Brazil-style tax may not work for South Africa

August 3, 2010

Traders in South African securities woke to a nasty surprise this morning — media reports that the ruling ANC party is considering slapping a tax on “short-term” financial market flows, possibly similar to the 2 percent tax Brazil brought in last October.  Luckily for them,  it may not happen.

Like Brazil, South Africa is worried about the strength of its currency, the rand, which rose almost 30 percent last year against the dollar and has firmed a further 1.5 percent this year to trade near 7.25 per dollar. Analysts like Elisabeth Gruie at BNP Paribas reckon fair value would be around 9 per dollar.  South Africa, like Brazil, is a commodity exporter so needs a fairly valued currency. Hence the call for capital controls to keep out foreign speculative cash.

But the similarities stop there.

Investors may not have cheered the Brazilian tax but few have pulled their cash from the country, betting the returns on offer make the 2 percent levy worthwhile. But South Africa may have a harder time.  Its economy may grow this year by 3 percent compared to Brazil’s 7.6 percent. Johannesburg stocks, especially those of multinational precious metals firms are attractive but they are not cheap — they trade at 11.5 times forward earnings while Brazil’s are at 10.6 times. And the domestic consumption story is still weak in South Africa which makes its companies more vulnerable to the global growth picture.

But the crux of the matter is: South Africa needs foreign portfolio investments more than Brazil does because its record on foreign direct investments is so poor — it ran a current account deficit last year of  96.6 billion rand, ($13.4 billion) which was more than financed by portfolio inflows of 107 billion rand. FDI in contrast was just $6.8 billion or less  than half.  Brazil too expects a large current account deficit this year of $49 billion but 80 percent of this will be financed by FDI.

So South Africa needs that foreign portfolio cash coming into its stock and bond markets or it must work to lure direct investment to its factories and mines. Otherwise it may end up borrowing to fill the deficit. Gruie says the finance ministry and central bank have rightly in the past opposed such capital controls. That’s why when the ANC considers the capital tax proposal at its Sept 20-24 meeting, the answer may well be — No.

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