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SA now harbinger for battered commodity economies

Waldo Swiegers | Bloomberg | Getty Images

South Africa, one of the emerging market's biggest success stories in recent years, is rapidly becoming a canary in the coalmine known as the commodities washout.

A deepening tumble in commodity prices — a fast moving train wreck that's been barreling down the tracks of the global economy since last year — has been linked directly to China's economic slowdown. For the first time in nearly a decade, investors are yanking more money out of emerging markets than they are putting in, a new report from the Institute of International Finance stated on Friday.

With the emphasis being on China and other Asian countries, investors have largely ignored developing economies such as South Africa, the continent's second-biggest economy and one highly dependent on natural resource demand. Sub-Saharan Africa is a net exporter of primary commodities, according to the World Bank, which becomes a mixed blessing when major markets that account for much of global demand stagnate or fall into outright recession.

Meanwhile, South Africa is becoming an exponent of the sell-off hammering global markets. Tumult in the world economy—and the G20 country's own structural challenges—recently sent its currency, the rand, to a record low. The rand's swoon is part of what Bernd Berg, a portfolio manager and strategist with Societe Generale, recently called an "unprecedented" tumble in emerging market currencies.

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Table Mountain, Cape Town
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Table Mountain, Cape Town

Economists note that the swift deterioration in these currencies stems from a worsening of domestic fundamentals and a weak external backdrop. After growing in the first three months of the year, South Africa's economy shrank by 1.3 percent in the second quarter, heightening fears of a full-fledged recession.

As a result, a perfect storm could very well be brewing for South Africa and its cohorts in the BRIC economies, which include Brazil, Russia, India and China. Last week, the International Monetary Fund warned that South Africa and other commodity-lined economies would likely see nearly a full percentage point shaved from their annual growth over the next two years.

Developing market capital flight "is most dangerous for the currencies of countries that face a sizable current account deficit and rely on short-term capital inflows," Berg said, issues that bedevil South Africa's economy.

South Africa's markets have not been spared from what has become a significant slump in the demand for emerging market bonds and equities since late July. According to investment bank Barclays Africa (Absa), the threat of a potential rate hike from the Federal Reserve and China slowdown fears have hit South Africa and other emerging markets hard.

Coupled with China's slowdown, analysts say there has been a growing loss of confidence in the big emerging market success stories of the last few years, which is now feeding into South Africa's woes. The downward spiral in Africa's economic powerhouse is dovetailing with the seeming demise of the commodities "super-cycle" that may get worse if the Fed follows through on a threat to tighten monetary policy.

"On a year-to-date basis, [South Africa's capital] inflows are still up on the year, equity inflows remain at six-year highs and SA's current account deficit has narrowed in recent quarters," Mike Keenan, a Johannesburg-based economist with Absa said in a research note last month.

"However, South Africa still has relatively large external funding requirements, which is why these waning portfolio flows remain a concern for both the country's balance of payments and its exchange rate outlook," he added.