Determinants of Financialisation in South Africa: A Balance Sheet Approach Rex A McKenzie October 3 rd 2013 Pretoria, South Africa

Focus of the paper This paper focuses on the process of finacialisation in South Africa. Financialisation is defined after Krippner (2005) and Arrighi (1994), as a pattern of accumulation in which profits accrue through financial markets and channels rather than through trade or commodity production in the real economy. We examine the financialisation of the South African economy from 1990 to 2012—both before and after major financial market liberalizations. 2EDD/UNDP/UNDESA/CSID

Five key features First, a precipitous increase in the size of the net acquisition of financial assets (and the net incurrence of financial liabilities) on the balance sheets of all agents. 3 EDD/UNDP/UNDESA/CSID

1. Net Acquisition of Financial Assets 4 EDD/UNDP/UNDESA/CSID

1. Net incurrence of financial liabilities 5 EDD/UNDP/UNDESA/CSID

2. JSE market capitalisation /portfolio flows Third a measureable relationship between levels of Johannesburg Stock Exchange (JSE) market capitalisation and levels of portfolio capital inflows. Model 1: A 10% growth in market capitalisation induces a 26. 1% increase in portfolio inflows. Further, there is a positive relationship between growth in money supply and portfolio flows. The results further shows that a 10% growth in money supply will result in an approximately 5% increase in portfolio flows. Last, the results show that there is a negative relationship between openness of the economy and portfolio flows, a 10% increase in openness will reduce portfolio flows by about 1.12%. The results tell us that market size, interest rate and previous portfolio flows were all insignificant determinants of portfolio flows in the period under study. 6 EDD/UNDP/UNDESA/CSID

2. JSE market capitalisation /portfolio flows Model 2: A 10% increase in market capitalisation results in approximately 30% increase in foreign portfolio investment. The model shows a positive relationship between an increase in money supply and portfolio flows; a 10% increase in money supply results in a 4.4% increase in portfolio flows. The model also shows that a 10% depreciation of the rand results in 1.2% increase in portfolio flows. Last, the results show that there is a negative relationship between openness of the economy and portfolio flows. 7 EDD/UNDP/UNDESA/CSID

3. Centrality of Credit and Foreign Funds 2012, provides a good overview of the financial inter- connections across the main sectors of the South African economy in The largest recipient of foreign sector funds in 2012 was the NFI sector, followed by the general government sector. The general government sector received R84 billion and the NFI, R116 billion. The NFI’S subsequently extended R98 billion to the general government sector, which allowed government to fund its net borrowing position of R194 billion. The MFI’S overall held a net lending position of R69 billion, from which it extended R66 billion to the NFI’S (Monyela and Nhelko, 2013). 8 EDD/UNDP/UNDESA/CSID

3. Centrality of Credit and Foreign Funds 66 MFI'S NFBS (82) 98 General Govt. 10 (194) 84 1 Households Foreign Sector 2 9 EDD/UNDP/UNDESA/CSID

4. Credit effects that overwhelm portfolio shift effects Duc and Breton 2009; According to the authors; “Variations in money holding by agents can be broken down into changes in the total financial assets held by agents and changes in the share of liquid assets within this total amount.” The authors identify two main sources of changes in the money holdings of non-MFI sector; the first is a “credit effect” where the rise in total financial assets of non-MFI is mainly due to credit. The second is a “portfolio shift effect” representing the shift between money and more illiquid financial assets in the total financial assets held by non-MFI. 10 EDD/UNDP/UNDESA/CSID

4. Credit effects that overwhelm portfolio shift effects The following identity formalises the distinction: M ≡ (M/FA) × FA Where, M stands - money and FA - (total) financial assets. FA represents the “credit effect”, and M/FA represents the “portfolio shift effect.” 11 EDD/UNDP/UNDESA/CSID

4. Credit effects that overwhelm portfolio shift effects 12 EDD/UNDP/UNDESA/CSID

5. High degree of financial intermediation Fifth, and last an unusually high degree of financial intermediation (when compared with the Euro zone area) that may be explained by the high degree of concentration in South Africa’s Monetary and Financial Institutions Sector (MFI’s). 13 EDD/UNDP/UNDESA/CSID

High degree of financial intermediation Aim is to assess developments in “market” financing versus “bank financing” in the South African economy. In other words, we want to quantify and thereby measure intermediation tendencies in the local economy. 14 EDD/UNDP/UNDESA/CSID

High degree of financial intermediation 15 EDD/UNDP/UNDESA/CSID

Conclusion From a policy point of view one big question emerges – given the constellation of financial intermediation in South Africa, its unique concentration, and the dominance of MFI credit effects in explaining changes in the liquidity holdings of agents - what can we say about the workings of monetary policy? Presumably the dominance of finance houses, their credit products in particular, and their large shadow over the macro-economy must have some impact on the workings of monetary policy. A lesser question relates to the impact of debt on the balance sheet of agents. Net incurrence implies debt, and as net incurrence grows so does debt; at what level does the debt become excessive so as to become a constraint on the agent and economic growth in the economy as a whole? Definitive answers to these questions will not be forthcoming until more studies and more research efforts are directed at these issues. For now we have a basic roadmap that can be used to define a research project focusing on the five key areas identified in the forgoing. EDD/UNDP/UNDESA/CSID16