Investors still keen on SA bonds despite political tensions and weak economy

Despite ongoing political tensions and generally weak economic activity, capital flows into South Africa have held up surprisingly well this year, says David Hedley, the Institute of International Finance’s (IIF) chief economist for sub-Saharan Africa.

In the latest IIF report on Capital Flows to Emerging Markets, the group highlights that non-resident capital flows have rebounded to $1.1 trillion in 2017, surpassing the $1 trillion for the first time since 2014.

This marks a solid recovery to 4% of emerging market GDP from just 1.5% of GDP in 2015—though this is still well below the pre-crisis peak of 9% of GDP, the group said.

The IIF noted that nearly all components that make up capital flows have risen, led by the doubling of portfolio debt inflows to $242 billion and “other investment” (mostly banking flows) to $293 billion.

The exception to this trend was a fourth yearly decline in foreign direct investment flows, to $467 billion, likely due to the lagged impact of falling commodity prices, protectionism and onshoring.

The IIF noted that one reason for this year’s rebound has been a big drop in emerging market resident capital outflows, from over $1 trillion in 2016 to an estimated $770 billion.

This rebound was driven primarily by the large fall in resident capital outflows from China (by more than half, to just under $260 billion).

As a result, the IIF noted, net capital flows to emerging markets have swung from large net outflows in recent years to a small net inflow.

South Africa

South Africa, together with Nigeria, attracts the bulk of capital inflows in sub-Saharan Africa, IIF’s Hedley said, with South Africa in particular benefiting from a revival in the search for yield in emerging markets.

“Foreign portfolio investors are choosing to turn a blind eye (at least for the time being) to increased domestic risks,” Hedley said.

With yields over 8% and the exchange rate no longer seen as overvalued, non-residents have increased their holdings of government bonds, purchasing a net $3.1 billion in the first 7 months of 2017 alone, the economist noted.

“This helped drive up portfolio flows in H1 to $7.6 billion—a sharp contrast with FDI and other investment, which were much lower at a combined $1.8 billion,” he said.

According to Hedley, prospects for capital flows in SA going forward hinge both on global market conditions (risk appetite as well as the speed and magnitude of Fed tightening) and domestic developments.

“Politics will likely play a key role in this regard and much may depend on the outcome of the ANC National Conference in December when a new party leader will be elected and the direction of economic policy is determined.

“An early indication of the latter may come from October’s Medium Term Budget Policy Statement, the first major fiscal policy document drawn up under Minister Gigaba. Equally important will be the year-end credit rating reviews when attention will be focused on Moody’s to see whether it maintains its investment grade rating,” he said.

If Moody’s cuts South Africa to sub-investment grade, this might precipitate significant capital outflows if institutional investors are forced to wind down their positions for fiduciary reasons, he said.

Investors not so keen on SA stocks

When it comes to the JSE, the tune is a little different, with Bloomberg reporting that it is looking likely that South Africa will easily match the record outflow of R125.8 billion seen in the local stock exchange in 2016.

With one more quarter still left in the year, outflows from the JSE have already reached R90.5 billion, the group reported.

“While the benchmark index is hovering near a record after climbing 11 percent this year, the stocks aren’t an attractive prospect for foreigners who have to factor in a weakening rand on top of anemic growth, rich valuations and political risks,” it said.

Economists have long said that South Africa’s market is not an attractive prospect for foreign investors due to the slow economy and political uncertainty, but the high yields on government bonds have consistently been a welcome sight.

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Investors still keen on SA bonds despite political tensions and weak economy