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Economic commentary: A slow but steady boat

Andre StrydomThe US is steadily emerging from the dark shadow of the fiscal cliff and debt ceiling. US Federal Reserve chairman Ben Bernanke warned that raising interest rates too early could jeopardise growth and cause the very same financial problems that it was intended to prevent. While short-term interest rates are kept low it forces investors to hold long-term assets. As a result, the underlying strength is mainly coming through the housing revival and increasing corporate earnings. The Fed reassured investors that they would remain vigilant for risks to financial stability caused by sustained low long-term interest rates.

The ECB is also keeping interest rates low to provide liquidity for struggling companies within Europe. Mario Draghi, ECB president, said that the bank is already very accommodative and that they don’t see any further interest rate changes in the near future. Unemployment is still increasing in southern Europe. People who don’t have jobs have less disposable income; as a result there is decreasing demand and decreasing inflation. The main focus currently is the Italian election: the fact that no resolution is in sight yet, creates unease about the way forward. For the moment Europe is slowly moving sideways toward their next great test, the German election in September.

In China there was a smooth handover of power to a new generation of leaders. This lessened the fears for political instability in that country. Capital started flowing to China: in January alone, individuals and companies bought a record RMB 684 billion (a billion is one thousand million renminbi) worth of Chinese currency. According to Wen Jiabao, China’s outgoing president, the growth target for 2013 is the same as that of 2012, viz. 7.5%. Although China’s growth rate last year was the lowest in a decade, it was still 7.8%. Analysts are expecting China to exceed its goal this year.

In times of low interest rates and high liquidity, risk-seeking investors seem to favour emerging markets that have higher interest rates and prospects of better growth relative to developed countries. This is what caused the Rand, along with other high-yielding currencies, to be overvalued in recent years.
South Africa faced labour unrest in the mining and agricultural industry, uncertain government policy regarding the nationalisation of mines and lower than expected economic growth. GDP growth was expected to be around 3% in the fourth quarter of 2012, but it turned out to be 2.1%. These domestic factors were the main force behind the depreciation of the Rand. During the course of the past year we saw the Rand weakening against all the major currencies. The Rand weakened from ±R7.50 against the dollar in March 2012 to ±R9.10 in March 2013, a depreciation of 21%.

A weaker currency can work in our favour. When the currency is weak, the export industry has to come to the party. Exporters should do as much as possible to boost production; they are now effectively getting a 21% increase in turnover just from the depreciating Rand. Combine this with higher production and it will lead to a reduction in our current account deficit, which now stands at 6% of GDP, and higher growth prospects.
Unfortunately, this is not currently taking place. Companies are reluctant to build new plants and invest in infrastructure; instead they are building up big cash reserves in case they have to fund unrealistically high wage demands in the year to come. The weak Rand is bad news for household consumers whose real income is eroded through more costly imports like oil and durable goods, and indirectly through more costly capital goods required to replace old plants and equipment. The weaker rand is therefore a two-edged sword.

Despite all these negatives, South Africa can be in for more record equity runs while the rest of the developed world moves sideways and searches for higher returns in emerging markets. Furthermore, investors are increasingly in search of exposure to Sub-Saharan Africa. South Africa has a substantial advantage in this regard with investors regarding the country as the gateway to Africa.

A slow boat perhaps, but steadied by the international demand for our assets as we are slowly sailing through a stormy political sea.

For more information contact Andre Strydom on 021 852 0382