Factors influencing the financial markets

Each effective market has a supply of a certain commodity, and a demand for that commodity. Savings (investments) represent the supply side in the money markets, and financing needs, as the demand side. Because of the interaction between the various financial commodities, money and service markets in a country, the simple theory of supply and demand determining prices cannot be applied in its basic form in these markets.

The theoretical system would determine that the rate (price for money) would drop if there is a surplus savings (supply) in the market, but if there are savings in the market which are not utilised to finance income-making activities, the national income will eventually decline, probably bringing about a decline in the rate of savings which could work against the fall in interest rates.

Another factor influencing the financial markets is expectations; for instance, if rates are high, with the expectation that the rates are going to decline in the future, the demand for securities and thus the supply of money will be high, pushing interest rates down, and security prices up.

Expectations of higher inflation could push up interest rates. Prices of goods are expected to go up, so consumers tend to buy now rather than later, which pushes up the demand for cash balances and hikes interest rates. Interest rates in turn has an effect on inflation. The level of savings and spending is to a significant extent determined by prevailing interest rates.

Fiscal policy decisions by the government also affect the financial markets. The decisions by the government also affect the financial markets. The decision on how to finance the government’s deficits will affect the supply and demand for cash balances, short and long-term deposits (M3 money supply), and thus influence interest rates. If the government decides to finance its monetary needs with the issuing of short-term securities such as treasury bills, the demand for money in the short-term market increases, exerting upward pressure on interest rates.

Examples of other factors affecting local financial markets are the following:


 - The local market seems to overreact on information and expectations. During 1994/95 the     expectation of higher inflation was one of the reasons for long-term interest rates going up by     more than 5 percentage points

 - The level of government spending has an adverse effect on inflation and interest rate     movements

 - South Africa had a two-tier exchange rate system (the financial and commercial rand) up to     March 1995. Some restraining foreign exchange regulations are still in place. The exchange     rate determines what a country pays for imports, and what that country gets for exports in     terms of its own currency, for example, the rand proceeds of gold exports. These import and     export payments have an effect on the foreign reserves have an effect on the foreign reserves     that South Africa holds and the amount of money in circulation in the economy. Foreign trade     and the resulting foreign exchange rate affect the local economic parameters influencing the     financial markets.

 - The integrity of the payments system in the financial markets. Trust in the South African     system was affected by the credit rating that South Africa received from overseas institutions

 - High labour costs, excessive political violence and significant political uncertainties in the     country have tended to keep away foreign investors. Because of the local political factors,     foreign investors want a premium on their investment yield to compensate for the risk and     uncertainty associated with investing in South Africa

 - Liquidity in the markets is low, and pooling of funds needs to be done to improve liquidity

 - Domestic funds, such as pension funds, tend to invest in shares rather than capital market     instruments because of risk and return factors and uncertainties about interest rates and     volatility. The demand for capital market instruments is thus lower, pushing up interest rates.     Previously, funds were forced to invest in certain government capital market instruments as a     certain percentage of their total portfolios

 - Financial disclosure concerning transactions, positions and risk involving financial markets is     not in line with generally accepted standards world-side.

 - Capital adequacy and interest rate risk

The general approach is that financial positions, which are exposed to interest rate fluctuations, should not be more than a certain percentage of the primary capital of a company. Internationally accepted levels are much lower than the levels in South Africa.