Evaluating an Emerging Market – South Africa

South Africa as an Emerging Market

South of the Sahara, South Africa is the dominant market and is considered an emerging market alongside Egypt and Morocco in the north and Nigeria in the west of Africa. As a Republic, South Africa has major industries in textiles, fertilizer, electronics, motor vehicles, and motor vehicle parts. The country has a climate, soil, minerals, and ports that can be harnessed into further developing and growing the economy. South African’s rise to the status of an emerging market can be credited to the rise of the local consumer, a growing middle class, a youth bulge, and most importantly the improved macroeconomic management.

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Back in the mid-20th century, the apartheid policies by the then government and policies were unfavorable to international businesses, which led to most of them pulling their operations from South Africa to other more stable parts of the world. The hostile political environment that threatened the economy further led to significant brain drain as most educated South African nationals of all ethnicities relocated from the country in search of greener pastures. However, by the late 1980s the apartheid government had realized the error of their ways and in 1990 released Nelson Mandela a lead freedom fighter and political prisoner. South Africa gained its independence from colonial rule in 1994 and elected Nelson Mandela as president a move that was applauded by the international community. Mandela, a champion of peace and reconciliation and his team of South African leaders saved the country, which was at the brink of war, managed to reassure its citizens, raised its standards of operation, and encouraged consumers and businesses alike to once again trade with the country.

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When South Africa hosted the 2010 World Cup, it significantly improved its public relations besides benefiting from the infrastructural upgrade that took place and economically from the tourists that flocked in. In the last decade, political tensions have been subdued and armed conflict is unlikely with politicians contesting unfavorable conditions by leaning towards political protests as opposed to paramilitary campaigns. As a nation that is navigating the difficult political terrain rather well, South Africa is likely to prosper; investors would be encouraged to maintain agility in order to safeguard their investments.

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Country Demographics

South Africa has a population of 50 million with a population density of 41 people per kilometer squared, a rather small population compared to other emerging markets. Nevertheless, the annual rate of growth of 1.32% is positive(Gauteng Provincial Treasury, 2013). The larger the population of a country, the larger the larger the engine for development and economic growth the country has. There are significantly large numbers of the South African population living with HIV (Human Immunodeficiency Virus) and community crime in the country is rated as high. In 2005, the Human Development Index (HDI) showed some regress due to a decline in the country’s life expectancy that was directly linked to the high prevalence rates of HIV. Regarding human development, this is an area that South Africa as an emerging market has to actively keep up with other emerging markets.

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As of June 2015, South Africa together with Brazil and Turkey displayed currency fundamentals that were the weakest amongst the emerging markets. At the beginning of 2015, the rand registered a 9% decrease against the dollar and has continually shown weakness throughout the year. According to the South Africa Reserve Bank (SARB) has forecasted that inflation expectations are anchored at the 6% mark, which is the upper limit of the target range of 3-6%, by SARB. All indications are however pointing at a worse inflation breach than the current forecasts by SARB, which indicate a temporary inflation breach only in the first and second quarter of 2016(Overberg Asset Management, 2015). Analysts are however, adamant that the inflation breach will occur much earlier, as in the last quarter of 2015 and is likely to persist for a prolonged period of time.

As the dollar has been getting stronger, the foreign exchange reserves have continually weakened which has led to a fall of South Africa’s gross reserves by a rate of -1.3% monthly, a situation that is likely to continue in volatility over the next few months. From April 2015, the gross reserves have fallen from $47.043 billion to $46.446 billion(Overberg Asset Management, 2015).

Gross Domestic Product and Liquidity of Local Debt

South Africa had a GDP of $ 475 billion as of the year 2011(Gauteng Provincial Treasury, 2013). The size of South Africa’s GDP experienced very little growth since before the 1980s and currently shows no real potential for becoming a potentially large economy. This reality indicates that South Africa’s categorization as an emerging market that joined BRICS (Brazil, Russia, India, China and South Africa) may have more to do with politics than it would economic figures and facts.

With a current account deficit of 5.1% of the GDP, South Africa had one of the largest current account deficit among the emerging markets, as of quarter 4 of the year 2014(Overberg Asset Management, 2015). This makes South Africa rather vulnerable and this vulnerability is further increased by the magnitude of foreign ownership of its financial assets, making a change in sentiment a potential risk factor. More than 40% of South Africa’s domestic bonds are in the ownership of foreign investors and out of all the emerging markets, South Africa’s bond market has one of the highest levels of foreign ownership. Since South Africa imports all its oil it was expected that the deficit would improve, but this large current account deficit appears to be worse especially in light of the significant drop in oil prices in the past year.

