As Indonesia and other weak-currency members of the so-called Fragile Five economies grow their exports and shrink their current account deficits, membership of the group could whittle down to a Fragile One …South Africa. That is a concern expressed in this Alec Hogg interview by Old Mutual’s Peter Brooke. Key to the solution, he says, is Government’s delivery on its National Development Plan. – GK
ALEC HOGG: Of countries that are particularly vulnerable, as a result of the dependence on, well not just foreign investments but problems that you have with current account deficits, high inflation and, of course, unemployment. Peter Brooke, who is Boutique Head of Old Mutual Investment Group Macro Solutions, joins us for more on this subject. When I met with the people from Morgan Stanley they were saying that the Fragile Five report that they put together in August last year Peter, had caused so much negative kickback from the five countries that were mentioned – sadly, South Africa being one of them – that they were stopping to use that term, but it seems to have stuck. We’re all talking about it now and it also – worse – seems to be coming more in the spotlight of those who allocate capital around the world. Why would this be?
PETER BROOKE: The reason it is coming back onto the radar screen is because U.S. Bond Yield started picking up and really, the U.S. Bond Yield is your indicator of your global cost of capital. The reason the Fragile Five are vulnerable is if the returns…if the U.S. rates go up, they are the ones who need the money, so we had U.S. Bond Deals drifting up and immediately we started to have the Fragile Five coming back on the table. However, in the very short term, with the U.S. Macro Data the U.S. ten-year bonds have dropped down to two-and-a-half percent, so it has kind of drifted away again. I think, on a secular basis, the way we see the world is U.S. interest rates will grind higher at the long end, and that will put pressure on those countries that are dependent on foreign capital, like South Africa.
ALEC HOGG: So it is all a competition for capital, a competition for money, and the Fragile Five are worst positioned to attract that.
PETER BROOKE: That’s right. Although time can heal many things, because with the weaker currency you will see an export response and an import response, so we’ve already seen, in some of those countries, for instance Indonesia, their export is starting to grow. Their imports are coming back and the current account deficit has started to narrow, so there is less reliance on foreign capital and, I mean my concern is, actually we could be talking about a fragile one, instead of a Fragile Five.
ALEC HOGG: And which is the Fragile One?
PETER BROOKE: Because a lot of the other countries have adjusted, so for instance…
ALEC HOGG: Which is the fragile one?
PETER BROOKE: South Africa. Yes. If you look at mostly other countries, so for instance Turkey hiked rates up very sharply, whereas we’ve only had 50 basis points. Our export side hasn’t responded as well as we would have hoped. Obviously, it is very difficult to see that because with the platinum strike muddying the data, exactly what is happening in that space is unclear, but certainly our current account deficit is still pretty big, by global standards. Our interest rates haven’t gone up as much. We’re still quite vulnerable.
GUGULETHU MFUPHI: Peter, you’ve mentioned that South Africa is the fragile one. You’ve touched on the fact that the platinum sector strike is muddying the water. This, coupled with the recent downgrades we’ve seen from ratings agencies, does this move us further closer to that junk status?
PETER BROOKE: Personally, I think the rating is a bit of a red herring. At Old Mutual we’ve got a major advantage in that we’ve got sister companies overseas, and we spoke to two of them, who manage emerging market bonds funds, including some of our own money, and when we talked to them about the ratings, they couldn’t care less. They’re looking at it. South Africa…that was priced in. It was expected. From here, we sit with our peers. It’s hard to see another ratings downgrade in the short term, so it has largely happened. What is interesting from their perspective is they see South Africa as very cheap, offering a lot of yield. The currency has really depreciated a lot and therefore, their inclination would be to go overweight but they are held back by the risks.
GUGULETHU MFUPHI: Peter, if you were sitting at National Treasury in Nhlanhla Nene’s Seat, then what would you be doing?
PETER BROOKE: Look, I think Government has got a plan, which is the National Development Plan, and they’ve got to deliver to that. Actually, South Africa, I think it’s got the ability to fix itself or heal itself. It’s just got to keep moving forward, and the difficulty, I think, is that we live in a competitive world. It goes back to what Alec said, about competition for capital, is we’ve got to keep on growing, expanding, because the rest of the world is as well, so if we are not delivering and we’re slow in our implementation of the National Development Plan, on a relative basis, we suffer.
