The vicious cycle sabotaging SA’s investment markets

As the JSE serves as a barometer of economic health and investor sentiment, declining valuations signal a lack of confidence in the country’s financial stability, says the author. File

As the JSE serves as a barometer of economic health and investor sentiment, declining valuations signal a lack of confidence in the country’s financial stability, says the author. File

Published Oct 16, 2023


By Andrew Bahlmann

South Africa’s investment markets, particularly the JSE, are caught in a negative feedback loop driving foreign capital away and impairing the country’s economic growth prospects.

Capital flight from South Africa is not solely a result of the negative feedback loop within its own investment market but also influenced by global economic conditions. Developed markets, such as the US and Europe, have been offering better returns and stable investment opportunities, taking precedence over riskier, emerging markets like South Africa.

In recent years, South Africa has faced macroeconomic challenges that have contributed to the capital flight. The country’s sovereign credit rating has been downgraded by global rating agencies, which has diminished investor confidence. A deteriorating macro environment, including high levels of unemployment, political uncertainty, and policy inconsistency, has added to the concerns for foreign investors.

These factors, combined with a lacklustre economic performance, have made South Africa an unattractive investment destination compared to more stable and growing developed markets.

Of greater concern is the drop in commodity prices which had buoyed our markets last year disguising the fundamental weakness in our economy.

In addition, falling valuations and volumes on the JSE have a detrimental effect on merger and acquisition (M&A) activity in South Africa. As the JSE serves as a barometer of economic health and investor sentiment, declining valuations signal a lack of confidence in the country’s financial stability.

Foreign investors become increasingly hesitant to invest in South African companies, as they perceive higher risks and uncertainty in the market. This reduction in foreign capital inflows limits the availability of funds for M&A transactions, making it more challenging for companies to engage in strategic acquisitions and expand their operations.

Additionally, decreased market volumes indicate reduced liquidity, making it harder for buyers and sellers to find willing counterparts for M&A deals. Ultimately, this negative feedback loop hampers M&A activity, impeding the growth and development of South Africa’s economy.

The negative feedback loop plaguing South Africa’s investment market follows a pattern that saps the vitality of the JSE and alienates potential investors.

It commences with investors selling stocks on the JSE to buy more attractive investments elsewhere in the world for the reasons mentioned above. When investors perceive better opportunities elsewhere due to more favourable market conditions – for instance markets with no load shedding, South Africa’s greylisting, political unrest, introduction of restrictive market policies, threats to property ownership, and low domestic interest rates – or higher potential returns, they divest from South African entities. This divestment directly impacts the valuation of stocks traded on the JSE.

This results in capital flows out of South Africa as foreign investors redirect their capital away from South African markets, which severely undermines the capacity for domestic growth and stifles opportunities for local companies to raise funds.

This in turn results in lower stock valuations: with South Africa MSCI South Africa at 8.8x, compared to MSCI Emerging Markets at 11.6x, and the All Country World Index 15.4x (data by MSCI). This diminishes shareholder rewards for being listed.

The decline in demand – with a 40% fall in volumes reported by the JSE – adds to decreased valuations, which negatively impacts shareholders. Investors are less likely to see returns on their investment, discouraging them from further engaging with the JSE.

As stock valuations erode, companies struggle to justify the rising costs of remaining listed on the JSE. These mounting expenses, such as regulatory compliance fees and ongoing reporting requirements, disproportionately impact smaller companies, reducing profitability and deterring potential listings.

This leads to companies either refusing to list or deciding to delist, seeking alternative markets to enhance liquidity and attract capital, a trend which has been in ample evidence on the JSE in recent years. This all adds to an unattractive investment climate resulting from lower valuations and higher costs.

Therefore, South Africa’s market becomes less attractive to investors. The dwindling reputation further erodes the prospect of attracting foreign capital, exacerbating the cycle’s negative trajectory. This in turn prompts even more foreign investors to abandon the JSE, and the cycle begins all over again, where investors seek more amicable investment avenues outside South African borders.

Breaking the cycle

To reverse this harmful negative feedback loop and rejuvenate the investment market, South Africa must undertake bold strategies to instil investor confidence and attract foreign capital. These strategies should include:

Implementing regulatory reforms: Streamlining and simplifying regulatory frameworks will reduce the associated costs of listing on the JSE, attracting companies and maintaining investor confidence.

Enhancing market transparency: By increasing transparency in financial reporting and corporate governance, South Africa can bolster investor trust and encourage sustained investment.

Diversifying the economy: Invest in sectors other than traditional industries, such as mining and finance. By promoting sectors such as technology, renewable energy, and agriculture, South Africa can broaden investment opportunities and attract a more diverse investor base.

Fostering political stability: Ensuring political stability is essential in creating a conducive environment for investment. Addressing corruption, providing policy consistency, and promoting good governance will bolster investor confidence.

The negative feedback loop afflicting South African markets is a self-perpetuating cycle that hampers economic growth, discourages investment and fosters capital flight.

Andrew Bahlmann is the CEO: Corporate and Advisory, Deal Leaders International.