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Johannesburg - Although the trading theme in South African remains largely one of a “better the devil you know”, emerging market economist Peter Attard Montalto of Nomura still believes most risks are known, can be analysed and a scenario planned around them.
However, there are two key risks that are of more immediate concern to him, namely the legislative agenda and what he terms “Zuma risk”.
"The former is likely to continue to weigh on foreign direct investment, with little impact on markets at this stage, while the latter may become more of a market focus in the not too distant future," he said on Monday.
"The rand has continued to trade in a wide range since the end of last year and a narrower range since the end of May of this year. Domestic news has largely washed over the currency, even the collapse of African Bank has had no discernible effect, nor major strike action from Amcu."
Montalto puts this down to the SA Reserve Bank’s credibility backstop and continued investment inflows into bonds and, to a lesser extent, equities that provide some backstop against the current account deficit.
"However, the fact that the market already knows about the strikes and has been aware of the issue of unsecured credit lead us to suggest the market is well priced for the broad risk outlook, with only a degree of intraday price reaction to risk as opposed to the establishment of a new trend," he said.
Montalto's key risks for the outlook
Economic risks
Gross domestic product
With weak external demand likely to continue through into next year, domestically it is likely to be about the Numsa short, sharp shock in July and then five months of recovery.
Although the Amcu strike in the platinum sector ended in June, it will have long-lasting effects, because it will take around six months for output to return to more normal levels and as such the knock-on effects for other sectors will similarly be felt.
Nomura's GDP growth forecasts for 2014, 2015 and 2016 remain at 1.6%, 2.5% and 3.2% respectively.
Inflation
The key event Nomura sees is core inflation breaching target at year-end.
Second, it sees headline inflation broadly unchanged around 6.2% to 6.4% for most of the rest of the year – hence the importance of looking at core inflation.
Montalto thinks the biggest uncertainty for inflation for the rest of the year is not core inflation (where risks are skewed to the upside), but non-core, particularly food.
Rates
Nomura sees Federal Reserve hikes from June next year, but an end to quantitative easing (QE) in October.
On the flip side there now meaningfully additional European Central Bank (ECB) policy loosening.
This mix should create a strained backdrop for current account deficit countries such as South Africa in Nomura's view, but not a “big blowup” type event that many feared a year ago during the "tpering tantrum" of of the third quarter of 2013.
Nomura sees rates through the second half of next year at 7.50%.
Montalto said he still fundamentally believes in a two-half hiking cycle, with the final fine-tuning 25 basis points in November before 50 basis points moves next year in the real normalisation phase of the cycle.
Nomura points to the risks surrounding its rates forecast:
- It seems unlikely that the macroeconomic situation will have changed sufficiently markedly by the September meeting of Sarb's Monetary Policy Committee, so Montalto thinks the only real risk is around the November meeting this year.
- If the Fed hikes rates at the start of next year, then Sarb rate hikes could be more aggressive next year. Equally, not hiking until 2016 on a stalled recovery in the US could push the Sarb much further out.
- However, the ultimate issue for the Sarb is financial market contagion that comes from moves on the US yield curve.
- Another key variable is the extent to which the Sarb wants to be "at the curve".
Current account
There should be some monthly trade number shocks in the next two current account data prints as the impact of the Numsa strike filters through.
Nomura's tracking estimate for the second quarter current account is around -5.3% of GDP, while for the fourth quarter it is around -5.0% after -4.5% in first quarter.
The big uncertainty is volatility in the income balance. The current view of a moderately-wide, sticky current account, however, should be broadly unchanged.
Sarb governor’s term
Governor Gill Marcus’ term ends on November 8 2014. Markets have become focused on her being replaced at this time, but Montalto does not believe there are any particular pressures on her to go at this time.
Credit risks
Strike action
Nomura does not expect any major strike action for the rest of the second half of the year.
The public sector wage round will start at year-end, but negotiations look set to continue into the first quarter of next year, meaning strike action is unlikely until February or March.
Eskom
Eskom remains a central and complex risk for Montalto. While the issues surrounding the company have been long running, the risk event outlook is much richer now, because of the forthcoming deadline for the government to provide a shareholder support package to the parastatal by the end of this month.
