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Cape Town - Despite Finance Minister Pravin Gordhan’s excellent fiscal credentials there is only so much he can do, cautioned Overberg Asset Management (OAM).
Due to weakness in economic growth "there is a substantial risk of fiscal erosion," OAM said in its weekly overview of the economic and political landscape in South Africa.
Gordhan has a hard task ahead given the certainty of fiscal slippage in the context of slowing economic growth and declining tax receipts.
"Amid continued financial hemorrhaging at state-owned enterprises, growing political discord and an absence of meaningful structural reform to promote economic growth, the Medium Term Budget Policy Statement (MTBPS) provides a lone beacon of hope to ward off expected credit rating downgrades."
South Africa economic review
• Consumer price inflation (CPI) stayed within the SA Reserve Bank’s (SARB) 3-6% target range for just one month before bouncing back from 5.9% year-on-year in August to 6.1% in September although below the 6.2% consensus forecast.
The CPI increase is attributed to elevated food price inflation at 11.3% and the base effect of weak comparative fuel prices. Core CPI, excluding food and energy, unexpectedly decreased from 5.7% to 5.6%.
Fuel price increases in October and November will cause CPI to remain above the SARB’s target range for the next few months but thereafter lower food price inflation should prompt a return to within the range at around 5.5%.
• Retail sales eked out a small gain in August of 0.3% month-on-month but not sufficient to reverse the -1.9% and -0.2% contractions in June and July.
On a year-on-year basis retail sales growth fell to just 0.2% down from 1.2% in July and well below the 0.8% consensus forecast, registering the weakest growth since June 2014. Pharmaceuticals, and hardware and paint were the only retail categories to show improved year-on-year growth.
Lackluster retail sales data indicate GDP growth of only 0.5% annualised in the third quarter.
• A paper prepared by the IMF, investigating the drivers of volatility in the rand since the 2008/09 global financial crisis, made the following conclusions. Key factors contributing to the rand’s volatility include commodity price volatility, global volatility, and local political uncertainty.
Surprisingly, the rand is affected far more by US economic data surprises than domestic economic surprises. While political uncertainty can be influenced by government, commodity price and global volatility are beyond SA’s control.
The week ahead
• SA Reserve Bank leading indicator of economic activity: Due Tuesday 25th October. After declining from 92.6 in June to 91.6 in July the SARB leading indicator is expected to show a slight improvement in August.
• Producer price inflation (PPI): Due Thursday 27th October. According to consensus forecast PPI is expected to remain unchanged in September from August’s level of 7.2% year-on-year.
• Medium Term Budget Policy Statement (MTBPS): Due Wednesday 27th October. Finance Minister Pravin Gordhan will present his mid-term budget to parliament. Due to weakness in economic growth there is likely to be some fiscal erosion, which will be carefully scrutinized by financial markets and the credit rating agencies. (See Bottom Line for more analysis).
Technical analysis
• While the rand has broken below key resistance levels versus the dollar at R/$ 14.20 and 13.80 the strengthening trend is not confirmed by momentum indicators, signalling that the currency is overbought.
• The US dollar index is testing a major 30-year resistance line, which if broken will pave the way for further strong gains in the currency.
• Following the Brexit vote the British pound hit its weakest level against the US dollar since 1985. The £/$1.30 level provides key support, which if broken would open up a Fibonacci projected target of £/$1.20-1.24.
• The long-term JPMorgan global bond index bull trend remains intact, with the yield targeting a new low during the fifth and final wave.
• The US 10-year Treasury yield has broken below key resistance levels of 1.6% confirming that the major bull trend in US bonds is likely to continue as the deleveraging phase is still in its early stages.
• The benchmark R186 SA Gilt yield has compressed to its lowest level since “Nenegate” last year falling below key resistance at 9.0%. The yield is now testing the bottom of the current consolidation channel at 8.5%, which if broken will target a yield of 8.0%.
• The MSCI World Equity index has broken downward from a rising trend-line which has been intact since the 2008/09 global financial crisis. Given the magnitude and duration of the 2009-2015 bull market the overall correction is likely to reach a downside target for the MSCI World Equity index of 1,400.
