How unsafe is SA financially?

Over the last few months, emerging markets have faced headwinds in the form of tighter monetary policy in the US, renewed dollar strength, lower global economic growth, ongoing trade tension, a higher oil price and political uncertainty.

As global financial conditions tighten, country differentiation will be a key consideration for foreign investors, Dr Hendrik Nel, head of the financial stability department at the SA Reserve Bank (Sarb), said at the SA Institute of Financial Markets Regulatory Summit.

Investors will likely favour emerging markets with relatively favourable metrics and turn away from countries with a heavy reliance on external financing, high rates of foreign ownership of domestic bonds, high and rising levels of US dollar-denominated debt (especially of a short-term nature), significant twin deficits and rising debt levels, he said.

This raises the question: how vulnerable is South Africa, especially in light of its reliance on foreign capital? How does it compare to its emerging market peers?

The Institute of International Finance’s (IIF) emerging market scorecard measures how exposed emerging markets are to the US (especially in terms of debt), whether they have large deficits that must be financed and whether their assets are fairly valued. A level below zero highlights areas of concern.

Nel highlights some areas of vulnerability. South Africa must finance twin deficits, its foreign exchange reserves are fairly low and there are various challenges at state-owned enterprises.

But there are also some positives. South Africa does not have a high level of foreign denominated debt and its assets are fairly valued.

“It puts us among countries such as Ukraine, China, Argentina, Turkey, and others,” says Nel.

One potential challenge facing South Africa is the foreign ownership of assets. Foreign holdings of domestic local currency (rand-denominated) bonds is the highest among emerging markets at 41%.

Nel says in the case of a serious event like a downgrade, foreigners may be forced to sell bonds and South Africa may see quick outflows.

However, local investors have surplus capacity to buy more SA bonds, which means there will be willing buyers locally to take up rand-denominated bonds in the event of a sell-off by foreigners.