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After a disastrous 2015, investment in South Africa has been on the rise this year. South African assets have continued to make impressive gains since January's turmoil, when there was severe uncertainty across emerging markets.
The rand rose 18% and stocks rose 6% in local currency terms (14% in dollar terms), while the 10-year bond yield fell from almost 10% to less than 9%.
Economic growth has been slow, to be fair. Gross domestic product (GDP) was virtually flat in the first half of the year after Tuesday's slightly better second-quarter data offset a contraction in the first quarter. But inflation appears to be under control at 6%, credit to the South African Reserve Bank for aggressively raising interest rates last year as well as in January and March.
With the benchmark policy rate currently at 7%, Medley Global Advisors, a macro research service owned by the Financial Times, predicts that the SARB will remain on the sidelines at its upcoming September 22nd meeting, and likely for the rest of the year. I think there is a possibility that it will remain in the public domain.
So is everything on track to continue the rally? If so. Once again, political risks threaten to undermine previous gains. And again, much of the blame lies with President Jacob Zuma. Last December, the president changed finance ministers three times in four days, causing market turmoil. He now appears to be pushing for the ousting of popular incumbent Pravin Gordhan from office.
Mr Zuma's motives are clear. His ruling party, the African National Congress, was severely reprimanded in local elections in August, with its vote share dropping to 54 percent (compared to 62 percent five years ago) and losing three major cities. Living standards have improved in recent years. ANC officials are increasingly worried that they could lose their majority in the 2019 general election after 25 years of one-party rule.
The president believes he can turn around the economy and, by extension, his political fortunes by turning on the fiscal spending tap. To do that, we need a more flexible finance minister. Mr Gordhan did not really want Mr Gordhan to return to the Treasury in December last year, and since then the Treasury has been involved in a deal with cash-strapped South African Airways and an expensive nuclear program promoted by Mr Zuma's allies. It has blocked additional funding for power plant construction.
To be clear, if Mr. Zuma were to lose office without first planning for a smooth succession and his own exoneration, then a series of corruption charges related to fraud and money laundering allegations would be against him. It was conveniently dropped in 2009, just before he became president, but that's a possibility. It will be restarted. So the stakes are high.
The problem for investors is that if the price of Zuma's political comeback (and personal survival) is Gordhan's ouster, the result is a more expansionary fiscal policy that lowers South Africa's credit rating to junk. This means that it will be. ” In Medley’s opinion, the race is certain.
This has already taken the shine off the rand and equities over the past three weeks, sending bond yields soaring. Mr. Gordhan seems determined to fight his cornered position, but the president is not fighting his way. The Indian Gupta brothers, who are accused of having undue influence over Mr Zuma, have decided to sell their South African interests all together by the end of the year. .
But it would be foolish to think that an experienced executive like Mr Zuma would not do everything possible to protect his legacy and himself, whatever the consequences. Investors therefore need to prepare for further volatility.
Dan Bogler is a commissioned editor at Medley Global Advisors.
Follow me on Twitter @em_sqrd
