Higher interest rates less likely to curb capital outflow to SA

Standard Bank’s manager of economic and market research, Mally Likukela.

Higher interest rates as a result of interest alignment in the Common Monetary Area (CMA) are less likely to stop capital outflow to South Africa, let alone reverse it to Namibia, because the fundamental cause of capital outflow to South Africa goes beyond the interest rate differential between the two countries.

Therefore, the use of tighter monetary policy to align interest rates with the hope of curbing capital outflow will only result in higher cost of borrowing and increased possibility of debt defaulting in Namibia.

Although conventional wisdom suggests that higher interest rates can stem capital flight, very often higher interest rates have only managed to increase the probability of debt default and led to anti-orthodox effects, particularly when the two options (countries) are not perfect substitutes.

Before we explore some of the factors that contribute to a biased (or skewed) capital outflow to South Africa, let us first describe what capital outflow actually is.

Capital outflow

Capital outflow is the amount of money that leaves a country’s economy  and is then kept or invested in other countries during a particular period. Outflowing capital can be caused by any number of economic, or political reasons but can also originate from instability in either sphere.

Regardless of the cause, capital outflow is generally perceived as always undesirable and many countries create laws to restrict the movement of capital out of their borders, called capital controls. If they are assumed to be caused by interest rate differentials, monetary authorities usually align their interest rate with the anchor country (as recently observed by the Bank of Namibia’s decision on April 12, 2016).

Causes of capital outflow to SA:

 Proximity to a larger and more developed financial market

Namibia is a neighbour to one of the world’s most developed and sophisticated financial market by size and quality. At December t 31, 2014 the total market capitalisation of the Namibian Stock Exchange (NSX) was only N$1.680 billion, compared to the Johannesburg Stock Exchange (JSE), one of the world’s 20 largest exchanges by its market capitalisation of just over U$1 billion. It is the largest exchange in Africa.

The risk and perceptions are quite different – making the two markets not perfect substitutes – and in favour of South Africa. The significance of South Africa’s capital markets in the economy and the region is substantial compared to Namibia’s market.

The market capitalisation of the JSE is 294 percent the size of the country’s US$324 billion gross domestic product, according to data from the World Federation of Exchanges, Thomson Reuters Datastream and the IMF. The currency, bond and derivatives markets are all among the world’s twenty largest by turnover.

Thus regardless of the difference in level of interest rate, South Africa will always be regarded as a better investment option for investors by virtue of its size and stage of development.

Historical linkages

The historic and political origin of Namibia, its institutions and policies continue to influence the direction of capital flows. Given that Namibia enjoys a very deep intimate relationship with its larger-than-life neighbour, South Africa, the economy of Namibia is closely connected to South Africa through both institutional relationships – for example the Southern African Customs Union – and a number of privately owned South African companies.

The South African Rand is a legal currency in Namibia and the currencies are traded on par locally. Namibia continues to depend on South Africa as a major source of imports. The import bill from South Africa rose by 19.8 percent to account for N$62 billion in 2015. South Africa remains the second largest export destination, accounting for about 19.5 percent of all exports (second only to Botswana)  totalling about N$11.4 billion.

Economic Integration

Namibia is a member of the CMA, hence the free flow of capital between the member countries. However, because South Africa has more developed financial markets, capital flows in the CMA are skewed to that market and any efforts – whether fiscal, monetary or otherwise – to limit the outflow of capital to South Africa remain futile and will not yield the intended results.

In fact, the main objective of free capital mobility is to foster the integration of member countries’ financial markets towards each other – and the Rand (South Africa) being the anchor currency, it draws all capital towards itself.

Diversification reasons

Capital outflow from Namibia to South Africa will persist, due to the high savings of institutional investors – mainly insurance companies and pension funds – that seek to diversify. Diversification is a technique that reduces risk by allocating investments among various financial instruments, industries and other categories.

It aims to maximise returns by investing in different areas that would each react differently to the same event. Most investment professionals agree that, although it does not guarantee against loss, diversification is the most important component of reaching long-range financial goals while minimising risk.

Domestic pension funds, as well as medical and insurance assets have grown noticeably over the past years. As a result of this growth, these institutions had to operate and comply with certain investment prudential guidelines. In an attempt to comply with these investment mandates, these institutional investors have designed an asset allocation strategy that enhances high returns with minimal risk.

As part of their diversification strategy, these institutions have been extending their asset class holding beyond the borders of Namibia by holding shares on the South African Stock Exchange. One can safely conclude that the main reason for outflow is an attempt by these institutions to diversify their portfolio risks and increase returns for savers.





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