The SA economy is vulnerable to large swings in foreign portfolio flows into and out of our debt and equity markets. It should be appreciated that the funds are attracted in part because they can be withdrawn at short notice, in what have proven to be liquid and, to a degree, resilient markets.
Furthermore the SA economy, given a lack of domestic savings (the result of a bias towards consumption spending to which government policies of redistribution and transformation contribute) cannot hope to sustain even modest growth without significant inflows of foreign savings, at the rate of 5% of GDP.
The difference between low savings, at about 14% of GDP, and higher rates of capital expenditure, running at about 19% of GDP is equal to the deficit on the current account of the balance of payments. South Africans, to maintain their standard of living, must hope that, on balance, capital continues to flow towards South Africa – for which we have to give up an increasing net flow of interest and dividend payments abroad. As a result of capital attracted over the years these payments now account for over half of the current account deficit.
These shocks may have little to do with South African events and much more to do with global events, for example global financial crises or decisions of the US Fed that impact on markets and yields in a global capital market, of which SA and other emerging markets are an integrated component of. Another factor may be the exchange controls that still apply to domestic portfolios. That the share of these portfolios held offshore may not exceed specified limits – 25 or 30 per cent – may mean that relatively favourable offshore market moves (perhaps the result of rand weakness) may require the partial repatriation of SA portfolios held abroad.
It needs to be appreciated that for every foreign seller or buyer of a listed security (unlike a new issue), there will be an equal and opposite domestic investor, attracted (or repelled), by lower (higher) prices and higher (lower) yields led by these foreign flows. These variable prices and yields act as one of the absorbers of the shocks that result in more or less foreign capital flowing in or out of the rand.
The other important shock absorber is the variability of the exchange value of the rand. A weaker rand may well lead to thoughts of a rand recovery, encouraging capital inflows while a stronger rand may well lead to the opposite.
We show, in the figures below, the link between these foreign net bond and equity market portfolio flows over a rolling 30 day period and the 30 day percentage move in the rand/US dollar since 2005. Rand weakness is represented by a positive number. The correlation between these two series is a negative (-0.40) over the period 2013-2014. Since early 2013, the worst 30 day period saw net outflows R1.382bn and the most favourable, net inflows of R759m. The best 30 day period for the rand saw it gain 12.5% and the worst was a depreciation of 5.6%.
Clearly these capital flows play a statistically significant impact on the value of the rand, though as clearly there are other forces acting on the currency market over any 30 day period. Foreign capital flowed out heavily towards the end of 2013 and then again in January 2014, enough to cause significant rand weakness. These flows have sinced turned positive and helped the rand to recover.
Ideally, capital flows to and from SA would be more predictable and the rand less volatile, to the benefit of SA based business enterprises. It would also make inflation and the direction of short and long term interest rates much more predictable, further reducing the risk of running an SA-based business. But there seems little chance of this, given the continued dependence of the economy on foreign capital and the shocks, both positive and negative, domestic and foreign, that will continue to affect flows of capital and the terms on which capital is made available.
The Reserve Bank has published its latest Financial Stability Report (FSR) (March 2014). Among its understandable concerns is this dependence of the SA economy on flows of portfolio capital into and out of the equity and bond markets.
The FSR shows how these flows in and out of the rand and shows how these flows were closely linked to much larger flows out of emerging markets generally:
The report states that “non-resident investors in South Africa were net sellers of R69 billion worth of domestic bonds and equities between October 2013 and March 2014. Over this period, a large part of of equity sales was concentrated in the mining and media sectors. Since the beginning of 2014, equity outflows from the banking sector have accounted for the largest proportion of equity outflows…………
The report goes on to state rather “…It would appear, however, that not all sale proceeds from the sell-off were transferred abroad”
This statement that indicates that not all the flow into and out of the rand from abroad can be accounted for by the statisticians and the banks that supply the record of foreign trade and financial transactions. The balance of payments accounts, that should sum to zero theoretically, are in reality balanced by what is often a very large item, known as Unrecorded Transactions. This line item was particularly large in Q4 2013, of R30.6bn, compared to recorded capital flows of R5.3bn. We show some of the the key balance of payments statistics below and the importance of unrecorded transactions in the scheme of things.
The reality is that the the SA balance of payments is somewhat mysterious; and so conclusions about the role of capital flows in the economy must be treated with some caution. The capital flows themselves may be under- or overestimated, as may exports or imports or even interest and dividend payments.
What however is fully known and recorded is what happens to the rand and security prices. Presumably the exchange rate and security prices act to equalise the supply and demand for the rand and securities denominated in rands on a continuous basis.
The important conclusion to draw is to let the markets act as the shock absorber, and for the monetary policy authorities to set their interest rates with the state of the domestic economy in mind. Monetary policy should aim at minimising the gap between actual and potential output. Interest rate stability and predictability is within the remit of monetary policy and should be an aim of policy. The influence of unpredictable exchange rates, led by unpredictable capital flows, on the rand and on inflation, are best ignored.