The US economy continues to show signs of recovery, and this bodes well for emerging and frontier markets. Federal Reserve Chairman Ben Bernanke announced this week that the central bank was willing to provide a further economic stimulus and is likely to maintain interest rates near zero until late 2014 at the latest. This development, in conjunction with other positive economic developments in the world’s largest economy, appears to foretell a shift back towards risky assets such as equity, and out of perceived “safe haven” assets. This could be a major boost for stock markets in Africa, many of which struggled to perform in 2011.
Indeed, on the news that the US would keep interest rates low, thus weakening the Dollar – emerging market equities, the euro and gold all rallied. Keeping interest rates low will drive down the yield on US bonds, thus making emerging market equities a more attractive investment.
Bernanke also hinted at the possibility of another stimulus package, referred to in this article as QE3, similar to those already provided by the US. The effects of QE2 on the global economy were pronounced, and led most notably to a surge in commodity prices. Gold witnessed a stellar leap, as did commodities like cotton. The effects of a possible QE3 could have similar effects, but may also lead to a strengthening of more relatively risky assets such as equity, and in particular emerging and frontier markets equity. The injection of cash should result in sustained rallies in equity investments in many emerging markets, especially considering that at the moment many emerging markets are perceived as being cheap, with South Africa’s JSE All Share Index PE currently below its historical average. Certainly stocks are cheap in Zimbabwe, and with December earnings reports about to hit the market, we can anticipate a lower PE ratio next month.
What sort of effects could a further stimulus package provide for emerging markets? A reliable measure is to look at the previous $600 billion stimulus package, which drove large quantities of money into emerging markets, particularly the BRICs. Commodities increased in price, the Dollar weakened and led to stronger currencies in a number of countries. However, QE2 stoked inflation, and led to monetary tightening in a number of emerging markets. This had the effect of reining in consumption. Zimbabwe’s situation is somewhat different though, because we are a US Dollar-based economy. What are the possible implications for our own market?
Unfortunately Zimbabwe finds itself towards the bottom of the list of frontier markets where foreigners would feel comfortable pumping in FDI in the event of a QE3. However, we may see institutional investors increasing their asset allocations in emerging markets generally, and this may include us. We could see an increase in investment inflows, and the stock market could benefit. The other likely development is the strengthening of the Rand, which has some positive and some negative effects. First of all, because the majority of our imports come from our southern neighbour, we might see an increase in inflation as the Rand strengthens relative to the Dollar. This does, however, present local manufacturers with an additional competitive edge with which to fight imports – if imports are more expensive, local manufacturers can afford to beef up production and invest more heavily in plant and equipment.
The other obvious benefit to Zimbabwe will be a rise in commodity prices such as gold and platinum. Our economy is almost entirely resource-driven, and is therefore at the whim of international markets. A higher gold price could lead to greater investment in the sector, and greater exports. The same could be said for a number of other commodities such as cotton, platinum and sugar.
Lastly, Zimbabwe is perfectly positioned to benefit from a QE3 because of its reliance on the US Dollar. Following the second stimulus package, other African stock markets recorded significant gains, but unfortunately resurgent inflation meant that real (vs nominal) returns declined. Zimbabwe does not suffer from this problem, because investors do not have to be concerned about exchange rates when investing here as we use the US dollar, and this is a significant draw card.
This line of discussion could perhaps serve as an argument against calls from some quarters to adopt another currency based on the perceived decline of the Dollar. Of course there are numerous reasons why Zimbabwe should not adopt the Yuan, or some other currency, and this serves merely to strengthen those arguments. Government’s role in 2012 should therefore be directed towards making Zimbabwe an attractive investment destination relative to its African peers, in an attempt to claim as great a share of foreign direct investment as possible, in readiness for a possible QE3.