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SA’s long-term future is in its own hands

John Mauldin -an outside observer’s opinion on worrying trends.

I’ve been coming to Africa generally (some 15 countries) and South Africa in particular (pushing ten times) for about 25 years. I have a special place in my heart for South Africa, as I have watched it evolve from its pre-apartheid isolation into its rightful place as one of the BRICS.

I have made many friends here over the years. I remember my astonishment some four years ago driving from Johannesburg to Pretoria and seeing that what was once basically just barren country had been transformed into a thriving metropolis full of homes and industry.

Meanwhile, your wines have evolved to garner not only local renown but international fame, even as your natural treasures continue to draw visitors from the world over. On this trip I look forward to spending some true vacation time at Kruger National Park prior to my speaking tour sponsored by Glacier.

Four years ago when I visited South Africa, I wrote a very positive, upbeat letter about my observations and experiences. And since then South Africa has justified my optimism. However, the global economy upon which South Africa depends is in the midst of upheaval.

These things always seem to happen at inconvenient times. South Africa’s current heavy reliance on external financing means that its future increasingly depends on its place in the global economy at a dangerous time for emerging markets. The Reserve Bank of South Africa is calling 2014 the beginning of the next phase of the global financial crisis. The governor of the Central Bank of India, Raghuram Rajan, agreed with that analysis in a recent, rather ominous statement that garnered a lot of global attention.

South Africa struggles internally to deal with damaging declines in global metal prices, coupled with inelastic energy demand, confidence-destroying wage strikes, and uncomfortably high inflation that is paired with a persistent fiscal deficit above 5%. Developing-market investors are starting to actively question the outlook for economic growth and financial-market returns for all emerging markets, including South Africa.

While the recent improvements in Q4 2013 economic data would normally point to stronger real GDP growth, higher employment, and a potentially shrinking current account deficit, South Africa, along with many other emerging markets, such as Turkey, India, Indonesia, and Brazil, is finding itself right in the crosshairs of three worrying global trends:

  1. The US Federal Reserve’s ‘tapering’ of its quantitative easing programme, which threatens to deflect a big wave of capital flight away from emerging markets, including South Africa, by shrinking the real interest rate spread over ‘less risky’ developed markets.
  2. China’s economic slowdown, which is already driving global commodity prices lower as its demand for foreign raw materials falls… and which could spark a sudden flight to safe-haven assets and a collapse in global trade demand.
  3. The Eurozone’s steady march toward deflation and the rising risk that populist voters or a policy accident could give rise to another wave of sovereign panics, a collapse in Eurozone import demand, and a flight to safe-haven assets.

(I should note that these are not just cautions for emerging markets but for the global economy in general. The minds of every investor in the world should be laser-focused on the above three trends.)

With these risks looming, South Africa will have a very hard time maintaining a positive economic trajectory without improving export demand, stabilising cross-border capital flows, and implementing critical fiscal reforms that improve the country’s long-term growth prospects, even though those improvements might come at the cost of short-term weakness.

And considering the profound risks to international trade, the new era of volatility in FX flows, worryingly high inflation rates, and already rising yields on central government debt, the window for growth-supporting reforms may be closing fast. South Africa now finds itself at the mercy of dynamics it does not control (aside from getting its inflation and fiscal deficit under control).

In its Reserve Bank policy statement, Reserve Bank Governor Gill Marcus acknowledges that ‘the adjustment to the withdrawal of quantitative easing is likely to create significant short- to medium-term challenges’ and goes on to highlight the unforgiving riddle that every emerging-market central bank must answer for itself:

How to respond to a combination of [1] sharply depreciating currencies, [2] capital outflows, [3] slowing growth, [4] rising inflation, [5] significant current account and/or fiscal deficits, and [6] deteriorating confidence is posing policy challenges and very difficult trade-offs for many emerging markets.

Confronted with the clear and present danger that shocks from abroad could rapidly exacerbate external imbalances and spark a sudden collapse in their currencies, many emerging markets are raising their domestic interest rates in an attempt to shore up their currencies – at the expense of slowing growth or outright recession.

So what is RSA to do when they cannot forecast the timing of such shocks from abroad any better than I can? I must admit that it is somewhat comforting not to have the responsibility for acting on behalf of a nation that is already facing such challenges. Although Gill Marcus will probably do the bare minimum until the coming elections have passed (as central banks worldwide prefer to do), there is a very real risk that global events will force RSA into action that could take its target rate up by another 100 to 200 basis points. They know that if they fall behind the curve, it could mean rates will need to jump by more than 500 basis points at some point in the future.

At the end of the day, investors have no way of knowing and can hardly even anticipate what will happen in South Africa or across the global economy in the coming years. It may be tempting to anticipate the domestic macro timeline and position your investments accordingly, but there is ultimately no way of knowing how policymakers will behave or how other market participants will react to changing economic conditions. Now more than ever, uncertainty, instability and interconnectedness are the defining characteristics of global markets.

However, when the current situation is viewed through the prism of the past, South Africa is far better off than it was when I first began coming to your fair country. And we can hope that the world as a whole will be dramatically better off in ten and 20 years as a result of rising global growth and rapidly accelerating technological change. Nobody will want to go back to the ‘good old days’ of 2014 by the middle of the next decade.

Many of the diseases that plague humanity will have cures. Life expectancies will jump dramatically. Global growth will increase the demand for the natural resources and food, both of which South Africa has in abundance. Your natural ability to act as a gateway to all of Africa is a huge advantage. Your educated workforce, in combination with the natural diligence of the South African nation, gives you an edge in global economic competition.

The future of South Africa, like the future of all nations, is dominated by the political choices you make. So while in the short term South Africa must react to drastically shifting global economic realities, in the long term your future is in your own hands.

This article was first published on Glacier by Sanlam here and republished with permission.

John Mauldin is Chairman of Mauldin Economics

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