Political events derail our economic gains
IN the past decade, developed-market economies have been increasingly characterised by low and, in some cases, negative interest rates. This has incentivised investors to hunt for better returns in high-yielding emerging markets such as South Africa.
In the wake of Brexit, there was a surge in portfolio inflows to emerging markets following a long period in which the asset class had been deeply unpopular.
According to the Institute of International Finance, portfolio flows to emerging markets increased to $24.8-billion (about R364-billion) in July from $13.3-billion in June, led by emerging Asia, up $19.1-billion, and Latin America, up $8.7-billion.
The catalyst was the market’s assessment that the additional risk to an already mediocre global growth environment would lead to even lower interest rates in developed economies. This made emerging assets, particularly bonds, which offered high yields and cheap exchange rates, very attractive.
The impact of the rise in emerging market inflows has been stronger currencies, lower government bond yields and higher equity prices.
There are fears that the surge in portfolio flows is papering over the cracks of still poor economic fundamentals, leaving a risk of a reversal in emerging-market risk assets if global investor sentiment changes. However, this view ignores nascent evidence of improvement.
The Chinese economy has stabilised, and commodity prices have increased partly as a result. Prospects in other large emerging economies are also improving. Brazil and Russia are exiting recession. India’s economy is accelerating and policy reforms such as implementing a national general sales tax, which will make doing business easier, will add to the momentum.
There are two main risks that could derail the turnaround in the emerging-market economic outlook.
First is a more hawkish US Fed. Last week, Janet Yellen said: “The case for an increase in the federal funds rate has strengthened in recent months.” This is on the back of a resilient US labour market. Moreover, recent Fed minutes suggest most committee members feel that low energy prices are waning, which should see US inflation edge up towards the 2% target near year-end, giving a green light for a rate hike. Federal fund futures prices — a proxy for interestrate expectations — show even odds of an interest rate hike in December.
The second risk to emerging economies would be another drop in Chinese economic growth, bringing commodity prices down with it. While the odds have declined, this remains a risk given the Chinese private sector’s indebtedness and its links to the banking system.
In the event of a return of risk aversion, most likely Fed-induced, investors will probably become more discerning about emerging economies. In a world in which US rates are rising, the battle to attract capital will increasingly be about our relative standing in the emergingmarket universe.
Unfortunately, we are moving from being a cleaner dirty shirt to a dirty shirt. And it’s not the economy whose income statement is adjusting appropriately, albeit painfully, that is to blame. Domestic spending growth is weak due to fiscal and monetary policy-imposed discipline and low credit uptake. But, importantly, when you spend less, you import less. So there is steep import compression, which has led to a cumulative trade surplus for the first seven months of the year of R17.4-billion. Our external vulnerability is declining.
We had been rewarded for this with positive investor sentiment, with the rand and the South African 10-year bond yield approaching post-Nenegate lows of R13.20 and 8.4% two weeks ago. However, domestic political events have again become the source of instability.
At the time of writing, the rand was trading at R14.67/$ and the 10year bond at 9%. The real-economy consequences of this will further hit business confidence, constraining real-economy private investment along with production and export growth and, ultimately, jobs.
Nxedlana is FNB’s chief economist