Emerging markets at the mercy of many

Sanisha Packirisamy

What Italy’s debt issue and China’s counter-trade-war efforts could mean for SA

As far removed as countries like Italy, China and Turkey may appear to be from South Africa, the local economy has been, and will likely continue to be, negatively impacted by the wide array of seemingly unrelated market issues – such as Italy’s debt woes and China’s retaliatory reaction to the US trade war – through a contagion effect.

This is according to Sanisha Packirisamy, economist at Momentum Investments, who says that financial markets in South Africa are particularly vulnerable because of their depth and high level of liquidity. “While investor jitters started in Turkey and Argentina, where economic mismanagement was evident, financial markets in these countries are not as deep and liquid as South Africa and Brazil, which have been targeted in the latest risk-off episode. It is therefore far easier for investors to get out of positions in these tradeable markets, and as a result, our local economy is impacted.”

The relative ease of exiting positions in South African financial markets, Packirisamy explains, is why South African citizens are negatively impacted in an emerging market-wide risk-off episode. “When the currency sells off in response to investor fears, the rand becomes cheaper against major currencies. Sustainable currency depreciation can have a negative effect on inflation outcomes and this could lead to a rise in interest rates if inflation threatens to exceed the 3% to 6% target band for an extended period of time.”

Zoning in on the situation in Italy, Packirisamy says that debt concerns present a risk to global financial markets given the interlinkages between Italian banks and a number of other economies. “Should Italy default on its debt, it would create uncertainty in the markets given Italy’s size and interconnectedness.

“In a risk-off environment, investors actively seek out less risky assets. Capital tends to stay at home rather than find its way into riskier markets – which is what South Africa is currently perceived to be – as a precaution to prevent potential losses,” she explains.

Packirisamy notes, however, that out of all of the emerging markets, China is likely to impact the South African economy the most in this respect. “China is one of South Africa’s largest trading partners, and if Chinese growth softens and demand slows, it would likely diminish South Africa’s exports to the region.

“China is also a key user of global commodities and South Africa is a net exporter of commodities. If China’s demand for commodities drops, the price of commodities that South Africa supplies to the rest of the world could drop, triggering a negative terms-of-trade (export prices relative to import prices) shock,” she adds.

While conceding that the rand is likely to remain on the back foot if uncertainty in these emerging markets persists, Packirisamy warns South African investors against making any impulsive investment decisions. “The reality is that as long as global investors paint all emerging markets with the same brush and remain hesitant to get back into risk assets, the rand could suffer.

“However, for investors with well-diversified portfolios and long-term investment goals, this is the worst time to start moving things around. The best thing that South Africans can do to protect their investments from these market fluctuations and the current high level of global uncertainty is to stay calm and prevent making rushed short-term decisions,” she concludes.