In­vest­ing in South Africa’s eco­nomic gloom

The Pak Banker - - OPINION - Matthew A. Win­kler

Just about ev­ery­thing is go­ing wrong in South Africa and that's why in­vestors in its bonds are reap­ing a bo­nanza. It's hard to find an­other coun­try with mi­nus­cule growth, ris­ing in­fla­tion, a quar­ter of its work­force un­em­ployed and a cur­rency that lost more than 25 per­cent of its value the past 13 months man­ag­ing to fi­nance its deficit with de­mand ex­ceed­ing the sup­ply for newly-is­sued debt.

In­vestors are able to ben­e­fit from South Africa's mis­ery be­cause a por­tion of the na­tion's bor­row­ing is de­signed to ap­pre­ci­ate as in­fla­tion ac­cel­er­ates and mar­kets an­tic­i­pate much worse to come. Since Jan. 1, the coun­try's in­fla­tion-linked bonds are out­per­form­ing all de­vel­oped and de­vel­op­ing coun­tries with sim­i­lar of­fer­ings, in­clud­ing Brazil, Ger­many and the U.S.

This does noth­ing to im­prove South Africa's eco­nomic prospects. Pres­i­dent Ja­cob Zuma re­cently­ac­knowl­edged his coun­try's dark­en­ing out­look in an ad­dress to his fel­low cit­i­zens, as­sert­ing, "We all have a lot to do to turn the econ­omy around."

Yet in­vestors can't get enough of South Africa's 359 bil­lion rand­de­nom­i­nated in­fla­tion-linked bonds, which com­prise 22 per­cent of the na­tion's to­tal debt. The link­ers, as they are nick­named, pro­duced a 4.7 per­cent to­tal re­turn (in­come plus ap­pre­ci­a­tion) this year. That was No. 1 among emerg­ing mar­ket coun­tries and among the 23 coun­tries that is­sue bonds pay­ing higher yields in their own cur­ren­cies when­ever the do­mes­tic rate of in­fla­tion in­creases , ac­cord­ing to data com- piled by Bloomberg.

The bonds are the only glim­mer of con­fi­dence in an econ­omy that is de­te­ri­o­rat­ing on mul­ti­ple fronts. The rand lost 25.2 per­cent against the U.S. dol­lar in 2015, the third worstper­form­ing cur­rency among the world's 31 most-traded be­fore gain­ing 0.23 per­cent this year, ac­cord­ing to data com­piled by Bloomberg. What's more, the rand is likely to de­cline an­other 7.6 per­cent by the end of 2016, ac­cord­ing to an­a­lysts sur­veyed by Bloomberg.

South Africa's in­fla­tion rate is lower than the African av­er­age but its eco­nomic growth is worse, ac­cord­ing to Bloomberg data. The con­sumer price in­dex rose 4.6 per­cent in 2015 and will climb to 6.2 per­cent and 6.3 per­cent this year and next, ac­cord­ing to econ­o­mists sur­veyed by Bloomberg. Growth is pro­jected to slow to 1.3 per­cent from 1.5 per­cent last year with pro- jected gross do­mes­tic prod­uct barely ris­ing to 1.6 per­cent in 2017.

The health of South Africa's pub­licly traded com­pa­nies also is get­ting worse, as mea­sured by the net debt to earn­ings be­fore in­ter­est, taxes, de­pre­ci­a­tion and amor­tiza- tion of the 40 com­pa­nies that make up the Africa TOP40 Trade­able in­dex. The debt ra­tio is the high­est since 2004, and while it still is less than the bench­mark for emerg­ing mar­ket coun­tries, the de­te­ri­o­ra­tion has made the dif­fer­ence the nar­row­est since 2013, ac­cord­ing to Bloomberg data.

Much of the plight of South Africa can be at­trib­uted to slow­ing growth in China and the col­lapse of com­modi­ties prices af­flict­ing many emerg­ing mar­ket economies. China has been South Africa's big­gest trad­ing part­ner since 2008 and ac­counts for $61.6 bil­lion of the coun­try's to­tal trade, al­most triple the amount seven years ago, ac­cord­ing to data com­piled by Bloomberg. Since the Chi­nese econ­omy be­gan to slow in 2010, the rand has lost 56 per­cent of its value against the dol­lar while the bond mar­ket de­pre­ci­ated 40 per­cent, ac­cord­ing to Bloomberg data. Traders are bet­ting that South African in­fla­tion will keep climb­ing as mea­sured by the 5year break-even rate, which rose from an av­er­age of 6.2 per­cent in 2015 to 6.94 per­cent on Thurs­day, ac­cord­ing to Bloomberg data.

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