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Investment views

Downgrade blues

25 April 2017
Author: Jeremy Gardiner

Less than a month ago, the South Africa story was so good. 14 months of hard work by government officials, business leaders and labour had repaired most of the damage done by the President with Nenegate. SA was dressed for success and looking attractive. We were ready for the inevitable shift in emerging market sentiment to bring the party we had been looking forward to for so long.

Emerging market inflows were strengthening the currency, which reduces the price we pay for oil and in turn brings down the petrol price, food prices, inflation and interest rates. Consumers then have more money, the economy grows, corporates hire more people, unemployment falls, more jobs equal more tax revenue, which means more service delivery to the poor (in theory at least) – happy days for SA.

Of course this all hinged on whether or not the President and his friends decided to spoil the party. And they did.

South Africans watched in horror as Prexit, rapidly followed by downgrades, played out ruthlessly in front of us, almost like watching a car crash in slow motion. A move – so brilliantly choreographed – by the President’s friends, family, and a nasty little PR agency, that civil society, SA’s institutions, opposition parties, labour and even the ANC itself, were seemingly unable to intervene.

And now the picture looks bleak. Take everything positive I said above and reverse it.

A weaker rand raises the price we pay for imports, which includes petrol. Food prices will therefore rise as will inflation, then interest rates, which will leave consumers with less money to spend. The economy will stop growing, start shrinking, head towards and into recession, shedding jobs as it goes. More unemployment, less tax payers, less tax revenue, less service delivery.

Less tax revenues means we have to borrow more (at a higher price due to the downgrade), which means higher debt to GDP going forward, much higher debt repayments and even less for the poor. You get the picture.

Who gets hurt most? Sadly, the poor will suffer most. Their taxi fares are going up, clothes and food as well, and when you’re living on the breadline anyway, that hurts – a lot. The middle class will be hit hard too, as higher interest rates will hurt anyone with a mortgage.

Remarkably, the currency, after an initial sell off, is reasonably strong. The reasons for this are fourfold.

Firstly, other emerging markets, against whom our behaviour is monitored, like Turkey, are behaving worse.

Secondly, I believe many foreign investors see this purely as a finance minister switch, without fully grasping the state capture implications.

Thirdly, a synchronised global recovery, with the US, China, Japan and Europe all growing, plus a trillion dollar infrastructure boost from the US, has seen commodity currencies back in vogue.

Finally, emerging markets bonds are back in favour after a long period in the investment wilderness.

The factors mentioned above could keep the rand ‘stronger for longer’. However, should anything happen to scare investors (think North Korea/US rhetoric heating up, UK/French elections going awry, or anything unexpected) a ‘risk-off’ environment would be straight back, and with it, the end and even reversal of emerging market flows.

And then I’m afraid there’ll be very little to hold the currency up, and weakness looks inevitable. Sadly, the strength in the rand has largely masked the potential negativity of the downgrades, lulling South Africans into a false sense of security, as the downgrade negatives will only be felt gradually over the next few years.

We as South Africans know that this is much more than a mere finance minister switch. So do the rating agencies, and it won’t be long before we are downgraded to junk by all 3 agencies. And then R120bn will be forced to leave the country. And this time, there’s no Pravin Gordhan ‘riding in on a horse to save the day’ predicted, or in fact any solution apparently coming from an increasingly captured ANC.

Mix in the reversal of emerging market economic fundamentals mentioned above, and the rand will suffer.

Of course, before we get too depressed, we have been through worse before. SA has a robust civil society, an increasingly vocal business sector, a free (mostly) and very vigilant press, and for once a united front of opposition parties and labour, all of whom have vowed not to allow the country to be stolen, and this fight has only just begun.

However, if you’re looking to internationalise part of your portfolio, you’ve been granted a remarkable, albeit temporary reprieve. Now would not be a bad time to act; you may not get another chance.


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Jeremy Gardiner
Jeremy Gardiner

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