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Investment views

The great unwind and calls for reforms and structural change

17 July 2019
Author: Lazarus ShigwedhaPortfolio Manager
Lazarus Shigwedha, Portfolio Manager at Investec Asset Management, looks at the reasons for the precarious state in which the Namibian economy finds itself, the need for structural change and sound policy decisions, and the tools at our disposal to shore up sustainable long-term growth.

Balance sheet recessions are the toughest to manage when they occur simultaneously with distressed debt conditions in the wider economy. During balance sheet recessions, asset values dissipate, while debt commitments become increasingly challenging to service.

As a nation, Namibia finds itself in this predicament, as over the last few years households have lived beyond their means. For as long as households can leverage wages that are growing ahead of inflation, living on credit is not an issue. But, as a nation we have pushed debt to unsustainable levels, therefore to service our debt commitments we must resort to asset redemptions. We are now having to unwind the excess built up over the last decade, the result of an extended expansionary fiscal policy and private sector credit extension growth that was way ahead of real GDP growth. In short, we printed too much money.

Asset redemptions in themselves result in a downward spiral, knocking consumer sentiment and investment confidence. Households are stretched: the Namibia financial stability report released in April 2019 indicates that non-performing loans (NPLs) in the local banking sector have increased to approximately 3.8% to N$3.5 billion as at the end of 2018 from less than N$1 billion recorded at the start of 2014.

NPLs increased by 53% between 2017 and 2018. A closer look at the quality of banking sector mortgage exposure indicates that around 10% of all mortgage holders are now in arrears. Households are increasingly resorting to microlenders and short-term borrowing to live month to month. Outstanding micro loans and credit agreements now stack up to N$6.4 billion compared to N$3.4 billion in 2014; this segment of credit has compounded at a rate of double the growth of overall private sector credit extension between 2014 and 2018.

Usually, at this stage of the cycle, the slack in the economy is shored up by the combination of an expansionary fiscal and loose monetary policy. However, fiscal space does not currently exist for the government to boost the economy. The government is at the opposite end of fiscal policy, consolidating the budget. On the other hand, little help has come in the way of easing interest rates through monetary policy, which begs the question why the Monetary Policy Committee (MPC) of the Bank of Namibia has not come to the rescue?

The MPC seems comfortable with the current level of inflation at 4.5% and reserves at N$34.1 billion, which translates into 5.4 months of import cover, enough to protect the peg of the Namibian Dollar to the Rand.

However, in our view the MPC has not provided enough communication as to why it has not adjusted the Repo rate lower from 6.75%, at which it has been since August 2017, particularly in light of the fact that the level of reserves and rate of inflation are not an issue. Furthermore, the local economy is contracting, with first quarter GDP growth reported at -1.9%. Both regional and global economic conditions have deteriorated – our largest trading partner, South Africa, recorded a -3.2% GDP growth in the first quarter and global institutions such as the International Monetary Fund (IMF) and the World Bank have downgraded global growth expectations for 2019 and 2020, including that of Namibia.

It is our view that monetary policy will be ineffective as a policy tool in resuscitating the local economy, because of the type of recession we are experiencing is a balance sheet recession.

During balance sheet recessions, households are more concerned with paying down their debt and increasing savings as quickly as possible rather than increasing consumption. Therefore, lower interest rates would not entice the uptake of credit but would certainly assist households in paying down their debts. Equally, during balance sheet recessions lenders are more concerned about managing the quality of their assets (managing their balance sheets) as opposed to growing incomes. The combined net effect of household deleveraging and financial sector reluctance to lend means that a significant portion of deposits do not re-enter the real economy. Rather financial institutions will park these deposits in treasuries.

As of the end of 2018 the banking sector had N$15.5 billion in treasury holdings compared to N$8.9 billion in 2016, holdings in treasury bills grew by 32% per annum during 2017 and 2018. Therefore, there is an interruption in one of the key functions of a deposit taking financial institution, which is intermediation aimed at matching borrowers with lenders. This interruption results in a major leakage in incomes, which has deflationary implications for the economy. The resulting deflationary impact further perpetuates the balance sheet recession, causing a downward spiral that damages household sentiment and business confidence. The FNB house price index points to average prices having receded by 6.8% over the first quarter of this year. Residential property valuations are off 20-30% compared to their 2016 peak prices. Considering that houses in most cases are the largest component of household balance sheets, the lower values are a massive blow to consumer sentiment. Reported closures of mom and pop shops in the local media add further evidence to the leakages referred to above.