Political and Economic Risks

South Africa like many other African countries has a much bigger lower income earning population, bigger than the growing middle class, which is capable of mobilizing and opposing unfavorable policies. The constant wage adjustments push and pull between government and public sector unions poses as a potential political risk. For instance, the wage agreement signed in 2012 stipulated that increase in wages would be calculated based on the consumer price inflation (CPI) and in the case where the CPI falls below the average projected, deductions of the difference would be made in the next year. In 2014, the actual CPI was recorded at 5.6% but the public sector wages were calculated against the CPI projected at 6.2%, which caused tensions with the public sector unions. In 2015, the public sector unions and the government agreed on a 7% wage increase but while making the pronouncement, the government quoted a 6.4% increase lower that what was agreed upon (Overberg Asset Management, 2015).These kinds of recurring tensions and problems could potentially lead to the cancellation of the latest wage agreement that was signed in May of 2015, as the worst-case scenario.

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Market Efficiency

            The fact that the financial market of a developed market is liquid and trades a higher volume, makes it a lot more efficient than that of an emerging market. While comparing the U.S and South Africa, it is easier to see why the developed U.S market is more efficient than that of the emerging South African market. The liquidity levels differ greatly and the trading volumes differ significantly. These differences can be explained in terms of GDP levels where South Africa had a GDP of $475 billion in 2011 while the U.S had a GDP of $13.2 trillion, that same year(Gauteng Provincial Treasury, 2013).

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While both countries may experience market efficiency individually and domestically, by comparing them the reasons why the developed market is more efficient than the other become more evident. They become evidently different in terms of supervision & regulation of the markets, accounting standards &regulations and the legal framework conditions, where the U.S markets has more advanced and refined versions while South Africa may still be in the developmental processes. As the world’s largest economy the U.S stock market pulls participation from all over the world while South Africa’s may mostly attract national investors(High & Honikman, 1995).

South Africa and Nigeria

There are numerous similarities between South Africa and Nigeria, two emerging markets in Africa. The economic growth of these two markets is pegged on fresh foreign investments as the two countries tap into international capital markets in order to develop infrastructure that is expected to sustain the growth patterns they are currently experiencing(Udo, 2013).

In the recent past, Nigeria an emerging market has experienced the force of the people who caused unrest in opposition to unpopular policies, for example the increase in utility tariff, fuel subsidies removal, and problems with service delivery. In South Africa, organized labor is considered quite strong and in the past has been able to realize various successes in wage negotiations over the years. Both of these countries just like several other African countries have a much stronger force of change in politically relevant group which is formed the poor majority than it has in the growing middle class. The low-income earners who reside in urban areas and make up the majority of the population have a greater ability to mobilize and influence changes(Udo, 2013).

Political, Economic and Technological trends of South Africa as an Emerging Market

South Africa is likely to attract short-term capital inflows from foreign investors but with increased volatility in foreign exchange reserves, there is a likelihood of raised interest rates by the U.S Federal Reserve Bank, which may cause a dwindling in the appetites of the foreign investors. Insufficient economic reforms and power constraints may affect South Africa’s already weakened economic potential. This is especially so because of the country’s low credit rating, contingent government liabilities, government indebtedness, large current fiscal and account deficits. South Africa depends largely on ‘hot money’, which refers to portfolio capital inflows and seems to be losing out on the more long-term and steady foreign direct investment, mainly because of its large current account deficit. Despite all of this, South Africa’s credit rating stands at BBB, this is a level above the speculative grade giving the country a stable outlook, as a downgrade is not likely. The country is likely to maintain this positive status.

Since the robust yearly increase of 3.8% and monthly increase of 1.2%, there is an expectation that manufacturing production will show a softening bias. This is despite the shrinking of the manufacturing sector by -1.5% in April 2015 caused by weak demand conditions from consumers and in the mining sector(Overberg Asset Management, 2015). This demand conditions are however, temporary, since a projected increase of 5% in mining output is expected.

In terms of infrastructural developments, South Africa is making progress, for instance Transnet Freight Rail; a state-owned enterprise, under their recapitalization program got into a loan facility agreement with China Development Bank. Under this program, Transnet intends to buy 1,064 locomotives and this loan, amounting to 30 billion rand; 60% of the 50 billion required amount will be used in the purchase of 591 locomotives(Overberg Asset Management, 2015). The loan has a maturity of 15 years and carries a grace period of 4years. In as much as the locomotives will be manufactured by China North Rail and China South Rail, it will be instrumental in developing the drive skills and manufacturing capacity of South African rail since stringent requirements have been in place to ensure the localization and supplier development targets are met. More importantly, this arrangement is expected create more opportunities for local jobs.

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Further depreciation of the rand is expected since the US dollar has been strengthening and if it manages to break the 30-year resistance line it is currently testing it will get even stronger, weakening the rand to the level of R13/$(Overberg Asset Management, 2015).

With diversification and a more flexible labor market, South Africa will grow significantly. In order to improve their chances of thriving, companies will need to develop risk management strategies that are tailored to specific local contexts and business activities.

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