In its latest annual report, the Bank for International Settlements (BIS) warns that leading economies are dangerously close to tipping into a high-inflation scenario that will prove difficult to reverse. The fears expressed by BIS appear founded when you consider that the inflation baskets of more than 60% of advanced economies and just over 40% of emerging economies are now reading higher than 5%.

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As a result, central banks around the world face an impossible decision. Do they continue to combat inflation via aggressive interest rate hikes, and risk the possibility of recession as a result? Or do they accept higher inflation as a new reality, which may cause financial instability in the medium to long term. 

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While energy prices have soared as European nations scramble to find alternatives to Russian gas supplies, South Africa’s power utility, Eskom, has been left relatively unscathed by the energy impacts of the war, thanks to its primary reliance on coal to generate most of its power. Of course, this is of little comfort to South Africans who have had to endure record levels of load shedding as Eskom’s power plants continue to deteriorate at an alarming pace, thereby placing additional strain on the economy. 

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The steady deterioration in the value of the rand over the past number of months is fuelling this challenging situation. In the first half of the year, the rand benefited from high commodity prices that lifted the current account into a surplus, with inflation rates supported by a particularly hawkish stance by the South African Reserve Bank. While the national currency had been fairly resilient during the first two quarters of the year, recent sharp declines point to the likelihood that it is finally beginning to succumb to the fears of a US recession. 

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South Africa also remains highly exposed to any decline in demand for the country’s raw-material exports, which would curb a vital source of foreign exchange. One can observe a positive correlation between the value of the rand and the price of industrial metals.

On the slightly more positive side, the prospect of a global recession may result in downward pressure on oil prices, which may help control inflationary increases. However, the consequence of lower oil prices would be a stronger US dollar, which would then put additional pressure on emerging-market currencies, not to mention having the effect of increasing funding costs. 

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All of this makes for a very challenging backdrop for M&A activity in the coming months, and possibly years. With projections for further rate increases in the second half of 2022, going into 2023, and the local currency forecast to hit R17.50 against the US dollar by the end of 2022, it’s likely that companies will continue to find it challenging to pursue large, strategic acquisitions in the coming months.

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Of course, challenges often bring with them at least some opportunities. There is a possibility that all the macroeconomic pressures outlined here may serve to fuel the market consolidation trends that have been seen in certain industries and sectors of late. If so, some companies may be prompted to seek out merger and acquisition opportunities rather than avoiding them. Despite the economic headwinds, most organisations recognise the need to adapt to fast-changing consumer behaviours and preferences, bolster the resilience of their supply chains and align with the global sustainable development imperative; and for many businesses, one of the most effective and efficient ways of doing so remains mergers or acquisitions. 

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So, while the slowdown in M&A is likely to continue for some time, the deal market certainly hasn’t ground to a complete halt. However, we can expect to see a far more cautious and measured M&A sector during the remainder of 2022.

 

Pillay is an Analyst: Corporate Finance | Nedbank Corporate and Investment Banking.