S. Africa's curious Dutch disease: Money is making the economy sick - then there's Zimbabwe

South Africa has the third-biggest market capitalisation relative to GDP in the world of 160%, second only to Hong Kong and Switzerland.

REPORTS out of South Africa show the number of initial public offerings on Johannesburg’s stock market in the first quarter of 2015 accelerated to levels not seen since the global financial crisis as the benchmark index rose to a record and companies took advantage of the rally - even as the broader economy is in the doldrums.

From January to end March three companies, including Lodestone REIT Ltd. and printing business Novus Holdings Ltd. sold stock.

In 2014 there were two IPOs in the first quarter, in 2013 just one, and none in 2012, according to data compiled by JSE Ltd., which owns the exchange. The last time there were more was in 2008, when there were five IPOs before April.

“These companies are successfully able to float on the market because there’s been a roaring bull market, so if they’re a decent company, they’re likely to find support,” Sean Ashton, chief investment officer of Anchor Capital told Bloomberg in a phone interview from Johannesburg on Wednesday.

It seems paradoxical that the stock market would be doing so well, considering the rest of the economy is all but stagnating, with growth rates now less than 2% and unemployment almost 25%. 

The rand has declined 2.4% against the dollar this year while the stock market has climbed 6.1% and touched a record in February.

“The JSE bears little resemblance to the economy,” Ashton said.

The puzzle

But far from being an aberration, the disconnection between what happens on the JSE and in the wider South African economy is central to explaining the country’s now sluggish growth, its shocking inequality, and the reason why the post-apartheid government has struggled to deliver on its promises of prosperity.

Mining is considered the backbone of South Africa’s economy, and historically, the gold and diamond mines were central making the country the richest on the African continent.

But today, the South African economy is actually driven by its financial sector which, relative to the economy at large, is one of the largest in the world.

Data from the World Bank shows South Africa has the third-biggest market capitalisation relative to GDP in the world of 160%, second only to Hong Kong and Switzerland - small countries that are basically financial centres with little activity in other sectors.

Market capitalisation of the JSE - the share price of each company, multiplied by its number of shares on the exchange, and then added together for all the companies - is nearly three times as large as the country’s GDP.

It’s remarkable that a country of South Africa’s size and population could have so much capital concentrated in its financial markets. The reason for this is rooted in the apartheid era, where mining barons could not easily stash their profits outside the country, and so ended up accumulating it within the South African economy itself, and particularly in the stock markets.

Dutch disease of sorts

The effect is a Dutch disease of sorts, where money multiplies itself endlessly on the stock markets and, therefore, there is little incentive to direct it into the productive economy - resulting in “jobless growth” and outsized gains for investors in the financial markets, who are able to comfortably live off interest accrued from their financial assets and do not necessarily have to build anything in the labour-absorbing economy in order to create wealth for themselves. 

There are other explanations for South Africa’s sluggish growth, including neglect of infrastructure, fractious labour relations and public sector corruption. But the over-financialisation of the economy is a major structural reason.

Surprisingly, Zimbabwe is second in Africa in its market cap-to-GDP, at 94.7%; the country has a similar “white settler” history as South Africa that resulted in the local accumulation of capital. 

Market cap Africa | Create infographics

Prior to 2007-08 when the Zimbabwean economy was battered by hyperinflation of 500 billion percent, the Zimbabwe Stock Exchange was outperforming exchanges in the South African region, and was effectively the only place in the market where local assets had been able to provide returns ahead of inflation.

Since then, the exchange has slowed down, with investors still wary of risk. But the elements of a developed financial system are still in place, though activity has shrunk.

Sophisticated Mauritius

Third in Africa is Mauritius, which has a sophisticated financial sector; market capitalisation of the island nation’s stock markets is 62% of GDP.

Nigeria, Africa’s biggest economy, has a tiny market cap-to-GDP of just 12.2%, which is a reflection various factors. First, the economy is not as formalised as in South Africa - for example, just 5% of Nigerians shop in formal retail stores, while 70% of South Africans do - so relatively few companies are publicly listed.

It could also be that rich Nigerians tend to invest in “solid” assets such as real estate, and may be less confident about throwing their money in intangible investments like stocks; and also tend to invest abroad, so there is less accumulation of capital locally - perhaps a carry over from the political turmoil that has shaped much of Nigeria’s history. 

Capital flight out of Nigeria - both by wealthy Nigerians and the multinational businesses that dominate the oil and gas industry - has been estimated at $10 billion annually between 1970 and 2008.

Big business wins

Although in South Africa the ANC government came into power in 1994 with promises of redistribution and social justice, big businesses won the day. The ANC government has largely been faithful to the inflation-targeting, economic liberalisation model, with a few (often politically-connected) black South Africans allocated rents in the form of the Black Economic Empowerment programme, but the overall structure has remained intact.

Since 1994, South Africa’s already large and sophisticated financial services sector grew from 15.3% of GDP to 21.4% of GDP in 2009.

It presents a dilemma for the ANC government, which, although it is under political pressure from its black constituency to “deliver the pork” i.e. the economic benefits of democracy, the structural reform needed to reduce the financial sector’s stake in the economy will be painful, and will probably face a strong backlash from big business - who are the major investors in the financial markets.

“South Africa’s enormous structural inequality is holding back the economy and threatening social stability, “ writes journalist and financial analyst Desné Maise in New African Magazine. “The country needs to rethink its relationship to finance – and realise that bigger doesn’t always mean better – if hard-won political equality is to translate into greater economic equality.”

-Additional reporting by Palesa Vuyolwethu Tshandu and Renee Bonorchis, BLOOMBERG

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