Since the last downgrade of South African debt and currency by Standard and Poor’s on November 25 last year the South African equity market was one of the best-performing equity markets globally.
Although the JSE is about 3percent down from the pre-downgrade level, the sharp appreciation of the rand against other currencies had a major effect on South Africans investing in equity markets offshore, as developed markets and emerging markets as measured by the MSCI World$ and MSCI Emerging Market$ indices are down by approximately 13percent in terms of the rand.
The South African bond market was a star performer among global bond markets since the credit rating cut by S&P. The risk premium on South African debt fell as the yield spread between the South African All Bond Index and the JP Morgan Global bond index narrowed by 1.4percent - at a time when inflationary pressures and strong global economic growth led to yield curves shifting higher, especially longer-dated yields.
A return to investment grade by the S&P and Fitch and a favourable assessment by Moody’s are probably priced into the South African bond and currency markets. So are the expectations that consumer and business confidence will improve further. From an investor’s point of view the question is where to from here. A return from tepid to solid economic growth will not occur overnight, as several headwinds lie ahead.
We cannot afford such a strong currency.
According to my estimates in the region of 20tons of gold representing some 20000 employees are produced by gold mines at a loss. If the rand strengthens by another 5percent while the price of gold in US dollars remains the same, another 10 to 20tons of gold will be mined at a loss and another 10000 jobs will be at stake.
In the case of platinum producers approximately 700000 to 800000 ounces of platinum is mined near break-even levels, with the risk that up to 50000 jobs may be lost should the rand appreciate by 5percent, while the underlying prices of the metals produced remain unchanged in terms of US dollars.
The multiplier effect - taking into account the dependants of those whose jobs are at risk as well as the impact on their local economies and the economy as a whole - is that in the region of 1million people’s lives are at risk to poverty. And the global economy is fast approaching the late cycle of the upswing and the signs of overheating are already there.
Long-term interest rates are rising strongly, commodity prices are rising strongly, business and consumer confidence are high, short-term interest rates are rising and production is on a strong upward trend. It should be remembered that foreign inflows are fickle, and when the tide turns the offshore investors are quick to exit the country.
According to World Bank and Unctad statistics South Africa had not experienced net foreign direct investment outflows since 1991, but inflows varied widely.
To ascertain the cash or near-cash deposits of foreign investors in South Africa the net foreign transactions as reported by the Bond Exchange of South Africa and net foreign transactions in equities were subtracted from the net foreign direct investment inflows into South Africa.
From that it was clear that while equities and bonds were sold on the local bourses the proceeds remained in the country.
The net inflows of cash and other direct investment is positively correlated with interest rate differentials between South Africa and developed economies such as the US and Eurozone.
Although Cyrilnomics is likely to improve consumer and business confidence the very tight budget is likely to dampen sentiment and economic growth.
The only tool left to help the economy along is a softer stance by the SA Reserve Bank’s monetary policy committee by cutting lending rates.