October 15, 2018
The exodus of foreign investment from SA, the slide in the rand in recent months, coupled with the announcement of a technical recession, have heightened pressure on policymakers to take immediate action rather than wait for the outcome of next year’s election.
What is needed is a more investor-friendly approach in restructuring the economy and stimulating growth.
Since the peak of Ramaphoria earlier this year when about R20 billion of net investment flowed into SA’s bond markets, there has been a R70 billion reversal of short-term flows. By end August, the year to date outflows were R50 billion. Between the rand’s strongest point of R11.24/US$ in February to just over R15/$ by the end of August, it lost 36% of its value against the dollar.
Unless the slide is arrested, the country’s current benign inflation trend will start to challenge the upper band of the 3-6% target. We may end up in a stagflationary environment, making it difficult for the SA Reserve Bank to raise interest rates in a low growth environment.
The rand has always been relatively volatile, which can be positive for exports but negative for imported inflation. SA’s deeply liquid and sophisticated markets make it easy for foreign investors to trade out of it as a hedge when they take a negative view on emerging markets. That is why SA has struggled to avoid emerging market contagion this year, even though the currency crises in Turkey, where the lira lost 72% against the dollar, and Argentina, where the peso has shed 50% this year, have little to do with SA.
The recent emerging markets contagion is not necessarily driven by the rising trend of US interest rates. So far, the US Federal Reserve has hiked rates in line with market expectations, although there can always be a level where, expected or not, it can still be untenable for countries that have weak fiscal matrices.
Several negatives are weighing on the currency and financial markets: a shrinking economy, rhetoric around land expropriation without compensation and ongoing policy uncertainty, not just about property but about other key legislation.
Government, the private sector and labour need to work cohesively for the country to reach a higher frontier. Brinkmanship will only take us backwards.
Although the President’s reluctance to make sweeping economic reforms ahead of the election is understandable, as the economy deteriorates further, he will be forced to take action. Announcements such as special envoys to raise $100 billion in foreign investment or a proposed sovereign wealth fund are good ideas, but will not yield results immediately and fall short of the fundamental reforms that are needed to halt job losses and prevent corporate defaults.
It is important that the medium-term budget statement delivers a consistent and realistic picture of the SA economic outlook and its revenue predictions. Former finance minister Nhlanhla Nene recently conceded that there are downside risks to revenue collections – more taxes may have unintended consequences. By mid-2018, the February 2018 budget was already looking over-optimistic. SA needs to avoid getting downgraded further to junk status by the ratings agencies. It cannot afford to lose all the inflows that have come from its participation in the WGBI (World Government Bond Index).
But there are many positives, too.
SA now has sensible leadership compared to the precipice we came back from last year and compared to some of its emerging market peers. It is evident there is resolve to make some hard decisions. SA also has an independent Reserve Bank and recent court judgments have demonstrated that it is a strong constitutional state. SA’s economic data, which underpins foreign investment decisions, has credibility.
Recently, the pass through rate, which is the effect of currency changes on the inflation rate, has slowed. Rand weakness has not resulted in steeper inflation because of slow domestic demand. Because the SA Reserve Bank does not hike interest rates to protect the rand, a weaker rand provides some stimulus for exports – however, that requires the private sector to invest to take advantage of it.
To avoid and/or limit the impact of exogenous factors, SA policymakers need to stop kicking the can down the road until after the election. Without bold decisions, the country will pay for political uncertainty through higher debt, which will make it even harder for government to fulfil its promises to the electorate.
In this volatile environment, investors should be cautious and follow a strategy of diversification. Income funds have low volatility but give a higher return than cash, and are still ideal for this environment. The picture will be clearer after the medium-term budget and rating reviews, which will help investors decide whether to take more risk.