Exploring the divided conversation on capital outflows from SA

This article first appeared in Sunday Times Business Times on 29 October 2023.

Institute of International Finance figures are not as substantial as JSE’s

By Isaah Mhlanga

Capital outflows from South African markets always generate a divided conversation, especially when macroeconomic fundamentals are weak and socioeconomic challenges are on the rise. Lately, there have been two strands of debate. The first is that foreign investors in  South African bonds and equities have sold off their holdings.

The second is that South African investors have taken billions out of the country when it needs capital to be invested in infrastructure to boost growth and employment. In both cases, these seem to be extreme views that do not pass the test of evidence.      

Regarding non-resident investors dumping South African assets, the data does not support the assertion that South Africa is the only unloved country. The Institute of International Finance (IIF) shows that non-resident capital inflows to emerging markets (EMs)  amounted to $117bn between January and September this year, split between $90bn in bonds and $27bn in equities. China is an outlier as it saw outflows of $76bn from its bond market, the largest from EM bonds, followed by Brazil with $3.1bn.  On the equity side, China saw inflows of $17bn, followed by India at $15bn. Excluding China, EMs had total inflows of $176bn split between flows of $166bn into bonds and US$10bn into equities.

As far as South Africa is concerned, using the same IIF data set shows that non-resident investors were net buyers of $2.0bn (R37bn) of bonds over the same period, which is not congruent with JSE data that shows $17bn (R312bn) in outflows. On the equity side, IIF data shows that non-residents were net sellers of only $0.8bn (R15bn), which is also very different from the JSE figure of $6.3bn (R116bn).

There have been questions about JSE data for a while. A possible reason for this discrepancy is how repurchase (repo) agreements and reverse repurchase agreements are accounted for. Reverse repos are simply legal purchases bonds which sell back at a defined later date of the bond, and vice versa for a repo. The JSE system might be following these legal conditions instead of the substance of the cash changing hands, which results in one leg of this trade not recorded correctly.

There are several observations if one looks at IIF data. First, non-residents’ disinvestment from South Africa is not evident in bonds but on the equity side. Second, the foreign investors’ disinvestment narrative seems to have been overblown as the figures from the IIF are not as substantial as JSE figures. Third, South Africa is not unique nor an outlier; it is in the middle of the pack among countries that have seen inflows into their bond markets and among those that have seen outflows from their equity markets.

The second debate pertains to domestic institutional investors’ offshore investments, governed by Regulation 28 (Reg 28). Since February 23 2022, Reg 28 has allowed institutional investors to take up to 45% of their assets under management out of the country. There seem to be unintended consequences from this adjustment, perhaps due to the timing and global market dynamics.

The unintended consequence is that domestic capital is leaving the country precisely when it requires capital investment in infrastructure to boost lacklustre growth. Some question whether the increase in foreign exposure from 30% to 45% was right and argue that it could have been done gradually. Others maintain that it was correct to provide a wider investment universe. There are some who argue for a partial reversal of Regulation 28 to a lower limit to keep capital invested in the country. In the final analysis, the right answer depends on which perspective the argument is made from.   

The policy rationale for allowing domestic institutional investors to take more funds out of the country is rational. First, the listed market is increasingly becoming smaller as companies have been delisting from the JSE, which implies that there is a smaller and highly concentrated investment universe. Second, South Africa’s economic growth has been much lower compared to global growth and even worse compared to other emerging markets. This implies that in addition to a reduced and highly concentrated investment universe, potential returns are also lower from a macro perspective. Individual sectors and companies, of course, are likely to perform differently and even outperform global counterparts, but the broad macro picture has been poorer locally, relative to offshore.

Mhlanga is Chief Economist and Head of Research at Rand Merchant Bank