| LONDON, March 20
LONDON, March 20 South Africa faces the risk of
a huge exodus of foreign investors who are seeing the plunge in
the rand's value rapidly erode their stock and bond returns.
Africa's largest economy has sucked in huge investments in
the past two decades, but also has one of the world's biggest
balance of payments deficits - over 6 percent of its economy -
and depends almost fully on portfolio capital to plug the gap.
Now a combination of domestic policy fears and structural
problems along with a poor global trade and investment climate
is weighing heavily on the country's currency.
South African stocks and bonds have been a magnet for
foreigners who now own a third of the bond market and up to half
the equity free float in Johannesburg, which is home to
multinationals like SabMiller and Anglo-American and remains
close to record highs.
A record 93 billion rand ($10 billion) flooded into the
country last year, when South Africa became only the fourth
emerging economy to enter Citi's key global bond index.
But a ballooning deficit, sluggish 2-3 percent growth and
fears of erratic policy before 2014 elections are weighing
heavily on the rand which has lost 8 percent this year versus
the dollar and a fifth of its value since early-2012.
Investor exits tend to pick up when returns turn negative
and the rand is now perilously near the 9.30 per dollar rate,
that analysts at UBS reckon is the "pain threshold" at which
longer-term bond returns will tip into the red.
"You are seeing rand weakness eating away investors'
returns," says Manik Narain, who co-authored the UBS report.
He estimates the average rand exchange rate was 7.70 per
dollar over the past four years when most bond investors entered
the market. Cumulative returns during this time amounted to 20
percent according to UBS calculations.
"Another 1-2 percent loss on the rand could see them exit
positions altogether," Narain adds.
Rand weakness also ties the hands of the Reserve Bank of
South Africa (SARB), preventing it from offering the economy
vital monetary stimulus. The SARB left interest rates on hold
this week, noting the currency's propensity to "overshoot".
EXTERNAL AND DOMESTIC HEADWINDS
Undoubtedly some funds are in for the long run, irrespective
of currency swings. Others will also have put in hedges against
HSBC currency strategists are among those arguing that even
at current levels the rand can be hedged. They note that inflows
are continuing, albeit at a less robust pace than last year.
Stock exchange data indeed shows net year-to-date inflows of
7.3 and 14 billion rand respectively.
But Narain says that if a currency keeps depreciating, it
can become harder to roll over the hedge. And the rand's moves
are being driven by bad policy and worsening macro economics
rather than short-term problems or global issues.
"Indeed it is very possible also that despite sitting on
strong cumulative aggregate profits investors would choose to
stop adding to a market, or exit from it, if they believe there
are structural shifts for the worse in that economy," he says.
Chronic labour unrest has slashed mining and power output,
depressing corporate profits and economic growth.
Soaring wage costs have kept productivity weak - data from
the World Economic Forum for instance ranks South Africa 97th
out of 139 countries in terms of labour flexibility.
The global trade slowdown led by China and Europe, along
with waning demand for emerging markets, is making things worse.
STOCKS A SEPARATE STORY?
So how does this macro-economic gloom square with the fact
that the Johannesburg stock market is at record highs?
First, much of this gain is locally-driven. Unlike many
emerging markets, South Africa has a powerful local investor
base which is less likely to take fright from currency weakness.
A weak rand can in fact be a plus for export-focused mining
companies whose income is in dollars.
Second, Johannesburg-listed stocks are often the best way
for overseas investors to get exposure to fast-growth markets in
the rest of Africa.
Mark Livingston, investment director for emerging markets at
Fidelity Global Investments notes that the top 60 South African
firms derive about half their revenue from overseas. That
according to him, provides a natural hedge to currency weakness.
"Of all the emerging markets...South Africa stands head and
shoulders above the rest for the way companies are run on behalf
of shareholders," Livingston says.
Yet many are uneasy, noting the sluggish domestic demand
story which contrasts so starkly with other emerging peers.
And in dollars, equity returns this year are minus 8
percent, with only Cairo and Prague doing worse. A net 80
percent of global fund managers are underweight South African
stocks, Bank of America/Merrill Lynch's latest survey finds.
"Investors have lost progressively as the rand has fallen.
At the end of the day, a lot will depend on where the rand
goes," says John Lomax, head of emerging equity strategy at HSBC
who advises clients to underweight South African stocks.
"For that we need more political clarity and for the current
account to start turning around."
($1 = 9.2738 South African rand)
(Reporting by Sujata Rao; editing by Ron Askew)