South Africa’s deceiving blip

Signs of strength, but many drawbacks await

South Africa is once again showing up on the radar screens of foreign investors, but the blip may be deceiving.

The value of the country’s stock market was up 12.3% in U.S.-dollar terms on the Morgan Stanley Capital International Index for the year ended March 31, making it one of the 10 best performers in the world for the period.

However, the market is regaining ground lost last year when it declined by nearly 30%. And South Africa’s economy appears to be heading into recession: GDP growth fell to a mere 0.1% last year from 1.7% in 1997 and is forecast to rise less than 1% this year.

The economic slump is the result of several factors, including weak commodity prices, a deteriorating rand and high interest rates to stem the outflow of capital.

Nonetheless, investors are attracted to stock market valuations that are currently discounted relative to their historical norms. The MSCI South Africa Index closed at 143.42 on March 31, down from its five-year high of 277.33 reached in January 1996.

The Johannesburg Stock Exchange is among the world’s top 20 exchanges, with a market capitalization of more than US$180 billion and more than 650 listed companies. In spite of its size, South Africa is considered an emerging market, largely because of infrastructural weaknesses and its corporate ownership structure.

Historically, almost 75% of total market capitalization has been controlled by six large conglomerates — Anglo American, Sanlam Group, Rembrandt Group, Liberty Group, Anglovaal and Old Mutual. These conglomerates, mainly life insurance companies, have tied up corporate control through a complex system of cross-ownerships and pyramid structures, leading to monopolistic control and almost insurmountable barriers to entry in certain industries. Over the past two years, however, the corporate structure has come under attack by the government and is slowly breaking down. The Sanlam Group and Old Mutual are expected to demutualize this year.

South Africa is also benefitting from renewed investor interest in continental Africa. It is the region’s largest and most sophisticated economy, accounting for nearly one-third of all business activity, and is seen as the springboard for companies wishing to expand into other African countries.

In addition, since the abandonment of apartheid in 1994 and the subsequent resurfacing of South Africa in the international financial community, an increasing number of investors want to take advantage of the opportunities in what had been one of the world’s most insular economies. Last year, foreign direct investment rose almost 10%, fuelled by consolidation and alliances. Investments have been mostly centred in the energy, mining and automotive industries. Malaysia, followed by Britain, Italy, Germany and the U.S., are the largest investors in the country.

Although foreign investment has increased for three consecutive years, investors continue to encounter enormous problems. The government lacks a coherent investment strategy, the bureaucracy is slow, incentives are inadequate, labour productivity is low, transaction costs are high and tough labour laws are a burden on industrial relations. Crime has become a major hurdle to investment and business executives are beginning to hire private security.

Canadian exports to South Africa in 1997 totalled C$371 million, while imports were C$495 million. Canada’s main exports included transport equipment, wheat, sulphur and wood pulp. Imports included platinum, precious metals, iron, steel, fruits and nuts. Canada normalized commercial and economic relations with South Africa in September 1993 and has since reached agreements on foreign investment protection, double taxation, trade and investment co-operation.

When South Africa returned to democratic rule, Nelson Mandela’s government embarked on an ambitious five-year, US$25-billion development program to redress the inequities of apartheid and create jobs for the 40%-50% of South Africans who are unemployed. Much remains to be done.

The government’s privatization program has also failed to gather momentum. Like most African nations, voters are opposed to divestment of state assets. Foreign investors are finding it increasingly necessary to have a black empowerment partner in order to participate in the process.

Some investors see South Africa as one of the last frontiers. But with economic and political uncertainty, the country will find it increasingly difficult to earn its share of foreign investors.

Dwarka Lakhan

Dwarka Lakhan is a pioneer in emerging markets journalism in Canada. His first emerging markets article, “Africa Joins Ranks of the Emerging,” appeared in Investment Executive, Canada’s leading newspaper for financial advisors, in September 1994. Since then he has written hundreds of articles on the full spectrum of emerging markets and has conducted more than two thousand interviews with emerging and frontier markets investment professionals.

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