Daniel Mminele: The importance of well-developed and functioning
capital markets for growth and development
Address by Mr Daniel Mminele, Deputy Governor of the South African Reserve Bank, at the
Opening Ceremony of the 1st South Africa-China Capital Market Forum conference,
Johannesburg, 7 August 2013.
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1. Introduction
Good evening ladies and gentlemen. Allow me to extend a special welcome to our visitors
from China. Thank you to the Johannesburg Stock Exchange, Shanghai Stock
Exchange and Frontier Advisory for inviting me to speak at this inaugural conference
of the South Africa-China Capital Market Forum. This initiative bears testimony to the
growing relationship between China and South Africa.
In the 15 years since the establishment of official relations between China and South Africa,
cooperation between the two countries has improved immensely. A number of Memoranda
of Understanding ("MoUs") have been signed, Foreign Direct Investment (FDI) has picked
up, and bilateral trade between the two countries has surged. China became South
Africa's biggest trading partner in 2009 and is now the largest destination for South Africa's
exports. With respect to FDI, China is actively involved in mining, manufacturing and
construction with China's FDI presence growing from around R340 million in 2005 to
roughly R50 billion in 2012. The most notable FDI transaction was in the banking sector,
specifically, the 20 per cent stake that Industrial and Commercial Bank of China acquired in
Standard Bank for US$5.5 billion in 2007.
South Africa and China also cooperate in various international groupings, including the
G20 and more recently as part of BRICS. South Africa, as you know, was invited to join the
BRICS group when China was the chair and successfully hosted the 5th BRICS Summit
earlier this year when it assumed chair of BRICS for 2013. Having been already allotted
an investment quota, at this Summit, the South African Reserve Bank (the Bank) and
People's Bank of China (PBoC) signed an agency agreement enabling the Bank to invest
in China's interbank bond market through the People's Bank of China. South Africa was
the first country on the continent to be given access to the Chinese onshore bond market
in this way. As part of the growing importance of trade between our countries, this
represents an opportunity to diversify the country's foreign exchange reserves accordingly,
and to invest in the world's fifth largest bond market which continues to grow rapidly,
both in depth and liquidity. Currently, the BRICS are negotiating both a Contingent
Reserve Arrangement (CRA) and the establishment of a New Development Bank (NDB).
The CRA is a type of financial safety net in the form of a self-managed facility
through which BRICS countries can provide mutual support to each other when dealing
with short-term liquidity and balance of payment pressures, and will likely take the form of
a swap agreement, with an initial size of US$100 billion. The aim of the NDB is to
mobilise resources for infrastructure and sustainable development projects in BRICS.
Chief Negotiators have been appointed by each country and have commenced negotiations
around issues such as membership; governance; capital size; structure and articles of
agreement, amongst others.
2. The importance of capital markets
Literature around the relationship between capital market development and economic
growth goes as far back as 1873, when Walter Bagehot (followed by Joseph
Schumpeter and John Hicks in the 1900s) pointed out that industrialisation in most of the
developing countries was due to the availability of the financial system to mobilise
productive financial capital. Today this remains a widely debated topic, with some division
among economists regarding the importance of finance for growth and the causal
relationship between the two. Some would argue that financial development is not important
and that it is actually economic development which creates the demand for financial
instruments. Others would concur with Bagehot and argue that a well-developed financial
system improves the efficiency of financing decisions, supports a better allocation of
resources and therefore promotes economic growth and development. Well-developed
capital markets not only support growth, but the ability to diversify sources of finance
stable
helps to foster more growth by ensuring that shocks to the supply of bank credit do
not impede growth. I would certainly lean towards the camp that argues that the financial
system is without a doubt essential for economic growth. To quote the words of Former
British Prime Minister Gladstone "...finance is, as it were, the stomach of the country, from
which all the other organs take their tone."
Various studies conducted over the years, found that equity market liberalisation led, in
some instances, to over one percentage point of additional economic growth in those
countries that implemented them in the late 20th century. In addition, as long as domestic
government debt remains at moderate levels, the growth of bond markets contributes
positively to economic growth and provides a basis for the development of other capital
markets. Such studies point out, however, that it is those countries with the highest
quality institutions that benefit the most in terms of growth, that is, institutions need to be
strengthened along with financial development, for without this, markets can become
fragile and pose a threat to financial stability and ultimately growth. Key in this regard is
good governance frameworks, transparency and accountability.
Well-functioning capital markets are particularly important to a country's long-term
financing needs as they help mobilise resources and efficiently direct the flow of
savings and investment inside an economy in a manner that facilitates the accumulation of
capital and the production of goods and services. In a similar way, the existence of robust
financial markets and institutions also facilitates the international flow of funds between
countries. Deep and liquid capital markets not only help provide finance for government
but also increase the benefits of financial integration and improve the resilience of countries
against shocks.
In the absence of well-developed financial markets, it becomes costly to raise capital,
information tends to be limited and there is a lack of financial transparency, which means
that information is not as readily available to market participants, and risks are likely to
be perceived to be higher than in economies with more fully- developed financial
systems.