• Since the 1950s the Dow Jones and S&P 500 have displayed 7-year up-cycles and the top of the current US equity cycle is likely to have just occurred. The next major wave down will complete the 16-17 year secular bear market that started in 2000. The secular bottom should occur between mid-2016 and mid-2017.
• The S&P 500 index has broken to new record highs but the rally is not being confirmed by momentum indicators, which suggests the market is overbought and in danger of correction. A further negative signal is that the Dow Jones Transport Index, traditionally a lead indicator for the broader market, is underperforming the broader index.
• Despite this year’s price rally Brent crude’s break below the key $30 support level in February suggests a continuation of the weakening long-term trend to a downside $25 target. Copper is regarded a reliable lead indicator for industrial commodity prices and barometer of global economic growth. Despite its recent rally the copper price broke below the key $4,500 support level in February suggesting further downside ahead.
• Gold has developed an inverse “head and shoulders” pattern, which indicates further upward momentum and a test of the $1400 target level.
• The JSE All Share index is testing an important resistance line but if this remains unbroken the index is likely to move back below the 24-month moving average at 50 900 in turn opening a downside target of 45 000. A break above 54 200 on the JSE All Share index would project an upward move to 60 000 marking a new high for the JSE.
The bottom line
• On Wednesday Finance Minister Pravin Gordhan will present the Medium Term Budget Policy Statement (MTBPS) to parliament. He has a hard task ahead given the certainty of fiscal slippage in the context of slowing economic growth and declining tax receipts. Between March and August tax receipts grew just 7.1% year-on-year compared to a budgeted increase of 9.2%.
• GDP growth in 2016 is unlikely to match the Treasury’s 0.9% forecast. Even the SA Reserve Bank’s 0.4% forecast may be too optimistic. Although supply-side constraints to growth have retreated, namely electricity outages and the effect of SA’s worst drought in a century, domestic demand remains depressed.
Growing job losses coupled with accelerating inflation, rising interest rates and political uncertainty, are undermining consumer confidence. Business confidence is also in decline with private sector investment contracting for six consecutive quarters.
• As a result of weak economic growth the budget deficit figure for the current financial year will almost certainly fall short of the -3.2% of GDP forecast by the Treasury.
The Treasury’s projections to stabilize national debt at 51% of GDP may also seem unachievable in the current environment. The interest cost on SA’s national debt is now the single largest expense item in the budget and rising by an estimated 14% in the current year, is also the fastest growing.
• Although Pravin Gordhan will reliably commit to fiscal prudence the economic environment and political backdrop make it almost impossible to keep his promise to credit rating agencies of over-delivering on the Treasury’s fiscal consolidation targets.
• Slowing tax receipts will pressure the MTBPS to deliver spending cuts but this seems a tall order while students are rioting for free university education. Free university education would require around R50bn in added annual state expenditure, equivalent to about 1% of GDP.
• Amid continued financial hemorrhaging at state-owned enterprises, growing political discord and an absence of meaningful structural reform to promote economic growth, the MTBPS provides a lone beacon of hope to ward off expected credit rating downgrades.
• Local markets may be disappointed. Despite Pravin Gordhan’s excellent fiscal credentials there is only so much he can do. There is a substantial risk of fiscal erosion.
For the full report, including a look at international markets, click here.
* Overberg Asset Management (OAM) is an Authorised Financial Services Provider No. 783. Overberg specialises in the private management of local and global discretionary portfolios as well as pension products.
Disclaimer:
Information and opinions presented in this report were obtained or derived from public sources that Overberg Asset Management believes are reliable but makes no representations as to their accuracy or completeness. Any opinions, forecasts or estimates herein constitute a judgement as at the date of this Report and should not be relied upon. There can be no assurance that future results or events will be consistent with any such opinions, forecasts or estimates. Furthermore, Overberg Asset Management accepts no responsibility or liability for any loss arising from the use of or reliance placed upon the material presented in this report.
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