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Cape Town - The market reacted positively to the fact that fiscal erosion is entirely attributed to lower tax revenues and not raised expenditure, notes Overberg Asset Management.
Despite the fiscal erosion the rand strengthened versus the dollar, pound and euro from R/$14.00 to 13.82, from R/£17.07 to 16.79 and from R/€15.21 to 15.11, it said in its weekly overview of the South African economic and investment landscape.
The projected tax revenue shortfall for full year 2017 is R22.8bn, resulting from weaker economic growth, OAM said further.
South Africa economic review
• In his presentation of the Medium Term Budget Policy Statement (MTBPS) Finance Minister Pravin Gordhan announced that the budget deficit in financial year (FY) 2017 is expected to be 3.4% of GDP rather than the 3.2% projected during the State Budget. The FY 2018 budget deficit projection was raised from a previous 2.8% to 3.1%.
Meanwhile, the debt-to-GDP ratio is projected to peak at 53.0% of GDP in FY 2019 compared with a previous projected peak of 51.0% in FY 2018. The Treasury reduced its GDP forecasts for 2016, 2017 and 2018 to 0.5%, 1.3% and 2.3%, respectively. (See Bottom Line for further analysis).
• Producer price inflation (PPI) fell sharply from 7.2% year-on-year in August to 6.6% in September substantially below the 7.2% consensus forecast. Food inflation eased as expected from 13.4% to 13.1% in line with the fading effects from the drought. Non-food PPI fell from 5.2% to 4.4% indicating a broad based decline in inflationary pressure.
The decline corroborates the decline in the prices paid component of the Barclays manufacturing purchasing managers’ index (PMI) to its lowest since 2010. The overall PPI data signals a quicker than expected deceleration in consumer price inflation, which has positive repercussions for monetary policy.
• The trade balance returned to a surplus of R6.7bn in September beating the -R1.1bn consensus forecast deficit and largely reversing August’s deficit of -R8.9bn. While imports decreased in September by -6.6% month-on-month exports increased by 10.1%.
Exports in the mineral sector were especially strong with precious metals and stones rising 37% on the month and other mineral products by 11% while vehicle exports enjoyed a solid 12.9% gain.
Overall imports were suppressed by a -30% month-on-month decline in mineral product imports, comprising mostly oil.
Despite September’s improved figures the R19.4bn cumulative trade surplus for the third quarter (Q2) is considerably less than the R79.9bn surplus achieved in Q2, which suggests the current account deficit may deteriorate from Q2’s level of 3.1% of GDP. The current account deficit is likely to widen to around 3.5-3.7% of GDP in Q3 and to around 4% in 2017.
• The SA Reserve Bank composite leading business cycle indicator increased in August by a surprisingly strong 1.4% month-on-month from 91.9 to 93.3 its highest level since June 2015.
The forward-looking indicator signals a marked improvement in the economic outlook over the next three-to-six months. Among the ten components making up the indicator, eight showed an improvement and two a deterioration.
The largest positive contributions came from the increase in the number of building plans passed followed by the improvement in the BER Business Confidence Index. The two detractors were the slowdown in job advertising space and the decrease in manufacturing order volumes.
The week ahead
• Barclays manufacturing purchasing managers’ index (PMI): Due Tuesday 1st November. The PMI increased from a depressed 46.3 in August to 49.5 in September but the key 50-level, which separates expansion from contraction, may remain elusive in October.
• National Association of Automobile Manufacturers of SA (NAAMSA) vehicle sales figures: Due Tuesday 1st November. According to consensus forecast the decline in vehicle sales is expected to continue in October at -12.9% year-on-year following contractions of -14.3% in September and -9.6% in August.
• Unemployment rate: Due Tuesday 1st November. In the absence of meaningful economic growth there is little hope that the unemployment rate will show signs of improvement in the third quarter (Q3) after registering 26.6% in Q2 and 26.7% in Q1.
• Outcome of the North Gauteng High Court hearing of President Zuma’s interdict application against the release of the Public Protector’s “State Capture report”: Due Wednesday 2nd November.
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 $1 400 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
• Finance Minister Pravin Gordhan gave a statesmanlike performance presenting the Medium Term Budget Policy Statement (MTBPS). Even though key fiscal measures deteriorated the overall reaction to the budget was positive.
• The budget deficit in financial year (FY) 2017 is now expected to be 3.4% of GDP rather than the 3.2% projected during the State Budget but this is better than feared. The FY 2018 budget deficit projection was raised from a previous 2.8% to 3.1%. Meanwhile, the debt-to-GDP ratio is projected to peak at 53.0% of GDP in FY 2019 compared with a previous projected peak of 51.0% in FY 2018.
• The currency market took the budget slippage in its stride. Despite the fiscal erosion the rand strengthened versus the dollar, pound and euro from R/$14.00 to 13.82, from R/£17.07 to 16.79 and from R/€15.21 to 15.11.
The projected tax revenue shortfall for FY 2017 is R22.8bn, resulting from weaker economic growth. Pravin Gordhan gave markets reason to cheer his fiscal prudence by announcing an additional R10bn in expenditure cuts for FY 2018.
• The MTBPS contained some disappointments. There was no mention of any major structural reform, which the credit rating agencies have highlighted as key to placing SA on a higher growth path. The lack of MTBPS initiative on state-owned enterprises means the disruptive threat of the recently formed Presidential State-Owned Companies Coordinating Council remains at large.
• While additional tax increases will be required in FY 2018, estimated by the Treasury to amount to R28bn, around half of this could be achieved by not adjusting tax brackets for fiscal drag.
• While the jury is still out the feedback so far towards the MTBPS has been positive. According to Colin Coleman, managing director of Goldman Sachs SA: “The mid-term budget hit the right sums. On an aggregate basis, there is reason to be hopeful with regards to the rating process.”
• Although structural reforms were conspicuously absent from the MTBPS, Standard & Poor’s (S&P) Global Ratings will be meeting with Treasury over the next month to gain a better understanding of the measures being taken. This should provide the Treasury with the opportunity it needs to reassure S&P prior to its rating announcement on 2nd December.
• Weak economic growth remains the key impediment to attaining fiscal consolidation and the Treasury’s 0.5% GDP growth assumption for this year is higher than the SA Reserve Bank’s 0.4% forecast.
• However, the SA Reserve Bank leading indicator, which predicts the economic outlook six months ahead, surged higher in August by 1.4% month-on-month to its highest level since June last year. 8 out of the 10 categories making up the headline index showed an improvement in August.
* 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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