the imbalances in emerging markets unchecked.
Closer to home, the tide of money that engulfed our shores for a number of years, amid foreign investors’ insatiable demand for high-yielding investments, fuelled capital inflows into South Africa. This is also known as the infamous carry trade, whereby investors, borrow funds in their country of origin (for example, the US or Europe) and use this borrowed money to investment in countries like South Africa, which offer attractive returns.
Unfortunately the tide of money is speculative, volatile, and is not used to grow the economy or add productivity.
Hence South Africa, alongside many other emerging-market economies, received capital inflows despite weak economic growth, sovereign debt downgrades from international rating agencies, and a volatile and ultimately damaging political environment under former president Jacob Zuma.
None the less the rand managed to appreciate, albeit in a volatile range from a weakest level of R16.85 to the dollar (when Nene was fired in December 2015) to a best of R11.44/$ (when Cyril Ramaphosa was elected ANC leader in December 2017).
For the first time since the 2008-09 financial crisis the tide of money is leaving and many emerging markets are exposed. As Warren Buffett said, "When the tide of liquidity recedes, you will see who is swimming naked."
We believe it is this receding tide that is a bigger driving force behind the current weakness in the rand, bond yields and equity markets in South Africa.
South Africa certainly falls into the category of being part of group of vulnerable emerging-market countries. Since South Africa’s financial markets are deeply connected with the rest of the world’s capital markets, we are vulnerable to changes in the global environment and global capital flows rather than to changes from the domestic environment.
Some statistics to illustrate this:
The rand’s daily foreign exchange turnover as a percentage of annual gross domestic product (GDP) is a staggering 20% even though we only account for less than 1% of global trade. The economy itself is too small to justify the massive forex volume — it is because of global flows and the carry trade.
Foreign investors hold on average 40% of local government bonds and 47% of shares on the JSE, leaving SA assets vulnerable to foreign investor sentiment. While this stat differs across emerging markets, the average for foreign ownership of local government bonds and stock markets is roughly 25%, according to the Institute of International Finance.
Why is the tide of money receding? After many years of accommodative monetary policy in the developed world, central banks — in particularly the US Federal Reserve — have begun tightening financial accommodation (raising interest rates and tapering the balance sheet) amid a strong US economy and rising inflation expectations.
The cost of borrowing dollars internationally has risen (making it expensive to fund the carry trade) and as a result foreign investors are abandoning riskier investments like the rand and other emerging-market currencies.
On top of this, uncertainly regarding global trade wars has raised concern about the prospects for global growth and commodity prices, leaving investors nervous about their positions in the carry trade.
We reiterate that foreign investors are retreating from South Africa not just because of concerns regarding our economy but also because of the rising cost of borrowing money to invest in South Africa
The global credit cycle has become very important to understand as capital outflows can weaken the exchange rate dramatically, putting upward pressure on funding costs. This leads to a fall in asset prices (stock markets and property price), ultimately damaging prospects for domestic demand in the real economy.
This is the vicious circle in which the real economy and the financial system feed each other, leaving economies like South Africa very vulnerable.
• Daya and Heyneke are macro strategists at Nedbank CIB Global Markets.