Global search for yield means parts of the economy are counter-intuitively doing well
The billions of dollars flooding into emerging markets are propping up financial markets, but this disguises the underlying crises in South Africa’s real economy. Economists for major banks and asset managers this week warned that both growth and tax revenues were likely to fall below the expectations of National Treasury this year.
At the same time, financial yardsticks such as the exchange rate and yields on government bonds are all counter-intuitively doing well, thanks to a global “search for yield” moving capital from developed to so-called emerging markets.
“In this environment, the local issues all get disguised,” said Nazmeera Moola, economist for Investec Asset Managers.
Actual investment in production by private companies is in the middle of an unprecedented period of decline where there is no external crisis to blame, she said.
Indicators, like arrears on rent and the cashing out of pensions, show that people are struggling to pay their way, added Ettienne le Roux, chief economist of Rand Merchant Bank.
They were part of a panel discussion at the Discovery Financial Planning Summit this week. Moola predicts economic growth will be less than 1% for 2017 and Le Roux likewise sees it coming in at between 0.5% and 1%. Treasury forecast 1.2% growth this year. Le Roux said that his bank’s growth forecast, if it came to pass, could result in a government tax shortfall of R45 billion in one year.
Doomsday predictions about the rand and government debt before the Cabinet reshuffle and the downgrade that followed have nevertheless not materialised at all.
The reason is the inflows into emerging markets, said Moola.
“Since the start of 2017, about $64 billion has flown into emerging market debt and equity funds. It was $31 billion into equity and $33 billion into debt.”
“If you are a debt market strategist ... South Africa, Turkey and Brazil are all 10% of your index.”
This might change if South Africa gets its randdenominated debt downgraded to “junk” status by Moody’s, which would mean dropping out of the very influential Citibank World Government Bond Index. This would trigger automatic sales of between $7 billion and $10 billion in government bonds, according to Colin Coleman, head of Goldman Sachs’ South African office.
“We are tap-dancing around structural reforms,” he said.
“Do we really need to own 100% of Medupi? What if we sold 45% to the Chinese, that is already $5 billion right there,” he told the audience.
“There is no reason not to do that. You still have a controlling stake, you still operate and set the terms of the sale of power output.”
Coleman later told City Press he does not propose wholesale privatisation, but efficient use of assets to help resolve the current crisis in state-owned enterprises (SOEs) which are debt-ridden and pose the most obvious risk to the state’s finances during this period of low economic growth.
“I said that in the context of addressing the budget deficit and improving the balance sheet of the SOEs.”
Apart from Eskom, Transnet and other large SOEs have enormous assets as well as significant debt and state guarantees. State capture was, however, holding the country to ransom and inhibiting these kinds of larger structural reforms, Coleman said. “We cannot embark on wholesale structural reform while regulatory policy and state interventions are driven by personal, and sometimes corrupt, interests.” “The only way we are going to get growth is by putting the eight million unemployed to work. The only way to do that is business confidence. Government must create an environment of good governance and peace.” “Once we clean out the governance issues and have a single-minded focus on job creation – then we can get labour reforms, SOE reforms, cooperation on workplace training. You would have a much better basis for foreign and local investment in the country.” “South Africa is a small economy despite being very liquid. Over the past two years foreign portfolio flows into the stock exchange and bond market continued because they can get in and out easily. We have a very conducive global environment with massive funds looking for yield.” Portfolio flows can quickly be reversed and are not long-term direct investment, he said. Coleman says there is a “dam wall” of deferred investment decisions building up. “No one, domestically or globally, will make big investment decisions when one does not know if the rules will change.” He said the ANC elective conference in December will be a watershed – either saddling South Africa with a 10-year continuation of corrosive patronage networks or a return to more “Mandela-esque” policies. “The candidates are not formalised yet, but the constitutionalists and modernisers will take South Africa in the right direction,” Coleman said.
“If you did not have those index flows you would have more of a reaction to idiosyncratic developments such as we have seen here recently,” said Isabelle Mateos y Lago, a strategist for Blackrock, the world’s largest asset manager with about $5.4 trillion in managed assets.
“South Africa is part of a lot of indexes, so you’d need something really dramatic to have a lot of movement,” she said.
Her presentation at the summit made the case for investing in emerging market equities.
However, investing in the stock exchange of an “emerging market” does not necessarily mean investing in that country.
“One of the reasons we are so bullish on emerging markets is because the main companies are global companies. It is not your local companies servicing your domestic market,” Mateos y Lago told City Press.
“It is a nuanced message, when you say buy emerging market equities, it really means buy global corporates that are geared to benefit from a global growth story.”
“It is a different message from saying we love South African fundamentals right now. We don’t.”
Mateos y Lago said the conditions that underpin the so-called carry trade – capital from low-interest developed markets “seeking yield” in emerging markets – were likely to persist for the next decade.
“We think emerging market debt is a pretty good investment from a medium- to long-term perspective.”
This is relative to the bonds of developed countries “which yield very little if anything and have quite a bit of volatility and essentially no income”. Working age pop lation UnemployeO anO OisMo rageO EmployeO Not looking for work