SA faces investor exodus if rand rout deepens

LONDON:

South Africa faces the risk of a huge exodus of foreign investors who are seeing the plunge in the rand’s value rapidly erode their stock and bond returns.

Now a combination of domestic policy fears and structural problems along with a poor global trade and investment climate is weighing heavily on the country’s currency.

South African stocks and bonds have been a magnet for foreigners who now own a third of the bond market and up to half the equity free float in Johannesburg, which is home to multinationals like SabMiller and Anglo-American and remains close to record highs.

A record 93 billion rand (Dh36.7 billion, $10 billion) flooded into the country last year, when South Africa became only the fourth emerging economy to enter Citi’s key global bond index.

But a ballooning deficit, sluggish 2-3 per cent growth and fears of erratic policy before 2014 elections are weighing heavily on the rand which has lost 8 per cent this year versus the dollar and a fifth of its value since early-2012.

Investor exits tend to pick up when returns turn negative and the rand is now perilously near the 9.30 per dollar rate, that analysts at UBS reckon is the “pain threshold” at which longer-term bond returns will tip into the red.

“You are seeing rand weakness eating away investors’ returns,” says Manik Narain, who co-authored the UBS report.

He estimates the average rand exchange rate was 7.70 per dollar over the past four years when most bond investors entered the market. Cumulative returns during this time amounted to 20 per cent according to UBS calculations.

“Another 1-2 per cent loss on the rand could see them exit positions altogether,” Narain adds. Rand weakness also ties the hands of the Reserve Bank of South Africa (SARB), preventing it from offering the economy vital monetary stimulus. The SARB left interest rates on hold this week, noting the currency’s propensity to “overshoot”.

Undoubtedly some funds are in for the long run, irrespective of currency swings. Others will also have put in hedges against currency depreciation.

HSBC currency strategists are among those arguing that even at current levels the rand can be hedged. They note that inflows are continuing, albeit at a less robust pace than last year. Stock exchange data indeed shows net year-to-date inflows of 7.3 and 14 billion rand respectively.

But Narain says that if a currency keeps depreciating, it can become harder to roll over the hedge. And the rand’s moves are being driven by bad policy and worsening macro economics rather than short-term problems or global issues.

“Indeed it is very possible also that despite sitting on strong cumulative aggregate profits investors would choose to stop adding to a market, or exit from it, if they believe there are structural shifts for the worse in that economy,” he says.

Chronic labour unrest has slashed mining and power output, depressing corporate profits and economic growth. Soaring wage costs have kept productivity weak — data from the World Economic Forum for instance ranks South Africa 97th out of 139 countries in terms of labour flexibility. The global trade slowdown led by China and Europe, along with waning demand for emerging markets, is making things worse.

So how does this macro-economic gloom square with the fact that the Johannesburg stock market is at record highs?

First, much of this gain is locally-driven. Unlike many emerging markets, South Africa has a powerful local investor base which is less likely to take fright from currency weakness. A weak rand can in fact be a plus for export-focused mining companies whose income is in dollars.