Investing in South Africa – risky business or not?

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There is no doubt that South Africa needs foreign investment to promote a healthy economy, strong financial markets and a stable currency. It is therefore important for us to understand what types of actions, especially those over which we have some measure of control, cause foreigners to change their perception of the risks pertaining to investing in South Africa.

There are, of course, also outside factors that the government does not control and which can influence foreigners’ perceptions of the risk attached to investing in South Africa.

One method of measuring the inferred risk of investing in South Africa is to look at the differential or gap between the long-term interest rate of South Africa and that of First World countries. The accompanying Graph A shows the spread (or gap) between South Africa’s 10-year bond yield versus that of the USA 10-year bond.

What is clearly evident in the graph is the fact that with each crisis, when the perceived risk of investing in South Africa increases, the bond yield spread increases. These crises can be either region or country specific, such as the 1976 Soweto uprising, President PW Botha’s Rubicon speech and the declaration of a state of emergency in 1986, or external such as the Asian crisis in 1997/1998 and the 9/11 terrorist attack in the USA. Risks also increase when a country’s financial affairs are not in order.

When global growth begins to decline and demand for commodities decreases, the risk of investing in emerging economies that are commodity based, such as that of South Africa, will also increase. This is evident in the graph where it shows the South African spread increasing significantly from 2007. The converse is also true as the risk declines as expectations for better global growth improve together with a resultant increase in commodity prices.

There is a very close inverse correlation between the bond yield spread of emerging economies and metal prices. When metal prices increase, the bond yield spread of emerging economies declines due to the prospects of improved growth for these economies from higher metal prices.

With South Africa being classified as an emerging economy, there is a close correlation between the bond yield spread of South Africa and emerging markets in general (see Graph B). However, there are times when South Africa’s spread moves out of line with that of other emerging economies. This occurred in 2006 when South Africa’s spread started increasing long before the spread of other emerging economies. This could be ascribed to the political turmoil in Zimbabwe, which foreigners viewed as negative for the whole region.

One can also see how the South African spread started to improve in 2008 after the demise of Lehman Brothers in the USA. The reason for this is the fact that it became evident that South African banks were not exposed to the credit crisis to the same extent as some other emerging economies.

What is important, however, is to determine what the prospects are going forward. Global economic growth and commodity prices could be bottoming – the odds are therefore in favour of risks declining rather than increasing. However, any further decline in the global economy will result in an increase in risks, with further capital outflows and a concomitant pressure on emerging-market currencies.

The upcoming election and pronouncements could result in South Africa’s risk rising relative to other emerging economies, as could any changes in fiscal and monetary policies.

Government bonds will in general not be a good asset class to be invested in when global growth begins to show signs of an improvement as this would mean rising yields and lower prices.

Graph A

26-mrt-a1.jpg

Source: Plexus Asset Management (based on data from I-net Bridge)

Graph B

26-mrt-a2.jpg

Source: Plexus Asset Management (based on data from I-net Bridge)

 

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