Distance from West likely to hinder foreign investment
It’s that time of year again when the world’s economic and financial luminaries gather in Washington DC for the spring meetings of the IMF and World Bank. Like the larger annual meetings in October, the spring meetings come with a wealth of new reports and research.
They also come with speeches on the sidelines, one of which was delivered at the Peterson Institute this week by Reserve Bank governor Lesetja Kganyago. His comments helped shed light on why the Bank’s monetary policy committee (MPC) surprised the markets with a higher than expected 50 basis point interest rate hike in March. They gave a flavour of the global inflation and interest rate risks he and emerging market central bankers worry about.
That gives context to the concerns he and others in Washington have about emerging market capital flows and currencies. But the latest IMF reports add another layer of geopolitical risk to those concerns.
Foreign direct investment and portfolio investment flows into markets seen as “geopolitically distant” from the US and Europe may already be taking strain as global tensions rise, the IMF’s researchers find. That surely has to be a concern for SA, with its foreign policy stance.
The “geoeconomic fragmentation” the IMF flagged this week wasn’t on the MPC’s list in March, but external factors loomed large. Almost everyone in the market had expected no more than a 25 basis point hike, either because the US Federal Reserve opted for just 25 or because SA’s economic growth rate is now so low, or both. The main thing that seemed to explain the committee ’ s surprise was the rapid weakening of the rand exchange rate since it last met, and the risk that the markets might punish the rand further if the rate hike wasn’t even more aggressive than the Fed.
So was the committee managing the exchange rate, not inflation? Yes and no. Kganyago used his Washington outing to spell out his answer. The Bank doesn’t follow the Fed as such, he told Bloomberg, because the Fed’s actions tighten global financial conditions, which leads to a “realignment” of exchange rates, including the rand, which feeds through into SA’s inflation rate — and the Bank then has to adjust interest rates. The rand has been one of the worst-performing emerging market currencies. Its depreciation has meant SA’s inflation rate has not benefited from the fall in global oil and food prices.
But it’s not just the short-term external risks we have to worry about but a global financial environment that might be unfriendly over a longer time horizon.
Kganyago spoke in his Peterson lecture of a shift in global inflation from one paradigm to another. The supply-demand mismatches resulting from the post-Covid reopening and Russia’s invasion of Ukraine are starting to abate, but they are not resolved. Inflation is proving stickier than expected, and the inflation environment far more complicated and uncertain than it used to be.
Central bankers are grappling with whether labour market and supply chain dynamics have changed permanently, whether global prices still transmit to local inflation rates in the same way, and whether uncertainty itself feeds through to higher inflation expectations.
The real interest rates advanced economies may have to maintain to keep inflation in check may have to shift higher, as Kganyago sees it. That could mean emerging economies are at risk of being permanently more prone to currency depreciation and higher inflation. It will mean SA and other emerging markets will need to work much harder to attract capital, he said.
If the IMF is right they will have to work even harder if they are on the wrong side of UN General Assembly voting, in a world in which the US and Europe are talking “friendshoring” and “reshoring”, to shift supply chains to countries seen as friendly. Amid tensions between the US and China and over Russia’s invasion of Ukraine, the IMF’s latest World Economic Outlook sets out how global fragmentation is reshaping the geography of foreign direct investment (FDI).
These flows have slowed and are concentrated among “geopolitically aligned” countries. “Several emerging market and developing economies are vulnerable to FDI relocation given their reliance on FDI from geopolitically distant countries,” says the report. “Firms and policymakers are increasingly looking at strategies for moving production processes to trusted countries with aligned political preferences to make supply chains less vulnerable to geopolitical tensions.”
A study by the IMF finds early evidence of this fragmentation, with the shift in FDI already happening. Sub-Saharan Africa is one of the regions losing out. SA tends not to get that much FDI anyway, relying more on foreign portfolio flows into bond and equity markets. But on portfolio flows too, the IMF’s Financial Stability Report finds geopolitical tensions among major economies matters for cross-border capital allocation. Investors are starting to use divergent voting behaviour at the
A BADLY PERFORMING RAND IS NOT BEING HELPED BY LOAD-SHEDDING, ZERO GROWTH AND A GREYLISTING
UN as a proxy for who is on which side, especially when it comes to USChina tensions, but also on Russia and the Ukraine. The IMF’s research finds portfolio investment is also being routed away from countries seen as “geopolitically distant”.
Doom and gloom tend to be part of the package at the IMF, where leaders gather to identify the risks so they can try collectively to manage them. But SA is facing a global environment that could be unfriendly in multiple ways for some time to come — especially for a country with daily load-shedding, zero growth, poor credit ratings and a greylisting.
President Cyril Ramaphosa can rally foreign and local companies as he did at his investment conference. But he and SA will struggle for capital, especially for fixed investment, unless he addresses the electricity, transport, crime and regulatory issues deterring investors — as well as the foreign policy issues.