The rand might have been one of the world’s strongest currencies last year, but that has not slowed the rush by South African capital for the exit door.
Nothing captures the waning confidence in South Africa than the following graph which shows direct investment by SA companies abroad. Last year it hit roughly R70 billion on a rolling four month cumulative basis up to September 2016. Back in 2012 it was zero.
So what’s going on here?
Old Mutual Multi-Managers chief investment strategist Dave Mohr says the outflow of capital reflects ongoing nervousness over the domestic economy. A year ago, power outages, the “three finance ministers in a week” fiasco, and the threat of a credit downgrade to junk were among the issues that pushed the rand past R17 to the US dollar at one point.
Since then the rand has come back strongly, but corporate SA continues to vote with its feet, moving money abroad as fast as possible. Corporate owners are planning for the long term, spreading their assets outside of the country. The real motivation for this is the expectation of persistently low domestic growth – expected to be a shade over 1% in 2017. Money moves where the growth is, and that is outside of SA. The UK has been a particularly popular destination for companies such as Truworths, Brait, Woolworths and Steinhoff, all of which made UK acquisitions in recent years.
The exodus of capital from SA continues a trend that commenced two decades ago. Fifteen of the biggest companies on the JSE now earn more than half their revenue offshore. These include MTN, Bidvest, Steinhoff, Naspers, British American Tobacco, Glencore and BHP Billiton. It is clear that the strength of the rand last year did little to halt the exodus of capital.
“The strength of the rand last year reflected the improvement in commodity prices and the outperformance of emerging markets,” says Mohr. “Plus the rand was extremely bombed out after the collapse of 2016 and prior years. On a PPP (purchasing power parity) calculation the rand was historically weak as well – so lots of bad news was priced in to the currency.
“The threat of a downgrade will linger, but we can avoid it if we tighten the budget as expected and our growth surprises on the upside. With growth expectations extremely low it will not be difficult to surprise on the upside. Recent good rains and an expected fall in inflation could be the triggers for such an upside surprise.”
Mohr expects the rand to hold its ground this year, after strong gains in 2016.
The fact that the rand recovered some of its losses last year is small comfort for importers who have seen a near halving in currency value against the US dollar since 2011.
The second graph shows the JSE All Share index in rand and US dollar terms. In dollar terms, the JSE is unchanged since 2009, and has been declining steadily since 2014. The JSE All Share index is up 12% in rand terms over the 12 months to date, but is up 40% in US dollars, thanks in large part to a 20% improvement in the rand-US dollar exchange rate over the period. This made it one of the strongest performing bourses in the world last year in US dollar terms.
Over the longer term, however, a steadily weakening rand has flattered JSE rand-based returns, and packed muscle on an otherwise fragile frame. Few economists expect the rand the strengthen much this year, which makes it a challenging year for local stocks to match last year’s performance in US dollar terms. A steady rand, however, would allow rand-hedge stocks to come back into their own after a relatively poor performance in 2016.
The MSCI Emerging Markets index is up 13% over the last year, the FT100 is up 21%, lofted by a post-Brexit weakening in sterling.
This year should be better for emerging markets, helped by a stronger global economy with a reinvigorated US under President Donald Trump. There is a risk is that his political style causes major upheaval and he acts impulsively by hiking tariffs, but he has surrounded himself with sound business minds. That risk is already receding.
“This year the global economy should do better and the key question is how inflation is going to react, which in turn will determine the trend in interest rates. Deflation fears are fading fast and G7 bond yields should rise, particularly as Quantitative Easing is rolled back in the US. There are some that view this scenario as bad for emerging markets, but with global growth doing better emerging markets typically benefit,” says Mohr.
What will it take to reverse the capital exodus? Higher domestic growth for a start. That in turn would require more pro-growth policies, bigger infrastructural investment and an easing in labour regulations that stifle job creation.
Another hot button that will determine the fate of the world economy would be the pace at which US short rates rise, which they are expected to do this year.
“Will the hikes derail the long US recovery? We do not think so,” says Mohr.