South Africa’s economy continues to struggle and faces significant headwinds in the immediate future. This despite a very supportive global environment and some improvements locally, such as a somewhat better growth picture and the support of lower inflation and interest rates. Unfortunately, medium to longer term growth prospects are not promising – and might actually be labelled dismal – in the absence of political certainty and meaningful economic reform, according to Old Mutual Investment Group Head of Economic Research, Johann Els.
Els points out that the strong global economy is indeed providing support to the SA economy through the ongoing supportive environment for commodity prices and Emerging Markets as an investment destination – both helping to ensure a relatively stable rand exchange rate.
Presenting at Old Mutual Investment Group’s Quarterly investment briefing today, Els says: “Unfortunately we have not received the full benefit that such a strong global economy would usually give – in fact the impact has been downright disappointing! This is due to the impact of significant political and policy uncertainty on local consumer and business confidence. This uncertainty and severe lack of confidence have inhibited consumer spending and business fixed investment.”
The global economy has strengthened significantly since early this year and expanded at a very strong 3.8% annualised growth pace during the second quarter. This momentum likely continued at a decent pace into the second half of the year. Upside growth surprises in Europe and Japan – as well as Emerging Economies outside of China – combined with still decent US and Chinese growth has meant a much more synchronised growth picture. This, combined with a still relatively weak US dollar, has helped lift commodity prices further. Risks for the current global picture – and perhaps more specifically the impact on SA – include Central Bank policy errors and their impact on the US dollar. Looser fiscal policy in the US versus tighter monetary policy could give the dollar a boost that might not be so supportive of Emerging Markets and commodity prices. For now though, global inflation remains low and the probability of significant fiscal policy expansion in the US remains relatively low. He still expects the Fed to be getting closer to the end of the rate hiking cycle – especially now that gradual balance sheet unwinding is starting.
At home, private sector fixed investment spending continues to contract. By the second quarter of this year real fixed investment by private business was down 15% from the recent peak in the last quarter of 2015. This of course reflects business concern over the lack of growth and growing concern over policy direction and certainty.
“Although our March prediction of an end to the local recession as a result of an improved short-term cyclical outlook for South Africa came true, we still expect somewhat better growth this year compared to last year (0.8% vs 0.3%) – political uncertainty has severely hurt growth prospects and we have not fully participated in the global recovery,” he says.
Els continues: “Our long-held very out-of-consensus view since early 2016 that the South African Reserve Bank could cut interest rates during the second half of 2017, came true in July. Given the further drop in inflation in recent months, the stable rand and the still weak underlying economy, we expect the Bank to lower the repo rate further over the coming months. We have pencilled in another two to three further rate cuts into 2018, assuming the rand remains broadly stable and inflation remains anchored well into the 3% – 6% inflation target range. We are disappointed by the Reserve Bank’s recent lack of clear communication to the markets, having chosen to surprise the markets both in July and September. This is in clear contrast to many Central Banks globally who choose to keep the markets abreast of their thinking and do not like to surprise the markets relative to expectations.”
Political and policy uncertainty leading into the ruling party’s elective conference in December – and beyond – will determine whether ratings agencies decide to downgrade South Africa’s local currency debt into non-investment grade status sometime early next year.
The key risk to South Africa’s ratings outlook remains poor growth, which impacts on the ability to achieve budget targets and thus on the sustainability of the debt ratio. Currently the lower than budgeted economic growth for this year is already severely impacting tax revenues and we are looking to a possible R30bn to R40bn deficit overshoot as a result. The Medium Term Budget Policy Statement in October will provide a clearer picture of the likely outcome for the full year, but markets will also closely watch what actions new Finance Minister Gigaba takes to keep the fiscal situation under control. The continued underperformance of State Owned Enterprises add to the vulnerability of the fiscus and thus the ratings outlook. Any concern that impacts ratings agencies’ view of institutional strength would be a big negative.
South Africa will likely remain in a low growth trap until greater political and policy certainty and predictability helps confidence to recover.
Also presenting at the briefing, Siboniso Nxumalo, joint Boutique Head of Old Mutual Investment Group’s Global Emerging Markets boutique, added that against this global and local economic backdrop, there is value to be found in the chaos. He says that the Old Mutual Global Emerging Markets Fund’s outperformance of the benchmark index by 12.2% over 2016 during the crisis in Brazil is a good example. Brazil also faced a lot of political and policy uncertainty. But Brazil cleared out the corruption in government and parastatals during operation “Lava Jato” or in direct translation from Portuguese operation “car wash.” What began as an investigation into money laundering quickly turned into something much greater, uncovering a vast and intricate web of political and corporate racketeering.
“South Africa is in a better situation than that which Brazil found themselves in, but they addressed corruption, political and policy uncertainty. During the Petrobas SOE corruption scandal some $6bn (R82bn) was misappropriated. Over 160 people were arrested, of which 93 people were convicted in 2016. For South Africa to improve growth prospects we would have to address corruption to bring about investor confidence,” Nxumalo says.
Over the long term, emerging markets have delivered superior returns. Since inception the Old Mutual Global Emerging Markets Fund has delivered 16.5% a year – an excess annual return above the MSCI Emerging Market Index of 2.0% in rands.
“The key to achieving alpha amid the chaos is to recognise the investment opportunity. Although there was economic and political chaos in Brazil, there were pockets of value. For example Brazil has an educational deficit that the government is trying to address. Government has committed significant funding to the undergraduate programs. Kroton Educational, as Brazil’s largest education company and the largest educational company listed in the world, will benefit, with profitability increasing. This too will be true for South Africa and other emerging markets, with many opportunities to turn chaos into profits,” concludes Nxumalo.