After many years as a favoured destination for emerging market investors, South Africa’s fundamentals now resemble those that precipitated Brazil’s downfall, says Hermes Emerging Markets Portfolio Manager, Elena Tedesco.
South Africa used to exhibit the hallmarks of a strong emerging market: stable politics, sustainable growth, good management teams at companies plus a ticket to the last frontier: corporate Africa. Times have changed. Its national politics are becoming increasingly messy, growth has declined, corruption has increased and its structural economic problems remain largely unresolved.
Although apartheid ended more than 20 years ago, South Africa still suffers from the emerging world’s highest Gini coefficient, indicating severe income inequality, which is compounded by the largest unemployment rate and worst incidence of HIV. The creation of Black Economic Empowerment structures has not achieved a balanced redistribution of wealth while also increasing the fear of dilution among investors, particularly those exposed to the mining sector.
Figure 1. One-quarter of South Africa’s working-age population is unemployed
Investors are concerned
South Africa is seen by some as a social time bomb and many locals prefer to invest abroad. Corruption has spread beyond state-owned enterprises and seems to be infecting the highest echelons of politics. Attempts to re-establish proper standards are prompting investigations of the reformers themselves, such as the one recently started by the Directorate for Priority Crime Investigation against new Finance Minister Pravin Gordhan. Investors have witnessed these strong-arm tactics in countries such as Russia, Venezuela, Turkey and China, but are not used to seeing them in South Africa.
The country risks losing its investment-grade credit rating due to its twin deficits and slowing growth. At present, the risk of a balance of payments crisis is low as the country has little foreign-currency debt and a favourable maturity structure. However, as foreign investors own a considerable level of the local debt and stock markets, portfolio flows are vital to funding the current-account deficit – another situation that ratings agencies will view in a negative light.
During our last visit to South Africa, we learned that the upcoming municipal elections will be a battleground not only for the African National Congress (ANC) and its rivals, but also for the various factions emerging within the party itself. Pro-market ANC members vie with populists keen on stopping the rise of attention-grabbing rival Julius Malema and his Economic Freedom Fighters, as well as friends and family of President Jacob Zuma and his son Duduzane. We left the country disillusioned and maintain an underweight exposure. There is a chance that a credit-rating downgrade can be avoided, but that may require a change in leadership or at least in style.
Hope for change
Following our visit, a balanced budget from Minister Gordhan increased the chance that the pro-market faction within the ANC will prevail, but it is still a very open contest. Should the ANC score poorly at the upcoming municipal elections, Zuma and his party members may get the blame. A change in leadership could be positive for the rand and for the market, depending on who ultimately comes to power. With the ANC national conference scheduled for December 2017 and Zuma’s presidential term officially ending in 2019, change is possible but might take some time.
The market is currently wondering if South Africa will become the next Brazil. It is unlikely that the toxic mix of fraught politics, slow economic growth, fiscal laxity and a collapsing currency will materialise to the extent we have witnessed in Brazil. However, these fears are real, but South Africa has time to get back on track and markets are giving it the benefit of the doubt – for now.
Figure 2. Not as bad as Brazil…yet
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