How is grey-listing likely to affect South Africa?

The Financial Action Task Force (FATF) has given the country until the end of January 2025 to fix eight strategic deficiencies related to the implementation of its anti-money laundering/combating the financing of terrorism (AML/CFT) laws. This is after the FATF announced on Friday afternoon that it had added South Africa to its grey list.

South Africa and Nigeria were added to the FATF’s list of countries under special scrutiny to implement standards to prevent money laundering and terrorism financing, the organisation said after the end of its plenary meeting in Paris.

Cambodia and Morocco were removed from the list. Of the 24 grey-listed countries, only South Africa and Turkey are full members of the organisation.

Read: EXPLAINER: How did South Africa end up on the grey list?

Asset managers’ perspectives

Since the prospect of the country being grey-listing started to loom on the horizon in the second half of 2022, there has been much speculation about how grey-listing may impact the economy, the financial system, and individuals – with some predictions more dire than others.

Allan Gray portfolio manager Sandy McGregor points out that grey-listing does not mean there is a ban on doing business with South Africa.

“Rather, all jurisdictions are encouraged to apply enhanced diligence in financial transactions with grey-listed countries to ensure that the guidelines of the FATF are not breached. However, in practice, given the box-ticking methodologies characteristic of compliance systems, grey-listing does impede inward capital flows and imposes increased compliance costs on the financial institutions within the country subject to enhanced diligence,” McGregor wrote in the asset manager’s fourth-quarter 2022 Quarterly Commentary.

McGregor continued: “Grey-listing should not seriously impede foreign investment in South Africa. Private sector companies in South Africa are well regarded and have long-established financial links, which will continue to operate. Trade between South Africa and the rest of the world will continue, especially as the world needs South African raw materials. Legitimate investment abroad by South Africans will continue.

“However, capital flows will be subject to more complex due diligence procedures, which could have a cost. Also, domestic interest rates could be somewhat higher because capital from certain foreign institutional investors will no longer be available.

“The cost of funding government debt will increase and accessing green finance for the energy transition will become more complicated. The total impact of these costs is difficult to quantify but should be manageable.

“Anything which reduces inward capital flows has an adverse impact on the rand exchange rate. However, the market does not depend on rating agencies or FATF grey- listing to decide whether a country is investable; it makes its own judgement long before these institutions make their pronouncements. For example, the market downgraded South Africa to sub-investment grade prior to the rating agencies.

“The impact of grey-listing arises because certain institutional investors are precluded by internal rules or by rules imposed by regulators from investing in grey-listed institutions. However, this will be of less importance than the principal determinants of the exchange rate, such as trade flows, international monetary policy, and the behaviour of the South African government.”

Peter Attard Montalto, the head of capital markets research at Intellidex, told Bloomberg earlier this week that the immediate impact of grey-listing is likely to be muted because South Africa’s myriad problems mean international banks have already placed the country in a higher risk category and markets have already priced in the move.

Sangeeth Sewnath, the deputy managing director of Ninety One, was quoted as saying that grey-listing will damage the country’s reputation, and higher transactional, administrative and funding costs will result in a less efficient economy with more frictional costs.

“Ultimately, the length of South Africa’s stay on the grey list will depend on how seriously the recommendations are taken, and how effectively the deficiencies are addressed,” Business Day reported him as saying on Friday.

In October 2022, Moonstone published an article by Anchor Capital that addressed the difficulties in quantifying the exact impact of grey-listing on capital flows.

Read: Grey-listing: what are the implications for the financial sector and the greater economy?

Potential impact on GDP and state companies

In the same month, Intellidex published a research report outlining two scenarios South Africa could expect if it exits grey-listing in the short term (18 to 24 months) or if grey-listing lasts longer (five years or more).

Optimistically, grey-listing could cost less than 1% of GDP a year because of higher international transaction costs. In a pessimistic scenario, grey-listing could reduce GDP by two to three percentage points a year, recovering gradually once grey-listing is lifted, Intellidex said.

Read: Research report advises South Africans to prepare for grey-listing

In September 2022, S&P Global Ratings said grey-listing would probably hurt state-owned enterprises (SoEs) the most, although South Africa’s sovereign creditworthiness was unlikely to be impacted.

The SoEs that are likely to be most affected are Eskom and Transnet because of their reliance on offshore debt capital markets for funding, a factor that would translate into higher hard currency borrowing costs, Business Day reported.

Hardly a surprise

The FATF’s announcement has been widely expected for months.

Even senior government officials predicted that South Africa’s efforts to avoid the grey list would not pass muster. These officials include the Commissioner of the South African Revenue Service, Edward Kieswetter, and Advocate Xolisile Khanyile, who is in charge of the Financial Intelligence Centre, the agency charged with spearheading the country’s efforts to combat money laundering and terrorism financing.

Minister of Finance Enoch Godongwana said during his Budget speech on Wednesday that South Africa should be “prepared for the possibility” of grey-listing.

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