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18 Nov 2011 06:48
Tighten your seat belts, “eurogeddon”, the implosion of the eurozone, is on our doorstep. As the eurozone teetered on the edge of an economic meltdown this week, policymakers worldwide were preparing to batten down the hatches.
In South Africa Reserve Bank governor Gill Marcus warned of “unthinkable consequences” as investors dumped eurozone bonds and borrowing costs for major economies such as Italy and Spain spiralled to unsustainable levels.
Rates on newly issued, five-year Italian debt exceeded 6.29% on Monday, the highest since June 1997.
Rates on Spanish debt also exceeded 6%.
Market uncertainty weighed on South Africa. Bond investors were seeking relatively high yields and growth prospects for an emerging economy, but the rand continued to be volatile, having traded in a range between R6.65 and R8.15 to the dollar since July. The rand was down 21.3% to the dollar at end-September, compared with a year earlier. But the JSE all-share index was at a near-record high of 32670 this week, as equities attracted foreign buyers.
The perversity of the financial repression - negative real interest rates - unfolding in Europe is that investors have ploughed into the South African bond market in a flight for yields.
“It’s crazy out there,” said Nedbank Capital head of flow sales Brigid Taylor. “Watching the movement on the screen — yes, it’s like Armageddon is coming. The financial repression is benefiting South Africa. We’ve seen massive inflows into our bond market. Investors worried about banks collapsing are buying government bonds in South Africa.”
South Africa has one of the most liquid markets. This year already net bond buying by foreigners has hit more than R54-billion compared with R60-billion last year. Halfway through November net purchases reached R4-billion.
But the rand, which is normally boosted by inflows into the bond market, has weakened.
“All market fundamentals have been thrown out. It’s scary. The rand is being completely influenced by the eurozone contagion,” said Taylor.
Marcus warned of the dangers to South Africa’s gross domestic product growth and of stagflation - rising costs and slow growth - indicating that the bank was ready to act appropriately should “eurogeddon” rear its head.
This implies further cuts to interest rates, currently at a 30-year low, to the detriment of rising inflation. South Africa’s GDP for 2011 has been revised downwards to 3.1%, but a eurozone collapse was not factored into this estimate.
The Americans, too, are in a panic. Federal Reserve officials are reportedly looking at a new round of stress tests on United States banks and treasury officials are said to be rounding up big US banks, demanding that they cut back exposure to Europe.
The British government is preparing contingencies for an “economic Armageddon” in a week when GDP was forecast to grow at just 1% for 2012 and the country’s unemployment rate hit a historic high of 8.3%, with the number of jobless increasing to 2.62-million for the quarter ending in September.
Authorities doubt that the proposed bailout for the eurozone, estimated at as much $6-trillion, will pull countries such as Greece, Italy, Portugal and Spain out of their debt hole. They also do not have faith in the new ruling technocrats’ ability to restore fiscal and political stability in Italy and Greece.
“It is debatable whether the partial solutions that have been devised are adequate to build a firebreak around Italy,” said Marcus. “There are no easy solutions to the debt problem.”
‘Where does it stop?’
An implosion of the eurozone would sideswipe the rand, as the local currency and the Mexican peso are traded as proxies by many funds for emerging market risk as a whole. Traders said risk aversion would be expressed by attacking the rand. While a weaker rand would boost South African exporters it poses inflation risks, which threaten to break the 6% target band.
South Africa is also exposed, in that Europe is our biggest export market.
It is unsustainable for the European Central Bank to print money without a clear exit strategy, said observers. “The problem is: where does it stop? That’s what the Americans and Zimbabwe did,” said a South African banker. “Once you start, it’s very hard to stop.
“The markets like it because the assets in nominal terms will rise in price, but it’s merely an adjustment for the weaker value of the currency. In real terms, when they sell the asset the central banks are still getting back worthless money. And the debt issue is still not solved.”
How exposed are South African banks to eurozone countries? In its financials Nedbank lists its exposure in terms of corporate loans to Portugal, Italy and Spain at about R2-billion. Standard Bank, Absa and Investec are also exposed, but have not released figures.
Absa deputy chief executive Louis von Zeuner described its exposure to European banks as modest.
“It is largely related to fully collateralised foreign exchange and interest rate hedging and with a very immaterial amount of contingent trade-finance risk,” Von Zeuner said. “Our key trading counterparts are the largest, most systemically important liquidity providers in France and Germany.” But he was worried about the domino effect of a eurozone collapse on local bank profit. “Europe remains an important trading partner for South African corporates and soft demand will affect local growth and corporate profitability,” he said.
FNB chief executive Michael Jordaan was more bullish. “Yes, our biggest vulnerability is exports, but we can offset that by directing exports to India and China. I’m not saying everything will be fine, but I am saying that it’s not fatal.
“If there is QE3 [quantitative easing], the risk is our currency could strengthen. The question is: Do we boost exporters who create jobs, at the expense of savers? Europe provides an important lesson of what not to do.”
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