Emerging markets, where the only constant is change...
mThis has been a turbulent year for South Africa. But the country is not alone.
ost of us are familiar with the expression “a change is as good as a holiday”, but considering the plethora of developments in South Africa over the past few months one might be tempted to disagree. In fact, they have possibly had quite the opposite effect. SA endured numerous changes in the first half of 2017 and, regrettably, they haven’t always been for the better. Much of the positivity and hope held by investors (and South Africans) in the beginning of the year has withered.
2017 held the promise of improved economic growth, and a decrease in the bulging unemployment rate. Instead, the first half of the year saw multiple downgrades, a still-struggling economy and a collapse in business confidence (now at the weakest level since the 2009 recession). In addition, the ever-changing political setting created much uncertainty, catalysed by questionable changes in leadership.
And regulatory changes have raised questions about political and economic policy.
Something to consider is why domestic financial assets barely reacted to this deluge of bad news despite softening commodity prices in recent months. The answer, unfortunately, lies not in local progress but rather in the support the country has received from external factors.
Even though the US Federal Reserve has been tightening monetary policy, the central bank is still behind the curve, which has buoyed foreign appetite for high-yielding emerging-market assets (such as the rand and South African bonds). This, coupled with US President Donald Trump’s promises on fiscal stimulus – which he has been slow to execute – has kept the dollar weaker and provided emerging markets with an environment in which to thrive. It is important to remember that this supportive market backdrop is unlikely to last and may expose SA’s already-fragile economy to factors such as the slowdown in China’s cyclical housing market, which will translate into weaker commodity prices.
External factors aside, hope springs eternal that a change in leadership (either through the impeachment of President Jacob Zuma or national elections), will reverse the economic underperformance of the past several years. The scenario of improved future economic governance has, to some extent, also been priced in by investors.
Emerging markets, no matter how similar, cannot be painted with the same brush. That said, there is value in drawing comparisons between countries that possess similar characteristics. Let’s take the example of the “Fragile Five” economies, consisting of Turkey, Brazil, India, SA and Indonesia. (The term “Fragile Five” was coined by a Morgan Stanley analyst in 2013 to represent emerging-market economies that had become too dependent on foreign investment to finance their growth.)
Apart from their vulnerability to tightening in global credit (and in particular Fed tightening), another shared feature was that all five countries ran large current account deficits. Therefore, the grouping can assist in illustrating how changes in leadership lead to changes in policy and as a result split the countries into two different categories (with the exception of Turkey).
The strongest reform momentum has taken place in India and Indonesia, and these economies are progressing well. In Indonesia, the government has already started to implement reforms to improve the investment climate and lift growth. These include expanding investment in public infrastructure, reducing the layers of government regulations and freeing up new areas of the economy to private investment. The government’s strategy to strengthen tax collection and broaden the tax base through tax reform is also likely to generate additional revenues to pay for priority government investment.
Brazil and SA’s slow (and sometimes absent) reform agendas have placed the two countries in a different position. Following the impeachment of former Brazilian President Dilma Rousseff last year, hopes of political change assisted in lifting the equity market and elevated optimism that the country would be lifted out of its worst recession since the 1930s. The anticipation and hope for transformation observed in Brazil is similar to what South Africans are experiencing today. One could argue that the example is too simplistic and ignores some of the fundamental social, political and economic differences between each country. This would be a fair point; however, the key theme of how leadership and a commitment to reform can change the fortunes of a country is a lesson that can be drawn here.
Most emerging markets continue to move in a positive direction with respect to politics, but autocrats, pseudodictators and corruption are ingredients that make these economies challenging to analyse. Recent events in Brazil (where President Michel Temer was charged with accepting bribes) showed just how unpredictable politically driven outperformance is and that it can reverse quickly and sharply. Politics is complicated and political risk is not unique to SA. This holds true for many other emerging markets. Elections and other political events, economic crises, and changing societal attitudes can disrupt the bestlaid plans in both emerging and advanced economies. ■
The ever-changing political setting created much uncertainty, catalysed by questionable changes in leadership.
Dilma Rousseff Former president of Brazil
Jacob Zuma President of South Africa