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Impact of capital flows on rand & JSE: Cees Bruggemans, consulting economist, FNB

What torrential capital flows into emerging markets mean for the rand and the JSE.

HILTON TARRANT: A good couple of SMSes have come through, one suggesting that David, you know very little about soccer and you should stick to the markets as far as Sundowns and Kaiser Chiefs are concerned.

DAVID SHAPIRO: [Laughs] I do know little about soccer. I’m an Arsenal supporter, that’s why I haven’t been watching for the last five years!.

HILTON TARRANT: Long-suffering, long-suffering! Let’s bring in Cees Bruggemans now, consulting economist at FNB. Cees you were privileged to listen to Carmen Reinhart, who is famous for her book This time is different, at the RMB fixed-income seminar last week, and really she helped put this all into perspective, the stuff that we have been talking about on this programme so far this evening. With this increase in liquidity you’ve got the Fed basically printing money in the US. There is this hunt for yield. You will find yield in emerging markets. And we’ve had these torrential capital inflows, as your column do eloquently put it this morning.
   How does this all fit together and how is this impacting the rand currently?

CEES BRUGGEMANS: Hi, Hilton. What struck me was where she put the emphasis when she said that. Yes, given this international backdrop and given then the capital flows that get under way, the receiving countries – especially small, emerging market countries – then tend to overheat. In other words, incoming capital causes the currency to become heavily overvalued and the mining growth exports. The government gets too easy access to money and tends to borrow too much. Households tend to have too much credit and you get housing booms and you get speculative booms on the stock market.
   These ultimately create their own excesses and at some point this causes foreigners to step out because the risks gets too big, Then you find in effect the capital flow reversing.
   But none of these things apply today to us. We had it in 2004, 2007, but since then we have actually struggled despite having all these capital inflows. But that doesn’t mean to say that we cannot have an impact ourselves.
   She specifically mentioned that at some point the Federal Reserve can be the trigger if it starts to ultimately withdraw its support. But her entire analysis suggests that this is still a long time away.
   But then she mentions a secondary possibility that other emerging markets – and she spoke about unidentified Asian countries that worry her – can have such overheating. And when you get an outflow going there and the currencies are weakening, that can ultimately then cause a contagion for us. And of course you remember ’98 in that respect.
   But for me the real one is ultimately what contribution we made from domestic sources to a situation where foreign investors take a look at us, don’t like the risks, and start to withdraw. And in the process, of course, causing a substantial weakening of the currency. That has got features that I think we see operating today.

HILTON TARRANT: Cees, bearing in mind these inflows that we have seen – and you do mention some of those risks that abound domestically – and this recent short-term rand weakness, we were in the kind of R8 to R8.50 range for quite some time and had a sudden and rather dramatic weakness all the way through the R9 level. I think at one point we went close to R9.20. To your mind what could be behind that?

CEES BRUGGEMANS: Over the past year we have seen three movements hanging around in the R7.50 to R8 range, then stepping up to the R8, R8.50 range, then stepping up for a third time to the R8.50 to R9 range, and now over the past week we suddenly have broken into the R9. And you ask in South Africa is this the fourth step, and are we now in a R9 to R9.50 range, and what is driving this?
     It seems to be a combination of the things. The rating agencies downgrading us and signalling unease about a couple of things. But then specifically our labour environment, our social environment, and sending the kind of signals of strikes, export losses, the current-account deficit basically doubling last year, and a lot of uncertainty as to actually on that front what still lies ahead this year. And that seems to be adding up to a degree where it puts the currency under pressure and effectively then foreigners not funding us as much as they were doing before.

HILTON TARRANT: Your column this morning uses the term “fragile vulnerability”. Are we as fragile and as vulnerable as those words would suggest?

CEES BRUGGEMANS: Yes, from the inside, not from the outside. In other words, the early part of the conversation. I do not think we are being endangered in the manner that she specifically analysed. But it is our own actions in the last 12 months and importantly what lies ahead this year that potentially could cause a rupture of some kind that we would have difficulty in foreseeing and understanding at this point.
   But the markets are very, very sensitive and that I think backs the kind of use of words like “fragile” and “vulnerabilities”. You see it happening in front of you.

HILTON TARRANT: Thanks to Cees Bruggemans. David, R9 to R9.50 – could that be the fourth step?

DAVID SHAPIRO: You know what bothers me? It’s that I think we’ve spoken about the movement out of bonds into equities. We are seeing massive flows of funds into equity emerging markets. it might have been our year last year when it came to equity markets. And what happens is in a active markets like this, when people are feeling buoyant, they tend to go for the frontier emerging markets – in other words, the less reliable ones such as, I don’t know, Mongolia, which is a growing country. I’m trying to think up names, names that we don’t normally associate with the equity environment. So you might find they are getting the money rather than us.
   But we are losing it on the bond market, and that could also create a bit of weakness with these flows, because we haven’t seen the same kind of energy into our equity market that we’ve seen before.

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