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AfricaNovember 1 2012

South Africa’s capital markets shows signs of strain

South Africa’s capital markets have been resilient amid a surge of negative news emanating from the country following the killing of 34 miners in August. But many bankers say the situation could deteriorate quickly if economic growth does not pick up or if labour unrest is not calmed. 
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South Africa’s capital markets shows signs of strain

In recent months, South Africa has been making headlines for all the wrong reasons. Since police shot dead 34 strikers at the Marikana platinum mine on August 16, in perhaps the most shocking incident in the country's post-apartheid history, and which was followed by labour unrest spreading throughout much of South Africa's minerals sector, the country’s image has taken a hammering.

Rating agencies acted quickly. Moody’s downgraded South Africa a notch to Baa1 in late September, while Standard & Poor’s followed suit a few weeks later to leave it rated BBB (one level below Moody’s). Both cited the likelihood of socio-economic stresses worsening because of Marikana and the possibility that the government, which has seen a fiscal surplus in 2008 turn into a deficit of about 4.6% of gross domestic product (GDP) today, will respond with populist measures and a spending splurge.

By October, the rand had come under strain, losing over 5% versus the dollar in the first half of the month (although it rallied in the few days after that), while government bond yields widened slightly. There were also several, albeit unconfirmed, reports that foreign investors had pulled deals, or were at least waiting until after the ruling African National Congress’ major policy conference in December before making a decision.

But given such a backdrop, South Africa’s capital markets have been remarkably resilient. Between January and the beginning of October, the Johannesburg all-share index rose 13%, taking it to all-time highs and making it one of one best performing exchanges globally. The bond market saw almost R90bn ($10.4bn) of net inflows in that time, which compares to just R42bn for the whole of 2011.

“Where we are is a result of foreigners coming in to the market,” says Victor Mphaphuli, a fixed-income fund manager at Stanlib, one of the country’s largest institutional investors. “If they hadn’t participated as much, I’m certain bond yields would be higher.”

Too big to ignore

For many foreign investors, especially those wanting exposure to Africa, South Africa is simply too important to ignore. Its stock exchange, with a market capitalisation of $800bn, is by far the biggest on the continent, while its overall financial system is easily the most sophisticated. It is hardly unusual for investors in London and New York that set up Africa-focused funds to give South Africa a weighting of 50% or more.

“A lot of the infrastructure here is first world, particularly the banking and legal systems, and the stock exchange,” says Stephen van Coller, head of Absa Capital, a large local investment bank. “It’s pretty much as companies see elsewhere. It’s a big advantage.”

Liquidity is also a draw. Portfolio investors in Africa lament the illiquidity across the continent – turnover in Nigeria, home to the second largest sub-Saharan stock exchange, is $17m daily, while the figure is a paltry $200,000 in Ghana. The Johannesburg Stock Exchange (JSE) is the exception, with about $1bn of securities traded on it each day, which goes a long way to mitigating the currency risk investors face when buying the country’s equities or bonds.

“This is a deep market,” says Brian Kennedy, managing executive of Nedbank Capital, another investment bank. “If foreigners need to dump their bonds, they can do so fairly quickly.”

Moreover, unlike in some other major emerging markets such as Russia, South Africa has a very developed local investor base. The state pension fund has R1200bn of assets, while local life assurers have about R1600bn-worth, according to Nedbank Capital. Justin Bothner, head of equity capital markets at Rand Merchant Bank (RMB), the investment banking arm of FirstRand, says this gives foreign investors a lot of comfort that they will find buyers should they look to exit positions. It is also one of the main reasons the JSE has risen so much this year despite foreigners selling a net R11bn of equities.

[South Africa] is a deep market. If foreigners need to dump their bonds, they can do so fairly quickly

Brian Kennedy

A more immediate explanation for strong demand for fixed-income assets this year has been the country’s addition to Citi’s World Government Bond Index in October. This made South Africa only the fourth emerging market to gain entry to the widely tracked index and saw investors rush to buy bonds in anticipation of its inclusion, which was announced in April.

Bleak outlook

Still, it is far from inevitable that investor sentiment will hold. Many bankers think that South Africa’s outlook is bleaker than at any time since the end of apartheid in 1994. The country's economy is growing at 2.5% annually, which is slow by African standards and widely viewed as too low to cut South Africa’s high unemployment. Given the malaise in Europe, the biggest export market for local manufacturers, several economists think that South Africa's economy could slow further next year. And poverty remains rife, while inequality has grown by most measures in the past 18 years. The prevalence of strikes is a consequence of such an environment, say most commentators.

Some parts of the capital markets are already being affected. Mergers and acquisitions (M&A) and initial public offerings have been rare recently. “Companies are wary about increasing capital expenditure and gearing their balance sheet too much,” says Barry Martin, co-head of debt capital markets at RMB. “They’re taking a very conservative view. The industrial conglomerates are sitting on a lot of cash and aren’t accessing the market as much as they used to.”

Others add that the JSE’s buoyancy this year may have deterred M&A. “You’ve got high valuations and low visibility on future earnings,” says Paul Roelofse, co-head of corporate finance at RMB. “That’s not conducive to large M&A transactions.”

The JSE is trying to capitalise on its position as the most advanced bourse on the continent and encourage companies from elsewhere in Africa to raise funds on it. “I would like to see South Africa utilise its strengths in terms of capital markets and [become] a place for investors to invest in the African story and for African issuers to raise capital in order for them to grow in their home countries,” says Nicky Newton-King, chief executive of the JSE.

This aim will be helped as South African companies seek to grow in the rest of the continent. Many, such as the biggest banks, a few retailers and telecoms firm MTN, already have substantial African operations. Few others do, however, although this is changing. “Right now, the overall contribution of Africa to South African companies is small,” says Andrew Vintcent, an equity fund manager and head of research at Stanlib. “But there’s no doubt that in the next decade or two we’ll see South African companies increasingly expand out the country.”

Pressure on

South Africa’s capital markets have made a great deal of progress in the past 15 years. The market capitalisation of listed bonds increased from R650bn in 2004 to R1350bn in 2011, according to Nedbank Capital. Ever more sophisticated products are being sold. Last year, supermarket group Shoprite and retailer JD Group sold R4.5bn of convertible bonds within a few months of each other, leading many bankers to say a local equity-linked market had finally been established. And while mining stocks still account for almost 30% of the JSE’s market capitalisation – despite the industry making up only about 6% of the country's GDP – the exchange has become far more diversified thanks to the growth of banks, consumer stocks and real estate companies.

“The market capitalisation of listed property companies has gone from almost nothing 10 years ago to about R150bn today,” says RMB’s Mr Bothner. “That’s phenomenal growth.”

Yet South Africa’s bond and equity markets will face plenty of pressure in the next two years. The government plans to stimulate the economy with increased expenditure, particularly on infrastructure (it says this can be done without hurting the public balance sheet, given South Africa’s fairly small debt-to-GDP ratio of 40%). But if this fails and growth remains low, or if strikes continue on a large scale, foreign investors could start to rethink their long-term commitment to South Africa. In that scenario, not even its position as the leading economy in one of the world’s fastest growing regions will be enough to save it.

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