As foreign investors flee emerging markets, South Africa might not have the foreign-currency inflows to pay for our imports.
Figures released this week show that last year South Africa had a current account deficit of R157-billion, of which R110-billion was funded by portfolio inflows into equities and bonds. This year to date, foreigners have been net sellers of South African equities and bonds to the value of R11,6-billion.
The South African Reserve Bank currently holds enough foreign-exchange reserves to cover five months of imports. This explains why the rand has gone into free fall, down 20% this year.
According to Nedbank Capital, when compared with the basket of currencies made up of our trading partners, the rand is at its weakest level since the 2001 currency crisis.
“If we can’t fund out current-account deficit, we will have to borrow the money offshore,” says Ian Cruickshanks, economic analyst at Nedbank Capital, who adds that Eskom, which is hoping to fund its infrastructure projects through issuing local bonds, might also have to go abroad for funding.
This at a time when there is a global liquidity crisis and little appetite for debt.
Although the fallout in the US around the sub-prime crisis has little to do with the South African economy, with the big four South African banks having no exposure to subprime, the impact of the US financial crisis on global liquidity and the resulting increase in risk aversion could have a detrimental effect on South Africa.
Last week, the Federal Reserve Bank was forced to bail out Bear Stearns, the fifth-largest US investment bank. This is the first time since the Great Depression that the Fed has put a programme together to provide cash to investment banks.
Measures to stem the crisis included a $30-billion funding guarantee to JP Morgan, which bought Bear Stearns for $2 a share, for the beleaguered bank’s illiquid assets.
The Fed also cut the discount rate, the rate it lends directly to banks, by 25 basis points. Earlier in the week, prior to the collapse of Bear Stearns, the Fed had already injected $200-billion into the market and, on Tuesday, in a further attempt to bring liquidity to the market, the Fed cut interest rates by 75 basis points.
If these measures fail to bring calm to panicked global investors or prevent further runs on US banks, South Africa might find itself out in the cold.
This liquidity crisis has come at a critical time for South Africa, which is facing its own set of economic woes.
According to Cruickshanks, foreigners have been attracted by South Africa’s growth prospects, but electricity disruptions, political uncertainty, high interest rates, high inflation and our high current-account deficit all jeopardise the growth story.
Although certainly not a write-off as an emerging market story, South Africa has become less attractive at the same time that global investors are moving to perceived safe havens such as US treasuries and German government bonds. If world markets recover and inflows into South Africa resume, albeit at lower rates than last year, South Africa should weather the storm. But, if our balance-of-payment constraints increase because of drastically lower portfolio flows, then South Africa will face an even weaker currency.
As FNB economist Cees Bruggemans points out, the good news is that our two precious metals, gold and platinum, with other rising commodity export prices, are effectively paying for our rising oil import costs. This was evident in the reduction of the current account deficit in the fourth quarter when the trade deficit almost halved to R26,7-billion, compared with R52-billion in the third quarter.
Unlike other parts of the emerging and rich world which don’t have such built-in hedges, we have a natural protection shielding us. For this reason the JSE, despite sell-offs by foreigners, is one of the best-performing markets this year so far as resource companies benefit from the weaker rand and high commodity prices.
What might be good for resource stocks, however, is very bad news for the local economy. As a result we have seen banks and retail shares plummeting. The financial and industrial index is down nearly 10% this year so far, compared with the resources index which is up 22% for the year. The JSE started the year at 28 958 and was hovering earlier this week about the 30 000 level.
A very weak currency means imported inflation. Again the timing is bad as inflation is already well out of the control of the South African Reserve Bank and expected to break 9% next month.
Yet, despite higher export prices, it is not enough to offset our imports. As a country in the middle of an infrastructure boom, we need to import most of our machinery.
These are seen as “healthy” imports, as opposed to the consumption-driven imports we saw over the past few years which are an indication of consumer spending.
Higher imported costs, including oil, mean higher inflation and this means our interest rates will stay higher for longer and put further pressure on our economy.
South Africa has much riding on the Fed’s ability to stave off a financial meltdown in the US.