By Nazmeera Moola, Co-Head of SA & Africa Fixed Income, Investec Asset Management
After a shaky 2016, South Africa’s economy was set for a recovery in 2017. The first quarter was always going to be weak, but better commodity prices were supposed to boost investment through the year. Improved consumer confidence was going to support vehicle sales. In early March I thought 2017 growth could get to 1.8%. What a difference four months make.
Listen to Nazmeera Moola and Lindsay Williams discuss the continued impact of the cabinet reshuffle on the South African economy.
Four and a half months ago, President Jacob Zuma reshuffled his cabinet and destabilised the South African economy. While the reaction of the rand was far more muted than anyone had expected prior to his actions, the destruction wrought by his actions of March 30th are becoming increasingly visible.
Let us not be fooled by the temporary bounce in growth in the second quarter. The high frequency data suggests that after contracting by -0.7% between the last quarter of 2016 and the first quarter of this year, on September 5th Statistics SA is likely to report that the South African economy grew by around 1.5-2.0% in the second quarter. At first glance this suggests my diatribe against the cabinet reshuffle is unfounded. However, a closer look reveals that the bounce is likely to have been confined to a bumper agricultural harvest, continued mining volume expansion on the back of higher commodity prices and some rebound in manufacturing activity after a very weak first quarter.
Construction and retail activity remained weak. The latest unemployment data showed that 113 000 people lost their jobs in the second quarter. Job losses occurred in the construction, private household, transport, storage & communication, mining and agriculture sectors. This was the first quarter to record losses since the second quarter of 2016.
The high frequency data also suggests that the statistical bounce recorded in the second quarter will not be sustained. While the agricultural losses were likely seasonal, the loss of confidence in the regulatory environment no doubt drove the job shedding in the construction, private household and transport sectors.
Regulatory uncertainty has choked the mining sector this year. Despite the solid rise in commodity prices, Mining Minister Zwane’s approach to regulation has ensured that this sector will not be investing in 2017. Instead the sector is planning closures that put 20 000 jobs at risk. Platinum production volumes contracted by 13.7% from a year earlier in June.
The forward looking Purchasing Manager’s Index dropped to 42.9 in July – its lowest level since 2009. Manufacturing production volumes contracted by 2.3% from a year earlier in June. In the first seven months of the year, car sales contracted by 1% compared to the same period in 2016.
Weak growth is feeding into lower revenue numbers. After being saved by a withholding tax windfall in March, Tom Moyane has had to concede that revenues are likely to disappoint in the current fiscal year. Revenues as collected by SARS are disappointing. Between April and June 2017, tax revenues grew by 7.2% – well down from the 10.6% growth rate projected in the February budget.
In particular, individual and corporate tax collections are behind budget. Although the aggregate VAT number is on target, this seems mainly due to very low VAT refunds. Given the personnel issues at SARS, there may well be manipulations here.
Not only are revenues disappointing, but South Africa’s interest expenditure is rising. The South African government will need to borrow a further ZAR191bn this year. State-Owned companies plan to borrow ZAR48bn, while development finance institutions like the Land Bank and DBSA will borrow ZAR18.4bn. All of this debt will cost 0.75% more in interest than if it were issued on 27th March 2017.
Therefore, the increase in interest charges on this new debt alone in the next twelve months amounts to ZAR2.3bn. That is ZAR2.3bn that could have been better deployed on infrastructure or education or housing. It is a wasted ZAR2.3bn. More scarily, over the 20 years of the life of the debt, it will cost South Africa an extra ZAR46bn in interest.
With so many negative numbers, it’s worth summarising the key points. To date, the cabinet reshuffle has resulted in:
- Significant job losses in the second quarter, which totalled 73 000 if we exclude the seasonal agricultural job losses
- A reversal in fixed investment plans as corporates opt to hoard cash instead
- A sluggish growth outlook, as growth forecasts have plunged from 1.5% for 2017 to 0.5%.
- Weaker than budgeted for growth in government revenue. On the current run-rate, the shortfall could be as high as R40bn
- An increase in borrowing costs that has cost at least ZAR2.3bn in the current fiscal year
- An inability by State-Owned Companies to raise commercial funding. This has already resulted in cash problems at several state entities.
The underlying cause is a lack of confidence. While the ANC continues to focus on its internal political battle (seemingly to the death), there will be no restoration in confidence. Therefore these trends are likely to continue.
Without a dramatic change of direction by January 2018, further rating downgrades will follow. This will exacerbate the problems. However, they will not cause the problem. A credit rating is a scorecard, not a root cause. The root cause is the lousy policies and low confidence levels evident in South Africa at this point.
Managing a fixed income portfolio in this environment presents challenges. Despite the local difficulties, since the start of 2017, emerging market debt has experienced inflows of US$45bn. A good portion has found its way into the South African bond market. This has propped up the rand and moderated the sell-off in bonds. It is difficult to be overly negative on SA bonds in this environment.
Therefore we have opted for a more nuanced approach – and take risk in very specific parts of the portfolio. Weaker revenues and increased demands from state companies puts pressure on the fiscus. As a result, we expect the government yield curve to continue to steepen. In particular we have little exposure to very long dated bonds as they are most exposed to fiscal deterioration.
With real risks of further downgrades from the rating agencies, we maintain some foreign exchange exposure in the funds that have capacity as protection. Lastly, we are now firmly overweight good quality Investment Grade credit – preferring companies with strong enough balance sheets to weather the current economic turbulence.
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