A comparative analysis of the dangers of capital inflows.

Abstract

This report examines the effects of running a high current account deficit in conjunction with large short term capital inflows into South Africa. In order to gain a better understanding of such effects, a comparative analysis with the Argentinean economy shall be undertaken. Argentina has experienced episodes of large capital inflows, preceded by periods of minimal capital inflows. This caused an economic slowdown in Argentina. Similarities are evident between the types of inflows into both South Africa and Argentina, with short term portfolio inflows being dominant. Nevertheless, Argentina received roughly 1.75 times the amount of portfolio inflows at its peak capital inflow as compared to South Africa. These figures suggest that South Africa is at a lesser risk (of being overly reliant on short-term inflows) compared to Argentina owing to the lower amount of portfolio inflows, however this is not the case. South Africa has extremely low foreign direct investment (FDI) numbers, which elucidates instability in terms of capital inflows (FDI provides stable inflows of capital for a long period of time). FDI is considered to be a source of long term inflows and thus more stable. Low FDI figures and, high portfolio inflows along with the high current account deficit figures indicate that South Africa may be in danger of being over-reliant on portfolio inflows to finance its high current account deficit. South Africa has been running an average current account deficit of 4.9 percent from 2006-2010, with portfolio inflows as a percentage of total capital inflows from 2006 until 2009, averaging 54 percent.