f we do not fix Eskom, we will not have enough power to support higher GDP growth that is essential to bringing our socio-economic ills under control. Photo: Mike Hutchings/Reuters
f we do not fix Eskom, we will not have enough power to support higher GDP growth that is essential to bringing our socio-economic ills under control. Photo: Mike Hutchings/Reuters

Investment: Not all doom and gloom for SA investors

By David Gracey Time of article published Dec 11, 2019

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JOHANNESBURG – South Africa may have its problems, but it isn’t prey to the persistently low-interest-rate environment that prevails in the developed world. In fact, we remain an attractive investment destination, red flags notwithstanding.

South Africa has been in the news for all the wrong reasons, and we know what they are: the parlous state of Eskom and other state-owned entities, low gross domestic product (GDP) growth, policy uncertainty, the threat of a downgrade by Moody’s.

We also know that if we do not fix Eskom, we will not have enough power to support higher GDP growth that is essential to bringing our socio-economic ills under control. Urgent solutions are needed, and time is running out to fix the economy. Yet it’s not all doom and gloom, as we often predict.

In its report, Investment decisions: Why South Africa, and why now? Forward-looking scenarios for the Ramaphosa presidency (2018-22), PricewaterhouseCoopers pointed out that there was a 75 percent probability of improved economic and political outcomes in the country over the next five years, compared to the preceding several years. This is worth bearing in mind; our potential junk status notwithstanding.

It seems, too, that we have something to offer foreign investors that they can’t necessarily get elsewhere. Our high interest rate environment, together with low inflation, has made us fairly interesting, especially as we’ve managed to achieve real returns from cash and bonds. Our assets appear valuable, if undervalued, and our bonds are in demand as the quest for interest intensifies. Local investors should capitalise on this as well.

The yield differential between us and the rest of the world buys us a little bit of time, and a possible downgrade has already been priced into the cost anyway.

Yields on government bonds from various countries are below zero, but in South Africa, we’ve seen a yield of 8.4 percent over 10 years. Even after inflation, the yield is almost 4 percent compared to -3 percent in the Netherlands.

European bonds remain expensive, and there’s a huge amount of inflation in sovereign balance sheets in Europe, Asia and the US, with debt levels spiralling.

In the US, President Donald Trump promised to reduce the national debt within a few years, but it’s currently standing at $22 trillion (R322trln) – the highest it’s ever been.

Debt isn’t that much of a problem when interest rates are at zero, but if they climb by 1 percent or more then debt will quickly become a major issue.

Although a global slowdown may not be on the cards, investors aren’t expecting phenomenal growth nor are they anticipating that the low interest-rate environment will change any time soon.

Within the next couple of years, they won’t be able to find decent yield without going into risky assets. But South Africa offers alternatives, which can work to our benefit – something easy to forget amid the doom and gloom of what remains a diabolical situation here at home.

The US-China trade war may not be resolved in the short term, with Trump saying he is not ready to start phasing out tariffs. It’s undeniable that better relations between the US and China would be to everyone’s benefit – but just how bad can the trade war get?

There’s a slim chance that an accelerating trade war would see China retaliating by threatening not to purchase US bonds any more but that would be an unprecedented event in global economics and it seems unlikely to occur.

Brexit remains an uncertainty, it is unlikely that a hard Brexit will be on the cards. A hard Brexit would not serve anyone. The UK’s election tomorrow may stop Brexit in its tracks, but if it doesn’t, we’re more likely to see a soft Brexit.

The UK market is under-performing, however, and investors are put off by the risk premium on UK assets and the fact that the pound is on something of a wild ride.

At home, we will have to keep an eye on Eskom, the albatross around our neck. The power utility remains in a vulnerable state, although France has put the possibility of a multi-partner loan on the table to help with restructuring.

According to Akinwumi Adesina, president of the African Development Bank, Eskom is “too big to fail”. But shifting Eskom’s debt to the sovereign balance sheet could make the company’s finances sustainable.

The only problem is debt-to-GDP ratio would shoot up to about 66 percent of GDP, which would precipitate a credit downgrade. It would, however, make Eskom more efficient – as would retrenchments and reductions in salaries. It should also try to claw back some of the stolen money.

We need Eskom to work as efficiently as possible until independent power producers can step in to assist. This is the story in South Africa for the next 10 years, and it’s not a great one, but we do have a chance to extricate ourselves, and we do remain an attractive investment destination.

The fact that foreign direct investment into South Africa grew last year, according to a UN report, underscores the fact that we don’t always see ourselves as others see us.

There’s a lesson in that.

David Gracey is Investec’s head of foreign exchange and fixed income trading.


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