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It is no secret that the South African economy is in trouble. After a brief bout of Ramaphoria, markets once again realised that we had had ten years of Zuma – and now four years of sideways market action with no real return.
This could no longer be ignored as SA has decaying economic conditions and wilting confidence, both domestically and from the international investment community.
SA has a monumental task before it and the changes needed within governmental structures and in the broader socio-economic landscape will take a lot of effort and a lot of time to affect.
It may feel like time passes quickly, but the reality is that things change slowly.
Optimism is not ill-founded. But we must stay cognisant of the current state of our economy and how the current economic backdrop can either perpetuate current market themes or perhaps ignite new ones.
Theme 1: Times of uncertainty
The theme dominating the SA investment landscape at present is probably that of uncertainty. No doubt something that many are tired of hearing about by now, as financial media has made countless references to uncertainty being the driver behind the poor market performance locally.
But to contextualise: Investors base their decisions to either invest directly into an economy or via financial markets on a set of long-term objectives unique to them.
They have an almost infinite number of investment options from which they can choose and therefore endeavour to choose the investment that they believe will best balance their appetite for risk with their expectation for return.
Going through five finance ministers in six years does not exactly communicate a message of stability and low risk.
When things like the leadership of arguably one of the most important ministries in a country can change so abruptly, it becomes difficult to forecast what conditions are going to be five or ten years from now.
Therefore, investors are reliant on the recent past as a frame of reference. Thus far that frame of reference indicates that the leadership structures in our government are unstable and unpredictable.
Even though we now have a very strong and credible finance minister in the form of Tito Mboweni, given the recent track record we cannot at all be certain that he is going to still be around in a few years from now.
Add to that the rhetoric around land expropriation without compensation; failing state-owned enterprises in constant need of taxpayer-funded bail-outs; growing discontent towards government from the public; our ailing economy; excessively high unemployment; and all the various external fears and shocks caused by the pull-back in international markets…
Ladies and gentlemen, we have a recipe for uncertainty about the future.
Put more simply, we have a lot of risk and no way of knowing whether that risk will reward investors in accordance with their expectations for returns.
This theme has had a major influence on our economy over the last two years.
This is best reflected in the decline in foreign direct investment in SA since 2016.
Theme 2: Recession time
The next major theme is that of decelerating GDP growth.
SA’s GDP growth forecast has been cut from 1.5% for 2018 to 0.7%, with the economy shrinking a seasonally adjusted annualised 0.7% in the second quarter, following a 2.6% contraction in the first quarter.
According to economist Mike Schüssler, and the BankservAfrica Economic Transaction Index (BETI) September report, GDP could well have picked up somewhat in August – maybe even enough to have put an end to the technical recession.
But he warns that the uptick in the BETI was mainly due to backdated “salary increases for civil servants in July and August, and the late salary adjustments of Eskom employees and some municipal workers. We may still see delayed backdated payments occur in September, which will add to economic transaction improvements.”
He warns that “one or even two months of data are hardly ever an indication of a change in trend. The delayed salary increases have certainly played a positive role but, once these are out of the system, the underlying downward trend may continue.”
The BETI measures economic transactions among bank accounts in SA and is a very reliable indicator for the level of economic activity with a very high correlation to GDP.
Schüssler’s report might therefore indicate a short-term reprieve from the contracting GDP, but the message is clear: Don’t hold your breath.
Theme 3: Government debt
Over the last decade, SA’s budget deficit has averaged 4.3% of GDP and came in at 4.6% of GDP last year.
This year it is forecast to be 4% (revised from 3.6%) and is expected to rise to 4.2% in 2019/20, after which it should stabilise at 4% in the years that follow.
This budget shortfall needs to be funded somehow, which means that government needs to borrow money from capital markets.
Over the last decade, government debt-to-GDP has nearly doubled to 53.1% of GDP last year, with the expectation that it will stabilise at 59.6% by 2023/24.
Therefore, debt payments are becoming a larger portion of government spending (it’s the third-fastest growing expense the SA government has).
Further, the rising yields of 10-year government bonds is a sign that investors are becoming less confident in SA’s ability to repay its long-term debt obligations and are thus selling their bonds.
It follows that if this trend continues, the cost of finance could increase to an unaffordable level over the same period that the government debt-to-GDP ratio is expected to reach nearly 60%.
Our new finance minister has warned that if government debt-to-GDP exceeds 60%, SA would potentially have to approach the International Monetary Fund (IMF) in search of funding the country.
The IMF is likely to impose all sorts of austerity measures as a condition to extending finance, which would pretty much guarantee lower levels of government spending.
That would probably cost our economy many government jobs, as well as even lower levels of overall service delivery.
Thankfully, Ramaphosa is being very proactive about bringing reforms to government and attracting direct investment into our economy.
Also, our new finance minister seems to be committed to not increasing government’s spending limit.
This could help SA fight back against the forces of a slowing economy and an ever-increasing budget deficit.
Theme 4: Investor confidence
The confidence that ratings agencies have in SA’s ability to turn the ship around has had a major influence on our economy and contributes to the theme of uncertainty.
Both Standard & Poor’s and Fitch ratings agencies have downgraded SA government debt to sub-investment grade, or junk status.
For now, Moody’s Investors Service has been SA’s saving grace as they still rate our government debt one notch above junk.
This means that our government bonds are still included in major global bond indices and are therefore still being held in major global bond funds.
Although Moody’s has expressed that it considered the medium-term budget policy statement, delivered by Mboweni in October, as credit negative, it has not made any adjustments to SA’s credit rating and is probably unlikely to do so until after the general election next year.
Politicians tend to beat all sorts of drums to get elected into office, but once there, their – and humour me here – “promise to delivery ratio” is rather low. Therefore, we are unlikely to have a clear plan on how land expropriation without compensation will be implemented, for example, until after the election.
On that basis, it is equally unlikely that we will see rating agencies make any changes to their outlook on the economy until “the pudding is served”.
Theme 5: A bear phase in developed markets
Tightening monetary policy in developed economies like the US and EU is not only removing liquidity from global markets and driving the flow of investment away from emerging markets into developed markets, but is also probably the main antagonist behind the global market correction.
The impact a larger-scale global correction could have on already underperforming emerging market economies should not be underestimated.
It would not be surprising to see developed markets enter a bear market, or even a recession, over the next 6 to 18 months.
If that does in fact happen, the likelihood that our economy and market follows a further downward trend is extremely high.
This is an extract of the cover story that originally appeared in the 8 November edition of finweek. For Petri’s stock picks and more on how you can pick your own stocks, buy and download the magazine here. Subscribe to our weekly newsletter here.
