DUBLIN – Ahead of Wednesday’s budget, it’s good to take a moment to consider the upside of South Africa. While the country has its troubles, in this article, The Wall Street Journal argues that South Africa is in a much stronger position than troubled peers like Turkey, Argentina, and Russia. While it’s true that there isn’t much fiscal space for investment and that the country has serious economic weaknesses, it also has strengths. It has a far more robust and functional democracy than Russia, sophisticated markets, and a reasonably diversified economy. There are plenty of downside risks, but for foreign investors, there’s enough upside to make South Africa worth a second look. – Felicity Duncan
Talking Markets: South Africa’s Appeal Outshines Other EM Countries
By Olga Cotaga
(The Wall Street Journal) For investors seeking opportunities in high-yielding emerging markets, South African assets may be worth a punt.
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South Africa has appeal where countries such as Turkey, Argentina or even Russia do not: more trustworthy politics, an independent central bank that can operate without political interference, and strong levels of foreign direct investment.
“South Africa is one of the markets that we see a lot of upside in,” said Diana Amoa, fixed income portfolio manager at J.P. Morgan Asset Management. It is one of the “markets where assets have been unfairly hit by emerging markets weakness.”
Like many other emerging market countries, South Africa has elevated debt and deficit levels, yet its high government bond yields have been attracting foreign investors despite the recent carnage in emerging markets. As the waters calm, South African assets continue to benefit.
High-yielding emerging market currencies are staging a comeback as U.S. Treasury yields retreat from a recent high. The South African rand is among the top performers so far this week, rising nearly 2% against the dollar, compared with a 1.3% rise for the Turkish lira and 1% for the Russian ruble.
South Africa’s 10-year government bond yield was last at around 9.24%, one of the highest in the area, not including Turkey and Argentina, which have been at the forefront of the emerging market turmoil since April.
The 9% yield “is hard to beat,” said Esther Law, emerging market debt fund manager at Amundi Asset Management. Yields rise as prices fall.
Investors demand a higher risk premium for holding South African bonds given the country’s high trade and fiscal deficits and high debt-to-GDP ratio. According to analysts at Societe Generale, South Africa has the second largest current account deficit after Turkey and its debt is more than 50% of the country’s gross domestic product.
However, South Africa doesn’t have the problems some other countries face, such as Russia’s risk of further U.S. sanctions, some investors say. Some think South Africa’s risks are worth taking.
We feel we are “compensated enough,” said Jon Jonsson, manager of the Global Bond Absolute Return Fund at Neuberger Berman. “There is no good or bad asset if the price is right.”
The South African rand has seen one of the biggest falls in 2018, losing about 20% of its value against the U.S. dollar. Since gaining from Cyril Ramaphosa’s appointment as president at the beginning of the year, the rand had depreciated on weaker-than-expected economic activity and slow reform progress. The South African economy entered recession in the second quarter of 2018 for the first time since 2009.
The decline in the rand, however, hasn’t stopped investors buying government bonds, even if denominated in the local currency. The price of hedging against such falls is still smaller than bond yields, which means investors still make a profit.
South Africa is “one of the few markets where you can still earn,” said Mrs Amoa, adding she prefers government debt to corporate credit.
The Bloomberg Barclays Emerging Markets South Africa index has been falling since April, when foreign investors started to sell emerging market assets. But the fall hasn’t been as steep as in the Bloomberg Barclays Emerging Markets Local Issue index.
Foreign direct investment in South Africa’s debt jumped to $2.21 billion in the second quarter of 2018 from $340 million in the first quarter, and nearly doubled compared with the same quarter in 2017, according to the Institute of International Finance. South Africa, together with Indonesia and the Czech Republic, have high levels of foreign ownership of domestic bonds, according to Societe Generale.
Still, having much of its debt financed by foreign investors makes South Africa vulnerable to investment outflows. Data from IIF show flows are volatile and portfolio investment in South Africa’s debt decreased substantially in the second quarter this year compared with the first quarter.
Moreover, the outlook for economic growth in emerging markets isn’t supportive enough to justify strong investment appetite. IIF’s emerging markets growth tracker fell to 4.1% in August on a three-month to three-month seasonally adjusted annual rate, the lowest since April 2016.
Amundi’s Mrs Law favors South Africa because of the change in political leadership, the central bank’s independence and because government debt offers good returns, but says it “will still be vulnerable.”
“South Africa may not be the best, but at least it’s not a deteriorating story.”
Write to Olga Cotaga at [email protected]
