SA must cut exposure to fickle global investors

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SA must cut exposure to fickle global investors
SA must cut exposure to fickle global investors

TWO developments dominated the economic news in recent days. The first was the unexpectedly large increase in SA's current account deficit to 6.2% of gross domestic product (GDP) — in money terms, a deficit of R222bn a year. The second was our fall by three places to 56 out of the 144 countries measured in the World Economic Forum's ranking of global competitiveness.

The two items are related. We have continuous large current account deficits because our poor competitiveness means we buy more from the rest of the world than they buy from us. This was exaggerated in the second quarter by the strike-related fall in platinum exports. However, we still imported much more than we exported in previous quarters when platinum output was normal. Not even a substantial weakening of the rand exchange rate has helped make the goods we produce competitive enough to change this.

Current account deficits must be funded by inflows of foreign capital. We cannot buy things from the rest of the world unless we have foreign currency to pay for them. Foreign currency is acquired when we export and also when foreigners bring in money to invest in SA.

Such foreigner investors usually buy shares on our stock exchange or the bonds issued by our government and companies to fund borrowings.

The foreigners invest little in new factories and machinery in SA. The reasons for this are obvious when our disappointing showing in the World Economic Forum's measure of global competitiveness is examined.

SA's global competitiveness is made up of a mixture of good performance in some indicators and shockingly poor performance in others. We rank first in the world in terms of the regulation of our stock market and auditing standards, second in protection of minority shareholders and sixth in the soundness of our banks. But in other critical areas we are the worst, or near the worst.

We rank last of the 144 countries measured in the teaching of maths and science, for example, and 140th in the overall quality of our schooling. We rank last or close to last in terms of cooperation between employers and labour, and the link between pay and productivity. The quality of our electricity supply places us only 99th. These low scores deter foreign and local businesses from investing more in SA.

As a result SA is forced to fund current account deficits by selling to foreigners increasingly large stakes in local companies and interest-bearing government and corporate bonds. The dividends and interest then earned by the foreign investors flow out of SA. These outflows weaken our current account balance. Hence a vicious cycle is created in which rising dividend and interest outflows create rising deficits, which are then funded by even more foreign purchases of shares and bonds, which in turn generate higher dividend and interest outflows.

Funding deficits this way makes the economy vulnerable to changes in foreign sentiment. The desire of foreigners to buy our bonds and shares can change overnight. If foreigners stop funding our deficits, the required economic adjustments will be enormously painful.

This is illustrated by the flows of financial funds between the various sectors of the economy documented in the March quarterly bulletin of the Reserve Bank. It shows that South African private nonfinancial companies collectively saved from their income almost everything needed to fund the R343bn they invested last year. They were able to fund most of their investments from cash, borrowing only RIObn.

Public-sector companies, on the other hand, invested R84bn more than they saved. The government borrowed the full R107bn it invested and had to borrow a further R91bn to cover the gap between its consumption spending and its tax revenue. The government therefore borrowed R198bn, public companies R84bn and private nonfinancial companies R1Obn — a total of R292bn. Only about R1Obn of this came from households and a further R85bn from local banks and pension funds. The remaining R197bn was borrowed from foreigners, mainly via their purchase of shares. It follows that foreigners funded fully 30% of SA's total investment last year, or the equivalent of all government borrowings in that year.

Our level of investment is already too low to fund the infrastructure we need to grow the economy. We cannot afford to cut it further should foreign inflows fall. Our vulnerability to a negative swing in global investor sentiment once interest rates and growth in the developed countries start to rise is obvious. The warning signs are already there with last week's weakening of the rand. SA must improve its rankings in the areas of obvious weakness revealed by the World Economic Forum. Only then will exports and savings rise, allowing us to reduce our unhealthy exposure to fickle global investors.

Article by: Gavin Keeton
Article Source: Business Day