THE LAST South African Reserve Bank (henceforth ‘SARB’ or ‘the Bank’) Quarterly Bulletin for 2012 was released today. The main story is a low GDP growth rate (1.2% annualised) cut in half compared to the preceding quarter. The blame for this goes to the violent strikes in the mining sector and its spillovers into other industries. On this blog I will aim the focus on what the bulletin has to say about cross-border capital flows.
The South African consumer demand is still strong, but SA manufacturing is struggling to keep up. Hence, a continued current account deficit of 6.4%, similar to the second quarter. This deficit was funded by financial inflows that were still strong in Q3 (if this will last into Q4 is unclear given the net non-resident portfolio outflows in October). The SARB explains portfolio inflows in Q3 by international bond investors attracted to a favorable interest rate spread against advanced economies. My personal opinion is that these flows are more likely to be explained by the lower price of risk and / or higher risk appetite in the same quarter (the VIX averaged 17 in the quarter, compared to 18 in the year to date, or 22 since January 2010). This low price of risk is possibly caused by the highly accommodative monetary policies in Europe and the US, and thus correlated to their interest rate differential with South Africa. Thus, one would expect easy monetary policy in these countries to increase flows to SA, but it is a tricky task to determine whether it is via the price of risk or carry trade profitability.
Increased direct investments in the third quarter is explained by the Bank as foreign investors (companies) increasing their equity stake in existing investments and by parent companies extending loans to South African subsidiaries. Current research (eg Shin and Bruno 2012) would suggest that such lending is also a product of lower price of risk globally and low policy rates in the source economies. The recent depreciation of the rand will make these loan porfolios more risky if they are extended in terms of the creditor’s currency, and will adversely affect their willingness to provide further loans to SA business. The Bank explains the weaker rand by labor unrest and illegal strikes, downgrading of Sovereign debt, rising trade deficit and upwards pressure on inflation.
My prediction is that South Africa’s trade balance will remain unchanged in Q4, but demand for South African assets (and indirectly the rand) will fall short of current account deficit at the current exchange rate. This will require a further rand depreciation to allow South African’s to maintain their current consumption level. Given the low growth rate in Q3, one may have reason to hope that the Bank does not respond to rand induced inflation pressure by raising rates.
The full bulletin is available here on SARB’s website.