South Africa: Grey listing still avoidable, but time is running out

LAGOS (Capital Markets in Africa) – A preliminary evaluation report compiled by the Financial Action Task Force (FATF) in October 2021 showed that South Africa complied with only three of the group’s 40 benchmark recommendations to combat illicit financial activity. South Africa has until October 2022 to put forward a credible plan that maps out how government intends to address deficiencies in the country’s ability to investigate and prevent illicit financial activity. Failing to do so will likely result in South Africa being grey listed when FATF members convene for a plenary vote in February 2023. The FATF is an inter-governmental body that sets anti-money laundering standards. When the FATF places a jurisdiction under increased monitoring, it means that a country has agreed to resolve its identified deficiencies within a specific time frame and is subject to increased monitoring during this period. The latter list is often referred to as the ‘grey list’. Across Africa, countries alternate intermittently through FATF’s grey list.

According to the financial watchdog’s website, there are currently 23 “jurisdictions with strategic deficiencies”, including Panama, Syria and Yemen. Six African countries are considered to have strategic deficiencies. A small number of Southern African countries were removed from the grey list not long ago – the most recent of which was Zimbabwe earlier this year. South Africa’s other northern neighbour, Botswana, was voted off the grey list in October 2021, having initially been grey listed in October 2018. The island nation of Mauritius was added to the infamous grey list in February 2020, and after addressing the strategic deficiencies in its Anti-Money Laundering and Counter-Terrorism Financing (AML/CTF) regime, was also removed in October 2021. What’s more, in January 2022, the European Commission removed Mauritius from the European Union’s ‘blacklist’ of high-risk countries suspected of having “strategic deficiencies in their anti-money laundering and counter-terrorist financing frameworks” – Mauritius was blacklisted in May 2020.

South Africa could become the second G20 nation after Turkey to be grey listed. That said, in the likely event that South Africa does get added to FATF’s grey list, the country’s largest banks’ risk management frameworks should allow them to navigate this environment as these institutions currently operate in African countries that have been grey listed in the past.

Markets will not be caught off guard
The exact extent of the economic fallout expected from a potential grey listing varies, but the general agreement is that South Africa will suffer acute reputational damage, the cost of doing business and raising international finance will go up – making it harder to do business, facilitate cross-border payments, ultimately thwarting foreign investment. And while the local assets have, to some extent, priced in the probability of a potential grey listing, short-term reaction is to be expected. Bond yields might rise sharply for a brief period, and given how quickly the rand can change in value, we highlight currency depreciation as another potential risk factor. After averaging R15.41/$ during H1 2022, South Africa’s rand has come under renewed pressure and is currently oscillating just above the R17-level. Broad US dollar strength and growing concerns about an economic slowdown – both at home and abroad – are weighing on risk sentiment, and we expect the rand to come under pressure in H2 2022. The local unit is anticipated to reach R16.94/$ by year-end, averaging R16.89/$ during the final six months of the year.

Other notable latent risks include the possibility of capital outflows during a period when the external environment has become less favourable for emerging markets. Although some analysts have likened grey listing to a sovereign credit rating downgrade, a massive capital exodus is unlikely. Fitch Ratings recently said that a potential grey listing event will not change South Africa’s sovereign credit rating or ratings outlook. Moreover, Russia’s self-sanctioning and frail macroeconomic fundamentals across the emerging-market world imply a fairly limited universe of alternative investment destinations. Moreover, South Africa boasts sound financial markets, underpinned by robust monetary policy credibility. A key risk for emerging markets and developing economies at the moment is the likelihood of capital outflows and currency weakness, as this could lead to even higher inflation and weigh on economic activity as policy tightening is ramped up.

Possible grey listing has been years in the making
Corruption flourished under former President Jacob Zuma’s tenure, and state capture had become entrenched in South Africa, crippling the economy. Acting Director-General of the National Treasury, Ismail Momoniat, has said that South Africa is doing everything within its power to prevent a grey listing. The government recently introduced two key pieces of legislation in Parliament. The Protection of Constitutional Democracy against Terrorist and Related Activities Amendment Bill was tabled in the Portfolio Committee on Police on July 19 and the General Laws Amendment Bill (Anti-Money Laundering and Combating Terrorism Financing Bill) was tabled in the Standing Committee on Finance on August 29. Both bills are subject to parliamentary procedures, including a public participation process, and the odds of having the bills clear the legislature before it goes into recess in late November or early December 2022 are low. Parliament will only resume with the State of the Nation Address (Sona) in mid-February 2023.

Several recent high-profile arrests have raised hopes that State Capture-related prosecutions are finally set to launch. The most significant of these was the arrest of former Transnet CEO and African National Congress (ANC) MP Brian Molefe and former CFO Anoj Singh on August 29. The cases are the most high-profile yet enrolled by the National Prosecuting Authority’s (NPA) Investigating Directorate (ID), a specialised unit launched to much fanfare in 2019 but which has failed to impress. Hopes have been raised that more arrests will follow. That said, it all boils down to whether the South African government can demonstrate it has made enough progress to fill the deficiencies in its ability to investigate and prevent financial crimes.

Contact author: Jee-A van der Linde, Economist – javanderlinde@oxfordeconomics.com.