The solution to get the economy going again in a balance sheet recession is for government to step in with an expansionary fiscal policy, mopping up savings and expanding spending with the aim of stimulating the economy, at best to cushion the economy but ideally to expand growth. The goal is to increase incomes, thereby increasing the ability of households to service debt commitments and ultimately drive consumer demand and defeat asset deflation.

However, the ratio of total public debt to GDP is 45% and projected to peak above 50% over the current fiscal period according to the 2019/20 fiscal budget. Public debt service costs as a percentage of revenues have more than doubled since the 2014/15 fiscal period to approximately N$7 billion. As a nation we now spend more than 10% of revenues on servicing interest payments. Elevated interest servicing costs means that there are less resources to invest in the productive capital formation. In short, government does not have the capacity to stimulate the economy through fiscal policy.

This means we need to reform the economy and initiate structural changes to get the economy going again.

The major risk we run at this stage of the economic cycle is policy mistakes. We must avoid policy mistakes to circumvent extended multi-year stagnation.

Over the first six months of 2019, proposals such as a once-off 2.0% contribution by all Namibian income earners has been advocated to shore up resources to fight the current drought. Another suggestion has been for public procurement for certain goods to be directed at majority Namibian-owned entities. While these ideas appear sound and noble, it begs the question: are these proposals feasible and in alignment with the nation’s developmental goals that will steer the economy in the right direction? Or are they merely a knee-jerk reaction, short-term remedies? Furthermore, what are the second round and third round effects of the policies that we are advocating in general as a nation?

History tells us that once certain actions are taken, it becomes very difficult for them not to be repeated in the future. Therefore, we would argue that there is no such thing as once-off tax, especially in the medium to long term. Climatic conditions are increasingly unpredictable, adverse weather conditions have become persistent and certainly common. Therefore, if as a nation our 2019 solutions is a once-off 2.0% levy on household incomes to fight a persistent drought challenge, what is our medium- and long-term solution? We need policies that are aimed at securing local long-term food supply and increasing the sustainability of both commercial and rural farmers. For example, we need a genuine solution to address the challenges around rural farm produce access to the formal supply-chain. The implications on rural incomes and impact on the import bill would be materially positive.

On the second proposal, which advocates for public procurement from majority Namibian-owned firms our thinking is that government needs to clearly articulate what it is this policy seeks to achieve. Because, if it is aimed at merely increasing purchases from majority locally-owned organisations then we would argue that it would have a limited multiplier effect on the local economy. Economic policies aimed at local procurement that excludes targeted efforts towards local manufacturing could and will result in increased public procurement costs and higher inflation, unless there is local latent spare manufacturing capacity for those goods which the government is seeking to procure locally. At this juncture, we also need to ask the policy makers... what happened to the growth-at-home strategy?

The IMF recent report on Namibia points to a local economy that is expected to contract in 2019 and gradually recover thereafter. If Namibia is to experience a step change in GDP growth, we need structural reforms to increase competitiveness. This involves identifying our potential competitive advantages, removing bureaucratic impediments to growth and pursuing coherent economic policies rather than simply reacting to short-term impulses.

As a start we need to create an enabling environment that allows for local firms to produce locally and compete in regional and global markets. Local production will create jobs, while trading in markets outside the local economy will aid in reducing trade imbalances and earn foreign currency. Firms that compete outside of their core local markets will be faced with competition, which should lead them to innovate, create more jobs and move the economy up the value chain. We need to build regional and global recognisable brands and services that will move the economy from an over-reliance on commodities, with which we have absolutely zero pricing power.

For example, how is it that Argentina is synonymous with great beef around the world and one cannot talk about salmon without thinking about Norway, but we are yet to build a global brand around Namibian beef or fish. As African examples go, Mozambique is synonymous with prawns, Kenya and Tanzania for safaris, Mauritius is a regional financial hub, Kenya has an impressive cut-flower offering and Ethiopia is increasingly doing well in textiles.