"We think this announcement will be credit negative given the downward pressure it will place on the ratings and marginally rates negative because of the feed through of higher tariffs into the headline Consumer Price Index (CPI), passing through into the core CPI and so monetary policy in the medium run," said Montalto.
Load-shedding remains an odd risk. It continues to have a deep impact on the economy through the requests on industry to cut back usage, while also dampening FDI sentiment.
Yet the market has ignored the impact with zero volatility on load-shedding events this year.
Fiscal
The medium-term budget policy statement (MTBPS) will be on October 22. It will be new Finance Minister Nhlanhla Nene’s first budget speech.
Nomura expects the broadly constrained expenditure framework to continue, but with revenue underruns thanks to strike action and lower growth (though offset in part with higher inflation) to be balanced by additional creeping increases in debt issuance.
"Further major policy changes are unlikely until the budget, when there should be more clarity on tax policy in particular - we expect some small shifts higher in corporation tax,: said Montalto.
Ratings
Fitch and S&P will report their next scheduled update on December 12. Fitch has South Africa with a Negative Outlook, with its rating a notch above S&P’s BBB- after its downgrade in June of this year.
Moody’s is Baa1 on Negative Watch and so sticks out somewhat. An update is expected in the fourth quarter, most likely after the MTBPS which is in mid-October.
"We think there is strong potential for Moody’s and Fitch to downgrade because of the Abil and Eskom situations, combined with the current account, labour, growth, fiscal and debt," said Montalto.
"Such decisions may fall to next year however, if the rating agencies want more certainty particularly on tax policy at the actual budget in February."
Although Nomura thinks downgrades are priced in, it can still be a volatility risk event.
Banking sector
The collapse of Abil was largely ignored by the market with part of the problem the lack of communications with foreigners since the Sarb stepped in and placed Abil under curatorship.
"There have been wider questions on other unsecured credit lenders such as Capitec, but we continue to believe it has far superior credit risk management and provisioning controls and is much better managed," said Montalto.
Political risks
Numsa/Cosatu
Montalto thinks this remains one of the biggest risks. Numsa’s increased aggression during its July strike was part of a broader arc of events that are being undertaken by the union.
"We still believe Numsa will break away to form a worker’s party of some sort for the 2016 local elections, but it remains to be seen if certain ANC-delaying tactics will be successful in maybe delaying this to only being able to form after that date. Things should become much clearer at the start of next year," said Montalto.
Zuma
Investors seem to be realising the longstanding issues on President Jacob Zuma.
There are a number of issues coming to a head:
- Nkandla: The situation has played particularly in the EFF’s hands with effective demonstrations by it in parliament. Public and internal ANC dissatisfaction on the issue is rising.
- Spy tapes: The so-called spy tapes were handed over this week to the DA, but getting charges reinstated (if the proof is there) and any real "outcome" from them may well be very far into the future.
- Health: Increasing local newspaper, Bloomberg and Reuters reports of Zuma’s deteriorating health have emerged since the election in May.
"Our baseline has always been that Jacob Zuma may well step back from being an ‘active’ President mid way through this term regardless of health, becoming more of a figure head, while Deputy President Ramaphosa becomes more of a Prime Minister," said Montalto.
Legislation
There is a slew of legislation being passed at the moment that could either directly or indirectly - depending on allowed discretion with it and the will of future governments - be profoundly anti-investment and anti-growth.
These include the women empowerment and gender equality bill 2014, the Broad-Based Black Economic Empowerment Amendment Act, the mineral and petroleum resources development amendment bill, the promotion and protection of investment bill and removal of bilateral investment treaties and the restitution of land rights amendment bill 2013, property valuation bill 2013 and expropriation bill.
"While many governments around the world have such powers, taken with the other legislation here and moves on government legislation on traditional communities’ rights the legislation is potentially worrying," said Montalto.
"We should state again here that the legislation is not in and of itself necessarily a concern to investors, but it is the scope for additional state involvement in the economy for both growth boosting and job creation-type policies in the future and also other political aims that is a risk over the medium run."
- Fin24
