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1. The changing South African financial scene
From the information published in the latest Quarterly Bulletin of the South African Reserve Bank (March 1996) the following statistics are available on the total pension and retirement fund business in South Africa
This may not include all provisions made by South Africans for retirement, but nevertheless provide sufficient evidence of the importance of this industry as an accumulator of contractual saving, and as an investor of funds in the South African economy. Total income earned on the investment of its funds, and the annual contributions made by both members and their employers generate a large amount of funds for investment on a regular basis.
The industry provides in a service that is of great importance for the total community of South Africa, apart from its importance in the macroeconomic development of the country. Most South Africans save very little outside of contractual saving made through the institutional investors. Last year, private households in total saved only about 1 per cent of gross domestic product. Indeed, discretionary saving by private individuals outside of contractual commitments to save was negative -- made possible by substantial spending financed with additional borrowing, particularly in the form of loans from banking institutions. The ratio of the total amount of consumer credit outstanding to personal disposable income rose from 23 per cent in 1994 to 25½ per cent in 1995. On the average, every South African family has therefore already consumed about one quarter of the income it will earn over the next year.
These perilous developments are taking place against the background of important changes in the South African financial situation in general. The liberalisation of financial markets, the introduction of new electronically-based trading and payment facilities, the increasing demands on resources for essential social and economic reconstruction and development, and the gradual integration of South Africa in the international financial markets are creating new situations and new challenges that will require careful management, particularly by institutions that function as trustees of the public's retirement funds.
It will also require careful consideration from the authorities in deciding on directives for prudential financial requirements of these institutions, in determining guidelines for investment by these institutions and in the taxation of the cash and income flows managed by the industry. Above all, South Africa must guide against the danger of discouraging saving in a community that already over-consumes and makes an inefficient contribution to the growing demands for the funding of the development needs of the country.
2. Effects of the integration of the South African financial markets in the world economy
The turmoil in the South African foreign exchange market in recent months provided a good example of the risks involved in the integration of the South African financial markets in the global system. There are obvious advantages in it for South Africa to open up its economy to the world markets, and to compete on an equal but aggressive basis with other countries for large amounts of funds seeking investment in the global economy.
Accessing the savings of other countries can supplement the low savings of South Africans, and can enable this country to develop its resources much faster for the benefit of all the people of the country. It is the only way for South Africans at this stage of the country's economic development to "live beyond their means" -- that is to absorb in consumption and investment more goods and services than what are produced within the country.
It is also the only way in which the necessary foreign exchange can be acquired for the payment of "surplus" imports -- that is imports of goods and services in excess of the South African production that is exported to the rest of the world. Taking account of the relatively low level of the official gold and foreign exchange reserves which is at this stage below the amount required to pay for six weeks' imports, the country can not afford to run a deficit on the current account of the balance of payments unless we can rely on a constant net inflow of capital from the rest of the world.
After experiencing many losses of investments in third world countries over the past twenty years, international investors in the global markets are wary of where they commit their funds. In the industrial countries, where total saving normally exceeds the development needs of the domestic economies, specialised fund managers now control billions of dollars, and decide on behalf of their clients and on the basis of their own risk profile analyses of countries on where to invest these funds. There are many developing and emerging economies, and also the economies in transition in central and eastern Europe, that now compete for these funds. South Africa is just one of the many competitors for these funds.
For South Africa it is important to learn more about and to understand better what motivates international investors to prefer one country above another in this very competitive market for investment funds. For almost two years, that is from the middle of 1994 up to the first quarter of 1996, South Africa was in favour and succeeded in attracting on a net basis more than R30 billion of foreign funds into the country and then, very suddenly, in the middle of February 1996, the situation changed dramatically when foreigners ceased investing in the country. At one stage in April, foreign investors were even withdrawing their previously invested funds when a net outflow of almost R2 billion took place as a result of net sales of foreign held securities listed on the Johannesburg Stock Exchange.
South Africa therefore for a two year period gained from the advantages of becoming more integrated in the world financial markets, but then reeled under the shock of a sudden reversal in the trend of the capital flows. The net inflow from the middle of 1994 up to the first quarter of 1996 enabled South Africans to increase the domestic consumption of goods and services in real terms by 6,7 per cent in 1994 and by 5,6 per cent in 1995, whereas gross domestic production on the average rose by only about 3 per cent over the two years.
