SA current account deficit increased to 9% of GDP in Q1 2008

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By Kevin Lings

In Q1 2008 South Africa recorded another shock current account deficit, equivalent to 9.0% of GDP. This compares with a deficit of 7.5% of GDP in Q4 2007 and 8.1% of GDP in Q3 2007. In value terms, the current account deficit widened to a record R194.7 billion from R157.7 billion in Q4 2007 (these are annualised numbers). For 2007 as a whole, the current account deficit was recorded at R145bn (7.3% of GDP).

Despite the sustained high commodity prices, SA’s exports reflected a relatively modest gain in Q1 2008, rising from R573 billion (annualised) in Q4 2007 to R614 billion in Q1 2008 – an increase of 7.2% q/q. In volume terms exports actually shrank by 7.2% between Q4 2007 and Q1 2008 (largely due to the impact of power outages on the mining sector). In contrast, imports rose from R600 billion (annualised) to R676 billion over the same time, an increase of 12.7%, largely due to increased oil, and machinery and equipment imports as well as the importation of a third submarine for the SA Navy. (Imports were up 3.4% in volume terms.) This means the trade deficit widened from R26.7 billion in Q4 2007 to a massive R61.4 billion in Q1 2008.

Importantly, as mentioned many times previously, the services account also remains under pressure. As a percentage of GDP the services account was recorded at 6.1% of GDP in Q1 2008. This compares with 6.2% in Q4 2008, and 5.5% in Q3 2007. It is clear from the charts attached that the services account has been widening significantly over the past few years, mostly due to an increase in net dividend outflows. In fact, in Q1 2008, the net dividend outflows amounted to 3.5% of GDP, exceeding the trade deficit, which was around 2.8% of GDP, in the quarter.

Given the increasingly large foreign ownership of South Africa’s equity market over the past four year, net dividend outflows from listed shares have risen noticeably. In addition, foreigners have a sizeable direct ownership of a number of unlisted companies. This means that net dividend outflows from South Africa have risen rapidly from a mere R10 billion, on an annualised basis, in Q1 2000 to a staggering R76.6 billion in Q1 2008.

Fortunately, although SA recorded its largest current account deficit, as a percentage of GDP, since 1982, foreign direct inflows were boosted in Q1 2008 by ICBC buying a 20% stake in STD Bank. This inflow accounted for most of the R40.6 billion increase in inward FDI. In contrast, portfolio investment declined by a net R20.6 billion in the quarter, while ‘other investment’ inflows increased by R34.3 billion. The ‘other investment’ inflows represent mainly non-resident rand and foreign currency deposits as well as short-term foreign loans by these banks. This is due to the increased interest rate differential between SA and many other, mainly developed, countries. (This is known as the carry trade.)

Looking forward, the current account is likely to improve, albeit modestly, during the remainder of 2008 on the back of an improvement in mining production and a slowdown in the domestic economy, and hence some import demand. However, looking further out, there is little doubt that South Africa’s import demand will rise noticeably in the years ahead as the country embarks on an extensive, and possibly unprecedented, infrastructural development programme. Consequently the trade account is set to remain in deficit for the foreseeable future. At the same time the dividend outflows, while perhaps boosted in recent years by exceptional corporate earnings, are also likely to remain relatively large over the next few years given that foreigners own around 25% of the listed shares on the JSE. Hopefully, the development of SA’s infrastructure, especially the port and rail infrastructure, will lead to some increase in exports in the years to come. Irrespective of the potential increase in exports, SA is set to run a current account deficit for many years. Ironically, this is actually crucial for the development of the country given that most of the key capital equipment needed to enhance the productive capacity of the country will have to be imported.

All of this is likely to raise significant concerns about the potential for further weakness in the currency. In the past few years the increased capital flows to South Africa have really been part of a dramatic increase in developed-market capital flows to emerging markets. These flows not only reflected the global search for yield, but also the improving economic fundamentals within most emerging markets. These included higher sustained growth, ongoing fiscal discipline and fiscal credibility, undervalued exchange rates, managed inflation rates, low foreign debt, improved credit ratings and a generally more friendly business environment. These are certainly the factors that benefited South Africa from 2003 to 2007. Unfortunately, the situation changed somewhat during the first half of 2008, and not just for South Africa. This change is reflected in the net portfolio outflows in Q1 2008. Fortunately, the ICBC/STD Bank deal clearly helped the balance of payments significantly in Q1 2008, but it would be naïve to believe that these types of deals can occur every quarter. This means that in the short term the country has become extremely reliant on the so-called ‘carry trade’, which really reflects the favourable interest rate differential between SA and Europe/US. This is far from ideal and represents a significant risk, especially if South Africa starts to reduce interest rates.

All of which implies that not only does the risk to the rand remain high, but the currency is also likely to remain relatively volatile. The situation also highlights how important it is that South Africa builds on the economic successes achieved in recent years, and that economic policy management remains sound for the foreseeable future.

stanlib-20-june-1.jpg

Source: Kevin Lings, Stanlib, June 19, 2008.

 

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