South Africa Is Hobbled by Market Change

(Bloomberg Opinion) -- The downside of being the most liquid emerging market currency is that it’s hard to avoid the impact when investors turn cold on risk assets. Unfortunately, South Africa’s rand has other issues to wrestle with too. The currency has recovered some of its poise after a selloff on Tuesday, which was sparked in part by nerves around the composition of Cyril Ramaphosa’s new cabinet. But even as the political situation settles, there’s another technical dynamic that will limit the country’s attractiveness: A re-weighting of the MSCI emerging market indexes.

Some 13.3 billion rand ($894 million) of South African equities were sold on Tuesday because of this re-balancing of the index, another factor in that day’s rand selloff. A series of changes to global emerging market indexes will see the inclusion of China and Gulf countries such as Saudi Arabia and the United Arab Emirates. Existing members will see their percentage share of the indexes fall, so investment funds will have to sell out of the old guard as they buy into the newly added countries.

Some emerging markets will still be assigned “over-weight” status to reflect their particular attractions. But South Africa has a raft of pressing problems that make it especially vulnerable in risk-off environments.

Ramaphosa’s cabinet makeup will be scrutinized by investors, who are keen to see a break from the corruption scandals that hung over former President Jacob Zuma’s government. The reappointment of the controversial David Mabuza as deputy president didn’t exactly deliver that, but the role is largely ceremonial anyway; and to exclude the deputy leader of the ANC would have been difficult for Ramaphosa.

Moody’s Investors Service looks unlikely to alter its Baa3 (stable) rating as it waits for the new government to bed in. It’s the only major agency to rate the country at investment grade, and the threat of losing that hangs over South Africa.

The economy will see a drop in first-quarter gross domestic product, by as much as 2% according to some forecasts, though growth should recover modestly over the rest of the year. Inflation has shifted down to the middle of the central bank's 3-6% target range, which might allow a rate cut by the end of the year. Reserve Bank Governor Lesetja Kganyago has maintained a rigorous hawkish bias despite two members voting for a rate cut at the last meeting on May 23.

South Africa's current account deficit is also steadily reducing. Foreigners still own 39% of the nation’s high-yielding debt, which means coupon payments sent overseas far outweigh what the nation earns from its investments abroad. Nonetheless, government bond yields are falling steadily in lockstep with U.S. Treasuries, which does ease the pressure on overstretched budget finances somewhat.

Still, with the steady shifting away of foreign investor interest because of the emerging market index changes, gains are going to be hard to come by for the rand, as well as South African bonds and equities. 

To contact the editor responsible for this story: James Boxell at jboxell@bloomberg.net

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Marcus Ashworth is a Bloomberg Opinion columnist covering European markets. He spent three decades in the banking industry, most recently as chief markets strategist at Haitong Securities in London.

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