1. 1 Which policies can reduce the cost of capital in Southern Africa? OECD Development Centre Seminar: "Cheaper Money for Southern Africa - Unlocking Growth" 7 October 2004, Paris Martin Grandes (American University of Paris and OECD Development Centre, Paris) Nicolas Pinaud (OECD Development Centre, Paris)

2. 2 This presentation:  Aim and scope: - What policies can reduce the cost of capital in Southern Africa, whereby promoting investment and growth in the region? Focus: local-currency denominated capital costs - Focus on CMA countries (Namibia, Swaziland, Lesotho, SA) + Botswana: 1992-2004  Policy relevance Post-Monterrey agenda, NEPAD Capital Flows Initiative (CFI), NEPAD-OECD Africa Investment Initiative, OECD Development Centre-sponsored meeting in Johannesburg (March 2004)  Policy recommendations - Why is the real cost of capital relatively high in CMA countries? - What can be done about it?

3. 3  What is the cost of capital for a company? Two pivotal concepts: 1) WACC = weighted average cost of capital (debt or equity) = cost of the debt/equity blend raised by the company Why a lower cost of capital is key to boosting investment and growth in less developed countries?

4. 4  More specifically, what is the cost of capital for an emerging country’s company? Debt Cost Why a lower cost of capital is key to boosting investment and growth in less developed countries?

5. 5  More specifically, what is the cost of capital for an emerging country’s company? Equity Cost Why a lower cost of capital is key to boosting investment and growth in less developed countries?

6. 6  What is the cost of capital for a company? Two pivotal concepts: 2) The hurdle rate EVA = Return on investment – WACC (cost of capital) (EVA: Economic value-added) Hurdle rate = breakeven rate: EVA = 0 ☞ The higher the EVA, the more incentive for investment  Increase the returns on investment or...  Lower the hurdle rate, i.e. the WACC - Bring the total risk premium down or… - Await a US monetary loosening cycle

7. 7 Financing costs: Where do CMA Countries Stand?  South African rates set the floor and the tune for CMA countries’ interest rates CMA a hybrid between monetary union and currency board (PB p.9) CMA a hybrid between monetary union and currency board (PB p.9) Consider, for instance the cost of debt for a CMA country Consider, for instance the cost of debt for a CMA country  Interest rates or bond yields in CMA should converge, unless there is a significant country premium….

8. 8 Why is the real cost of capital relatively high in CMA countries?

9. 9  South African rates set the floor and the tune for CMA countries’ interest rates  CMA countries’ interest rates are high compared with in OECD countries

10. 10 Why is the real cost of capital relatively high in CMA countries?  South African rates set the floor and the tune for CMA countries’ interest rates  CMA countries’ interest rates are high compared with in OECD countries  Why? Because so are South African financing costs! Equity costs for an ungeared South African company: Equity costs for an ungeared South African company: - About 15%: South African RFR: 10% (incl. Intern. RFR 4%) Equity risk premium (ERP) of 5% - By comparison, US: 8% = RFR of 4% + ERP of 4% Debt costs: Rand currency debt costs for companies are even higher because of little appetite of South African investors for bonds… Debt costs: Rand currency debt costs for companies are even higher because of little appetite of South African investors for bonds… ☞ High debt and equity costs → high WACC → low investment

11. 11  Some elements of the macroeconomic policy framework implemented since the mid-1990s might have had some adverse impact on the real cost of capital in South Africa: Structurally low savings; taxation policies not conducive to higher surplus Monetary and exchange policy developments High and volatile rand premium Then, why is the real cost of capital so high in South Africa?

12. 12  South African spread on local currency denominated bonds has been essentially driven by the rand currency premium Then, why is the real cost of capital so high in South Africa? ☞ It’s the “Rand Premium” which accounts for high levels of interest rates differentials in CMA countries.

13. 13  Some elements of the macroeconomic policy framework implemented since the mid-1990s might have had some adverse impact on the real cost of capital in South Africa: Structurally low savings; taxation policies not conducive to higher surplus Monetary and exchange policy developments High and volatile rand premium: - “peso problem”? - “Zim effect”? Specific features of the local financial industry + liquidity premium On the demand side, little appetite for risks On the supply side, restrained scope for diversification Then, why is the real cost of capital so high in South Africa?

