SA economy shines in the gloom

By MOIN SIDDIQI

Despite exceptionally sound economic fundamentals and a robust performance by the Johannesburg Securities Exchange, the South African rand continues to suffer from a lack of confidence by investors. In times of global turmoil, it’s practically impossible for even well-managed markets to avoid the ?contagion’ effect. Tito Mboweni, the Reserve Bank’s governor told the Times of London: ?We are not entirely able to escape the jitters about emerging markets. But our macroeconomic policy foundation - fiscal, monetary and trade is much stronger now than it was. We are not doing badly at all.?

Attractive local equities

Whilst the rand is still trying to rebound from its historical low (R8.47) against the US dollar a month ago, the Johannesburg Securities Exchange (which ranks among the top 20 global exchanges) has been exceptionally resilient. The market’s continuing stability, coupled to the bearish sentiment prevailing in major developed markets, especially New York and Tokyo, is encouraging a gradual return of substantial SA flight capital. David Shapiro, managing director of Societe Generale Securities in Johannesburg, says: ?Sentiment is improving and money is flowing back, because the JSE has performed well and stocks are cheap.?

In late August, the JSE All-Share index fell by 1.4% in dollar terms. But this drop was modest compared with hefty falls in Turkey (-48.5%), Brazil (-36%), Egypt (-31.2%), Poland (-31%), Hong Kong (-25.5%), Czech Republic (-22.6%) and Argentina (-22%).

The recent upgrade in SA’s weighting in the Morgan Stanley Capital International (MSCI) index from 11% to 15.3%, should lead to more foreign portfolio investments. The country’s investment-grade status can facilitate capital inflows from large US and European mutual and pension funds. Dedicated investors should therefore consider increasing their weighting in SA stocks, which could offer a possible defensive play against worsening global emerging market woes.

In the near-term, however, the same old problems may continue to prevent powerful market rallies: disappointing economic growth in 2001, projected by Nedcor Bank at 2%, and Merrill Lynch at 2.8%, falling below the government’s forecast of 3%; lacklustre corporate earnings and low market liquidity due to the continuing dominance by a few giant stocks.

The top-five stocks quoted on the JSE are Anglo American plc, Richemont Securities, BHP Billiton plc, Old Mutual plc and Anglo Platinum. Anglo American alone represents between 12-15% of the market’s total capitalisation.

The battered rand

The country’s economic fundamentals, like the declining budget deficit (1.9% of gross domestic product in fiscal year 2000/01), improving external accounts and more transparent government policies, are broadly supportive of the rand. In the real world, however, foreign exchange markets are governed more by investor sentiment than by pure fundamentals.

The rand is unfairly being hit by an over-valued dollar and the ongoing volatility of emerging markets’ currencies, mainly the Turkish lira, Argentinean peso and Brazilian real. Nedcor Bank comments: ?The government has reduced its deficit and monetary policy is tight, which should help to keep the rand fairly stable amid the tempest in emerging markets.? The bank estimates that on purchasing power parity, the currency is presently undervalued by 20% versus the greenback.

The rand is also vulnerable to regional financial and political instabilities. Linah Mohohlo, the governor of Botswana’s Central Bank, said the Zimbabwean crisis has had a direct effect on the depreciation of the rand and was discouraging foreign investments across the region. The SA economy, accounting for 70% of southern Africa’s output, stands to lose out most. Tito Mboweni has also warned that ?the wheels have come off? in Zimbabwe and land problems have fuelled the rand’s precipitous fall.

Speculative selling a problem

The South African government is unhappy about offshore speculators’ aggressive ?short-selling’ strategy. One effective measure to counter speculative selling was put forward by Standard Bank’s chief economist, Iraj Abedian. He suggested that the government could penalise financial institutions taking long positions against the rand by barring them from government-advisory work, especially in the lucrative fee-earnings businesses of privatisations and Euro-bond issues.

Some members of the ruling African National Congress add that another reason for the trickle of foreign investment into SA is because white investors simply cannot overcome their deep-rooted prejudice against ?a black-run economy’, even if it is prudently managed!

In coming months, the rand could find some support from a recovering euro against the dollar. But after averaging 6.94:$1 last year, the rand is expected to trade well above R8.2:$1 in the fourth-quarter and early 2002. JP Morgan Chase, the US investment bank, projects a 12-month rand/dollar rate of R8.38.

So far, the currency’s trade-weighted value, (a measure of the rand’s value against SA’s major trading partners) remains largely stable.

On the positive side, a softer rand boosts the price competitiveness of SA’s manufactured exports.

More rate cuts in store?

Following the global trends, the Reserve Bank is on a sustained path of monetary easing. The benchmark ?repo rate’ (currently 11%) could be reduced by a further 1-2% by year-end, in order to stimulate subdued growth. Thus the prime lending rate may drop to 11.5 - 12.5%, which is still high by international standards. In Britain, the bank rate stands at 5%.

During the past few months, capital flight into SA government bonds has reduced yields on rand-denominated debt to 10.4%, the lowest in 20 years. When long-term interest rates fall, the prices of underlying bond portfolios rise. This in turn, generates capital gains for potential investors. Conversely, when bond yields are rising, as in August 1998, hitting a record high of 20%, bond prices fall sharply. Today, bond investors are increasingly confident that the independent central bank will meet its 2002 inflation target of between 3 and 3.6%.

There is plenty of excess liquidity which can provide a powerful stimulus for the markets. According to Investec Investment Banking, SA institutional fund assets total a staggering R1.4 trillion ($175bn). So if investors decide to inject 10-20% of their assets into domestic equities and bonds, that is a potential flow of R140-R280bn ($17.5-$35bn).

The general outlook for SA is better than that for any other emerging economy, says Trevor Manuel, the Finance Minister. True, the country’s international credit worthiness remains sound. This reflects economic sophistication, sustained political stability and manageable external debt ($25.4bn), compared, for example, to Argentine’s huge debt of $130bn. Moreover, there is no Asian, or South American-style rampant corruption. Corporate SA is, in effect, the most efficient and transparent of the emerging markets.

The economy looks set to outperform many Asian and South American countries. Indeed, Argentina, Taiwan and Singapore have recently dipped into recession because of plunging exports.

The equity market - underpinned by low valuations, with the price/earnings ratio down to 10.5, good growth prospects and continuing corporate restructuring - offers attractive value. Dave Mohr, chief investment officer at Cape Town-based Citadel says: ?South Africa’s strong economic fundamentals are expected to finally shine through.?

Low valuations offer excellent buying opportunities for long-term investors. Analysts recommend that financial and industrial stocks, which are more reliant upon domestic economic fortunes, could be among the best performers next year. Robust domestic demand and improving business confidence could boost real GDP growth to 3.5-4% in 2002.

As the JSE may outperform other major markets over the next year, investors should take a fresh look at the SA markets.

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