One thing working well in South Africa

Most recently, this has seen foreign investors pump money into South Africa’s bond market, with local government debt proving attractive. 

While this is partly driven by the high yield offered on South Africa’s government debt at just below 10%, it is also because of the reputation of the country’s local capital markets. 

These capital markets have also ensured that South Africa has avoided the grave mistake that many emerging markets are forced into when they raise debt in foreign currencies. 

South Africa’s debt is still overwhelmingly rand-denominated, and the country’s capital markets are the main reason why the government has been able to raise debt in the local currency. 

This ensures the government avoids the pitfalls of many emerging markets, such as being unable to convert their currency and pay off foreign debts, resulting in a financial crisis and political turmoil. 

Morningstar’s chief investment officer for Europe, the Middle East, and Africa, Mike Coop, explained to Daily Investor why foreign investors look for emerging market exposure through South Africa’s capital markets. 

The local currency often trades as a proxy for sentiment towards emerging markets due to the well-regulated and liquid nature of South Africa’s financial system. 

“There are many indicators that the local economy is not working well. But what is the case is that South Africa has a really well-developed and long-term tradition around capital markets,” Coop said. 

“This tradition around investing, around financial institutions and banking, is the legacy of Anglo-Saxon roots and the way in which the local economy has developed.” 

Coop explained that this gives investors greater certainty around the ability to get money into and out of the country. 

It also provides certainty that adequate safeguards are in place in the local market to protect investors and ensure their money is safe. 

Another key factor is the liquidity in the currency market, which enables investors to be confident that they can invest comfortably in South African assets without fear that they cannot repatriate their returns. 

Reserve Bank is the saving grace

The Reserve Bank is the main reason South Africa’s capital markets are so respected, with the National Treasury also playing a major role. 

The Reserve Bank is globally respected for its ability to manage inflation in an emerging market, despite a weakening currency. 

This, again, provides certainty for investors that the rands they invest in will not become worthless in a short period of time.

“Inflation has been problematic around the world, but South Africa’s central bank took it on the chin early in terms of raising rates and tightening monetary policy in the aftermath of the pandemic,” Coop said. 

This was effectively short-term pain for long-term gain, with the Reserve Bank able to keep a lid on inflation and be in a position to cut rates with price increases under control. 

“The central bank is independent and it is generally seen to be conducting its mandate well, albeit possibly a bit on the conservative side, which might give scope for further rate cuts,” Coop said. 

“So, there are a number of factors here that indicate that things are better than they have been for a while in South Africa and, in comparison to global challenges, investors could relook at South African assets.”

Because of South Africa’s well-regulated and managed financial markets, the country has managed to avoid raising a significant amount of debt in foreign currency. 

In this way, the country dodged a bullet that caused the collapse of many emerging market economies and fellow African states. 

Typically, these countries cannot raise debt in their own currency as they have shallow capital markets and an unsophisticated local financial system. 

Raising debt in foreign currency exposes a country to significant risk, such as foreign exchange rate fluctuations, which often result in the debt burden becoming unsustainable.

Around 13% of South Africa’s government debt is held in foreign currencies, with much of it being in US dollars, euros, or with the International Monetary Fund.

This is extremely low compared to many other African countries and emerging markets, which do not have the luxury of raising debt in their own currency.

“The foreign exchange reserves held by the Reserve Bank are more than sufficient to pay off South Africa’s foreign debt,” renowned economist Dawie Roodt said. 

“The one thing the ANC did not break was the local financial system by going on a borrowing binge overseas and raising debt in foreign currencies.” 

“The reason why they did not raise too much money abroad was that we have this well-developed financial system and markets in South Africa. It was relatively easy for them to borrow money in South Africa.”

Issued on Daily Investor by Shaun Jacobs | https://dailyinvestor.com/finance/101602/one-thing-working-well-in-south-africa/