Borrowing costs could come under strain
The foreign capital inflows, which have helped finance South Africa's widening current account deficit and lower government's borrowing costs are not expected to continue at the record levels seen over the last year, particularly when it comes to local bonds, at a time when the economy remains heavily reliant on these flows.
This week, the Reserve Bank reported in its quarterly bulletin that the current account deficit for the fourth quarter of 2012 had come in at a higher than expected 6.5% of gross domestic product (GDP), and the deficit of the third quarter was revised up to 6.8%.
The rand slumped to below R9.20 to the dollar during trade on Tuesday, before recovering slightly in reaction to the news.
Arthur Kamp, an economist at Sanlam Investment Management, said the deficit was ultimately the result of the country's inability to save. National savings increased only fractionally from 12.7% of GDP to 12.8% between the third and fourth quarters of last year, according to the bulletin.
Kamp said the deficit had to be financed by foreign capital inflows and this was a reflection of the extent to which South Africa needed foreign savings to grow the economy. These flows were "very volatile", which restrained the ability to grow and had implications for currency weakness, he said.
Foreign capital flowing into the local bond market has helped to lower borrowing costs for the state. The treasury has noted that capital inflows coming off the back of a global search for higher yields improved emerging market prospects, and South Africa's inclusion in the Citi world government bond index had helped to boost demand for local bonds. This contributed to the funding costs on long-term, fixed-rate bonds falling by an average of 2.34 percentage points since 2010, the treasury said in the 2013 Budget Review.
The Reserve Bank put the total net purchases of local bonds by nonresidents at an all-time annual high of R88.6-billion in 2012 and, according to the Budget Review, international investors' holdings of local currency government debt rose to 35.9% last year, the first time they have exceeded the holdings by local pension funds.
But Thuto Shomang, chief director for assets and liabilities at the treasury, said it did not expect the same level of inflows seen in recent years, given the indications that the United States could slow quantitative easing.
Interest rates in developed countries were expected to remain low into 2014 said Shomang, supporting the continued hunt for yield, but it was expected to slow down.
The Budget Review made it clear that the government recognised the risks associated with increased investment from overseas "including currency volatility and the potential for rapid withdrawal of capital". Internal domestic factors have also come to the fore. Foreign investor confidence in South Africa was bruised at the end of last year by labour unrest in mining and agriculture and rating downgrades.
"Despite South Africa's inclusion in the Citi world government bond index, the acquisition of domestically issued bonds by nonresident investors contracted sharply in the fourth quarter of 2012," the Reserve Bank said in the bulletin.