The G20 has recognised the importance of developing local currency bond markets and in
this vein adopted an Action Plan to Support the Development of Local Currency Bond
Markets (LCBMs) in 2011. The Action Plan recognized that financial deepening in general,
and LCBM development in particular, could enhance the stability of the international
monetary system by (i) raising capacity of economies to absorb volatile capital flows and
intermediate them efficiently and safely; (ii) reducing reliance on foreign savings; (iii)
attenuating external imbalances; (iv) mitigating the need for large precautionary reserve
holdings; and (v) improving the capacity of macroeconomic policies to respond to
shocks by allowing balance sheets to adjust more smoothly.
A recent guest post by Jingdong Hua of the International Finance Corporation notes that
capital markets have been a driver of China's economy, which has displayed remarkable
growth of roughly 10 per cent over the past three decades. China has introduced a
number of innovative reforms to spur the development of its domestic markets, including
amongst others, increasing the ceiling on its Qualified Foreign Institutional Investor (QFII)
programme, and doubling the amount of domestic stocks and bonds that foreign institutional
investors are allowed to buy.
Some steady progress has been made over the past number of years in developing
Africa's capital markets, but these still remain shallow and illiquid and tend to be small
and fragmented, owing to a number of factors including low income levels; weak judicial
systems; and scarcity of human capital and financial infrastructure. The financial sector is a
key driver of growth in South Africa. The South African economy has over the years steadily
moved towards being a service oriented economy. As a percentage of economic output, the
tertiary sector accounts for almost 70 per cent in real terms, with the finance, insurance, real
estate and business services making up 34 per cent of the tertiary sector.
South Africa stands out on the continent as having the most well-developed and liquid
financial markets. Across emerging market countries, South Africa also compares favourably
with its peers. Turnover in fixed-income securities trading on the JSE has been gradually
increasing, from below R10 trillion in 2004 to a record of almost R23 trillion in 2012.
Turnover on the equity market over the same period increased from R950 billion and
reached R3.4 trillion in 2012. Market capitalisation on the equity market is roughly R9 trillion
and R2 trillion for the debt market.
There is no doubt about the many benefits that South Africa has reaped from having
welldeveloped capital markets. The local currency bond and equity markets helped cushion
the country during the financial crisis, helping to absorb capital inflows, reduce the
dependency on foreign debt and therefore limit the adverse effects of the global crisis.
The liquidity of this market, combined with investors' search for yield in recent years, has
seen non-residents become the largest investor base for government funding, holding
close to 40 per cent of government bonds (a ratio similar to Poland, Indonesia, Mexico and
Malaysia), from 10 per cent at the beginning of the crisis and exceeding the 28 per cent
held by pension funds. The South African bond market is well developed in the sense that
it is not only dominated by financial institutions and the government, but also comprised of
a large number of non-financial corporates, while the maturity extends beyond 30 years.
The biggest challenge in South Africa has been that of developing secondary market
liquidity in the corporate bond market, while a more developed derivatives market would add
to the depth of the market.
Although not a typical central bank function, the South African Reserve Bank initially played
an active role as participant in the development of the domestic government bond market
through its various phases of development. The Bank played an active role in developing
the secondary bond market in the 1990s as the sole market maker, and played a
leading role in bond derivatives, inter alia to ensure continued net selling of government
bonds in adverse market conditions. In the late 1990s, the Bank reduced its involvement in
the secondary market, which at the time was judged to be sufficiently mature.
Capital markets of course also play an important role in policy making, providing
instantaneous feedback to policy makers on market expectations and perceptions of policy.
Such perceptions and expectations are reflected in bond and equity risk premia.
Having noted the benefits of well-developed financial systems, my remarks would be
incomplete without at least briefly referring to the global financial crisis and how this may
have changed the views of some on the positive impact of financial development and the
role of markets. John Lipsky, former IMF First Managing Director, put it very well when
he said that "...much of this reassessment is natural and sensible. However, it is fair to
say that the idea that financial markets are not perfectly self-regulating does not represent
a novel insight. To the contrary, there are good reasons why they are regulated
universally." In a nutshell, this highlights the importance of regulation and effective
supervision in order to try and avoid a repeat of the global financial crises, which led to
an economic and sovereign debt crisis, which after 6 years the world economy is still
struggling to recover from. However, it is also important that regulation is appropriately
calibrated, and that a defensible balance is struck between ensuring maximum benefit
from capital markets through innovation on the one hand, and the need to protect markets
and financial systems that may be still be in their infancy or not yet sufficiently
developed on the other. Particular care needs to be taken when formulating global
regulatory standards that do not appropriately take account of country-specific
circumstances and may have unintended consequences.
Let me now conclude by congratulating you on this important initiative, which will
contribute to the further development of efficient and well-functioning capital markets in both
countries, and also promote regular interaction between issuers, investors, brokers and
others in the interest of growth and development. I wish you every success in your
endeavours, and no doubt you will go from strength to strength in years to come.
I thank you.