The inflow of capital made it possible for the country to raise its total imports of goods and services by about 60 per cent from 1993 to 1995, and to run a current account deficit of more than R12 billion last year without worrying about the availability of foreign exchange reserves. On the contrary, last year the net inflow of capital amounted to almost R22 billion and was sufficient to cover the current account deficit and raise the official gold and foreign exchange reserves by almost R10 billion.
Furthermore, because of the capital inflows, the exchange rate of the rand remained relatively stable, the local banks experienced no liquidity shortages and interest rates did not increase excessively under the persistent stress of a big demand for funds, emanating from government, businesses and private individuals.
The switch-around in the capital account of the balance of payments in the middle of February 1996 brought this utopian financial world to an abrupt ending. The exchange rate of the rand depreciated by about 15 per cent since the middle of February; the liquidity in the banking system was drained very quickly; long and short-term interest rates rose by between two and three percentage points in just three months; and prices of certain imported goods, for example petrol, already increased to compensate for the depreciation of the rand.
It is still too early to judge how permanent this change in the attitude of foreign investors will be, or whether the inflow of foreign funds into the South African economy will be resumed again in the near future. For the time being, however, all South Africans have no alternative but to accept the realities of the situation and to understand that the performance of the South African economy without a net inflow of capital from the rest of the world will not be as good as that of the past year. It will not be possible to maintain growth in demand at a level of double the rate of expansion in the production of goods and services, without the substantial support of foreign savings flowing into the economy.
The situation in the South African financial markets, that is the foreign exchange market, the capital market and the money market, can therefore change very suddenly, very unexpectedly and very dramatically in a relatively short period of time. The managers of South African trust funds, such as pension and other retirement funds, have a much more difficult task in this environment from the days of South Africa's isolation from world events, and a relatively stable but stagnant domestic economy. They now have to be much more aware of developments in the global financial markets, for example movements in American bond yields which had a significant effect on the events in the South African financial markets over the past few months.
3. The lifting of exchange controls and the South African financial markets
South Africa has made good progress over the past two years in relaxing exchange control. Over the period from the beginning of 1994 we have:
terminated the debt standstill arrangements in terms of which the repayment of certain loan funds to non-resident lenders to South Africa were restricted;
abolished the financial rand system in terms of which non-resident investments in South African equities were blocked in the country;
applied a more liberal policy on South African companies that wanted to acquire or establish foreign subsidiaries and branches;
built up the country's official net gold and foreign exchange reserves from a zero level to about R15 billion at the end of last year;
reduced and modified the Reserve Bank's role in the spot and forward foreign exchange markets; and
started in June last year with an asset-swap facility to enable South African institutional investors to diversify some of the large portfolio's of investments managed by them into foreign securities.
The events of the last few months and the volatility caused by the international capital flows, raised the question, at least in some circles, and particularly with foreign investors in South African rand securities, whether this programme for the abolition of exchange controls is not going too fast. At least one prominent South African financial paper that never misses the opportunity to criticise whatever the Reserve Bank might do, last week raised the question of whether the financial rand system was not abolished prematurely.
South Africa, however, cannot have it both ways. We either have to become part of the global financial system and share in the benefits of huge amounts of investment funds flowing across international borders, or remain isolated and depend on our own scarce savings for the financing of our development needs. In the former situation, economic development will on the average be at a higher level, but we shall have to learn to manage greater volatility. In the latter case, the path may be on a more stable and perhaps even easier route, but economic growth and development will be more depressed. I have no doubt that the preferred route for South Africa should be the first one.
Most managers of large funds in South Africa believe that they will be able to improve the yield on investments managed for their clients once exchange controls have been removed, also for residents. In certain situations, particularly in the short term, this may be true, but in the longer term market forces should equalise investment opportunities in the different suburbs of the global village. For example, the risk of exchange rate depreciation will, in effective and well-functioning financial markets, be covered by higher interest rates in the weaker than in the stronger currency countries. Foreign investors that were lured to South Africa by nominal interest rates of 15 per cent or more, compared with rates of 5 per cent or less in their own countries, now know why these high interest rates apply in South Africa, after they have lost more than one year's interest income differential in a matter of a few weeks in the foreign exchange market.
Similarly, the nominal interest rates in a country with high inflation will compensate for the inflation differential that may exist between the home country and other possible places for investment, provided financial markets are allowed to function effectively and without undue government intervention, that is without major tax discrimination.
It is for this reason that it is important to prepare the way by developing the total market economy for the removal of all exchange controls. Once all markets perform with equal effectiveness in a relatively free environment, exchange controls will in any case no longer be necessary.