14. 14 Macroeconomic and financial policies in South Africa  Why making the case for cheaper local currency denominated resources...after all?  A pivotal prerequisite: to carry on with the “good” macroeconomic management which has prevailed since the mid-90’s Fiscal (Ahmed, 2004) and monetary indicators (Grandes, Peter & Pinaud, 2003) are found the main determinants of the SA sovereign and currency premium respectively. South Africa, a “no original sin country” High real cost of capital in Southern Africa: what can be done about it?

15. 15 Macroeconomic and financial policies in South Africa  Why making the case for cheaper local currency denominated resources...after all?  A pivotal prerequisite: to carry on with the “good” macroeconomic management which has prevailed since the mid-90’s  However, further bold policy steps are required to lower capital cost in South Africa: –To enhance the development of the domestic bond market –To prop up domestic savings –To complete structural reforms –Decoupling from risks of political instability in the region (e.g. Zimbabwe) High real cost of capital in Southern Africa: what can be done about it?

16. 16 Macroeconomic and financial policies in South Africa  Why making the case for cheaper local currency denominated resources...after all?  A pivotal prerequisite: to carry on with the “good” macroeconomic management which has prevailed since the mid-90’s  However, further bold policy steps are required to lower capital cost in South Africa  Issues remaining open to debate: Residual exchange control regulations on South African residents The inflation targeting regime The exchange rate policy High real cost of capital in Southern Africa: what can be done about it?

17. 17  Resource gap on the African continent to meet NEPAD growth objectives & MDGs requirements  Developments in capital flows to Africa over the period 1995-2002 do not bode well for the future The Johannesburg financial centre as a regional “financial hub”: relevance, impediments & challenges ahead High real cost of capital in Southern Africa: what can be done about it?

18. 18  Rationale & relevance Political willingness in South Africa (see Mr. Manuel statements, FT) Political willingness in South Africa (see Mr. Manuel statements, FT) Liquid and sophisticated financial markets unrivaled on the continent; Liquid and sophisticated financial markets unrivaled on the continent; A reliable, stable and comparatively business-friendly legal and political environment; A reliable, stable and comparatively business-friendly legal and political environment; A unique position of ”No-Original Sin” country enjoyed by South Africa: potential benefits for CMA countries A unique position of ”No-Original Sin” country enjoyed by South Africa: potential benefits for CMA countries High real cost of capital in Southern Africa: what can be done about it? The Johannesburg financial centre as a regional “financial hub”: relevance, impediments & challenges ahead

19. 19 High real cost of capital in Southern Africa: what can be done about it? The Johannesburg financial centre as a regional “financial hub”: relevance, impediments & challenges ahead  Impediments Remaining capital control regulations in South Africa re: the access of foreign (excl. CMA countries) entities to SA financial markets Remaining capital control regulations in South Africa re: the access of foreign (excl. CMA countries) entities to SA financial markets Lack of opportunities and risky lending activities in neighboring countries. Only bank lending, despite excess of liquidity Lack of opportunities and risky lending activities in neighboring countries. Only bank lending, despite excess of liquidity Risks: regional financial integration might reinforce the role of South Africa as a magnet for neighboring countries’ capital seeking investment opportunities Risks: regional financial integration might reinforce the role of South Africa as a magnet for neighboring countries’ capital seeking investment opportunities South Africa’s Net Foreign Asset position with Africa (source, Thomas, 2004)

20. 20 The Johannesburg financial centre as a regional “financial hub”: relevance, impediments & challenges ahead  Challenges ahead Still, South Africa’s capital pool is shallow and narrow by G-7 standards. Strengthening of local financial systems in neighboring countries with a growth-enhancing view (Aziakpono, 2004). More and profitable investment opportunities are wanted! Removal of remaining capital controls to non CMA residents in South Africa. Would foster market liquidity but caution with potential heightened volatility Reduce the “Rand Premium”  Channeling resources through a financial hub located in Johannesburg alone will be no miracle recipe High real cost of capital in Southern Africa: what can be done about it?