As a small nation, solving the unemployment challenge should not be arduous compared to our peers on the continent and other emerging economies whose populations are multiples of ours. Local procurement which is inward looking is regressive to say the least; the opportunity lies in exploiting the massive regional and global markets.

At the risk of coming across as an armchair critic, we believe there are several measures that we as a nation can implement to drive a step change in our GDP and increase incomes sustainably over the long term. In the same way that apps have improved efficiencies in the digital age, we have listed below our suggested ‘apps’ that can shore up growth.

Firstly, reduce government’s role in the economy through privatisation and outsource non-critical services to the private sector. This will result in increased service efficiencies and provide a solution to the bloated public wage bill. Outsourcing should focus on technology-led solutions to ensure transparency, ease audits and drive accountability.

Secondly, expand the agricultural sector to produce multiple varieties of cash crops for the export market and staples for the local market. The agricultural sector can serve as the platform for job creation, especially for the unemployed youth who do not have the skills, experience and educational qualifications to meet formal sector minimum requirements. Areas for potential irrigation in the south and north of the country which are close to water bodies should be exploited for farming using modern water wise methods.

We have a very good case study in the grape farming activity in southern Namibia, which is a large seasonal employer of low-skilled labour. Our suggestion is that Namibia should focus on crops that can be cultivated efficiently in other seasons so that cash crop production is not tied to one season.

It is well for Namibia to aspire to become an industrialised country, but the reality is that most of the working age population is at this stage ill equipped with the skills required by an industrialising economy. Therefore, we are suggesting agriculture as a realistic app to create massive employment opportunities for those who will be left behind as the economy advances.

Third, establish Namibia as an education hub in Africa. We need to encourage private education institutions to set up in Namibia and attract foreign students, teachers and lecturers. Private education incomes from foreign students will be annuity incomes in foreign currency, while the spinoffs and multipliers are numerous, impacting property values, tourism, retail etc. After all we have a case study in the Angolan students’ market that we have had in Namibia post-independence. Great research and development produced from these institutions should be utilised to encourage the development of further ‘apps’, which will contribute to an agile economy that is better positioned to compete in higher-value economic activity.

Finally, encourage local production and institute outward economic policies. Judging by history, every great nation apart from those in post-war reconstruction phases or in the post-communist era, achieved the highest economic expansion periods by seeking opportunities beyond those available in their local markets.

This last app ties in very well with the current thinking which advocates for Namibia as a logistics hub, but we would rope in the private sector as the key driver of this ‘app’.

The government should utilise increased revenues generated from these ‘apps’ listed above to deliver critical social services such as medical services, desalinated water produced with renewable electricity, and an overhaul of the failing public education system, while attracting competent talent to the public sector.

As significant investors in Namibia, one of our portfolio holdings is Namibia Breweries (Nambrew). The economic opportunity for Nambrew is greater outside Namibia, to the point that the economic opportunity available through their exposure to the South African market alone (notwithstanding the current economic challenges there) completely dwarfs the economic opportunity available in Namibia.

Today we would say that Nambrew is probably the most mispriced brewer on the African continent, partly due to limited information that is accessible to investors. However, the value of their foreign operations is indisputably attractive. Competing outside Namibia has forced Nambrew to innovate to compete against global competitors. Nambrew has a great portfolio of brands that talks to a broad consumer base which is paired with efficient operations. This is apparent judging from the operating margins, return on invested capital and free cashflow the business generates.

Our greatest opportunity thus as a nation lies not in encouraging entrepreneurs to confine themselves to the local procurement trough (which at any rate would result in increased and entrenched rent-seeking behaviour). Rather, we need the government to increase space for the private sector in the economy by not overreaching or overtaxing factors of production and by increasing policy certainty and transparency. At the same time, we need to see a refocused effort on the part of government to deliver critical social services to the nation, ensure that public resources are optimally allocated and wastage minimised.

Lazarus Shigwedha
Lazarus Shigwedha Portfolio Manager

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