If we want foreign flows we must change gear
Acouple of publications have highlighted the extent to which the taps have been turned off on a source of foreign cash that SA had increasingly relied on over the past decade — foreign investment in the growing stock of bonds the government has issued on the domestic market. SA has more than doubled its national debt since the financial crisis, mostly to finance rising current expenditure on public sector pay, and foreign bond market investors supplied a big chunk of the funding for this. Whereas many other emerging markets, including many of our African neighbours, have gone to international markets in recent years to raise hard-currency dollar or euro debt, SA’s government has continued to do 90% of its borrowing on the local market, in rands. But foreign investors bought much of this rand-denominated, local currency debt over the past decade, helping to finance the government’s growing debt burden and to plug the gap in SA’s balance of payments.
That has meant, as the Reserve Bank’s latest quarterly bulletin highlighted last month, that the nonresident holding of SA’s domestic local currency government bonds was as high as 42.3% of the government’s total debt in March 2018. That’s not entirely unusual among large emerging markets even if it is at the top end — in Mexico the ratio was 32%, in Russia 34% and in Turkey 20%. But SA stands out in terms of the extent to which government debt has jumped since 2010, from about 30% of GDP to 50%, with the foreign holding of the local currency debt almost doubling over the period. The Reserve Bank’s economists note that large nonresident holdings of that debt “create external vulnerability, as exogenous events … could trigger selloffs”. Those exogenous events have indeed come to pass recently as international investors lost their appetite for emerging-market risk and debt, selling off their bonds in large quantities. This is highlighted in a report from the Institute of International Finance (IIF), which expects that portfolio capital inflows to emerging markets, excluding China, will decline 30% this year, with portfolio debt flows falling by over 60%.
The Bank’s quarterly bulletin reports a dramatic decline in portfolio inflows in the second quarter of this year, with foreign purchases of SA’s debt instruments falling from R47bn to less than R4bn — and the IIF’s numbers suggest the full-year trend won’t be much better. Nor does the IIF see capital flows to emerging markets rising much next year either, and the implications for SA, which is one of the more vulnerable emerging markets because of its high fiscal and balance-of-payments deficits, are profound.
SA has tended to rely heavily on these more volatile foreign portfolio inflows into its bond and equity markets in recent years because it hasn’t been too good at attracting more stable, longer-term foreign direct investment. The government has been good at selling the South African story of well-developed, well-regulated financial markets; it’s been pathetic at providing the political and economic environment that would have made it attractive for foreigners to sink large amounts of long-term capital into greenfields projects that would have boosted capacity and economic growth and generated jobs.
Now the world has changed and without that stream of bond market inflows, the rand will remain under pressure. So too will the cost of government debt, which is already consuming more and more of the tax revenue the government raises. If SA wants to be less exposed to fickle foreign debt market investors in an unfriendly global environment, it needs to do more to deliver the environment that will attract more faithful real-money investors — those who will commit for the longer term. And as the World Bank suggested in its Africa’s Pulse report this week, the ambition must be to attract the kind of foreign capital that will boost the economy’s capacity to grow.
SA needs to deliver the environment that will attract more faithful real-money investors