Mini budget: markets will punish politicised rhetoric

2017-10-24 21:30
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Cape Town - The National Treasury's MTBPS to be delivered on Wednesday will be Finance Minister Malusi Gigaba’s first budget and likely to be the most difficult budget of recent times.

He will deliver his maiden mini budget amid annualised revenue shortfalls of R35bn to R45bn and an increased budget deficit of 3.9%-4.3% of GDP, Overberg Asset Management said in its weekly economic overview of the Sa landscape.

OAM said the bond and currency markets have already factored in a moderate budget-neutral increase in payments to SOEs in the region of R5bn to R10bn.

"However, financial markets will punish any politicised rhetoric or larger than expected SOE allocations.

"Given the looming threat of further credit rating downgrades when Standard & Poor’s and Moody’s review their ratings on 25 November, the National Treasury is likely to err on the side of caution and stick to its long track record of fiscal prudence," said OAM.

South Africa economic review

• Consumer price inflation (CPI) headed higher in September, rising from 4.8% to 5.1% year-on-year above the 5.0% consensus forecast. However, core CPI excluding food and energy prices, which are traditionally volatile, remained unchanged at 4.6%.

The rise in headline CPI is attributed to higher petrol and diesel inflation, which accelerated from 5.7% to 12.1%. Other culprits were owner’s equivalent rent inflation, which increased from 4.9% to 5.4% and meat price inflation, which increased from 15.0% to 15.6%. However, food inflation continued to decline from 5.7% to 5.4% helped by record grain harvests.

Despite the recent uptick, CPI is expected to return to sub-5.0% territory amid continued food price disinflation and weak domestic demand. CPI is well within the Reserve Bank’s 3% to 6% target range paving the way for further interest rate cuts over the next 6-9 months.

• Retail sales grew in August by an unexpectedly strong 5.5% year-on-year, up from 1.6% in July and well ahead of the 2.7% consensus forecast. This marks the strongest growth rate since May 2013.

Growth was broad-based with all retail categories making positive contributions although the biggest improvement was in “textiles, clothing, footwear and leather” with year-on-year growth picking up from 0.1% to 2.5%. Growth in the “household, furniture, appliances and equipment” category improved from 7.1% to 9.0%.

The latest data indicates consumer spending built on its second quarter (Q2) growth of 4.7% quarter-on-quarter annualised in Q3, and made a positive contribution to Q3 GDP growth. Retail sales are expected to maintain their gradual uptrend over coming months as falling interest rates and declining inflation boost household disposable income and consumer confidence.

The week ahead

• Reserve Bank Composite Business Cycle Leading Indicator: Released on Tuesday, 24 October. The Reserve Bank's composite leading business cycle indicator decreased by 0.3% on a month-to-month basis in August 2017. It was expected to build on July’s solid increase, as businesses start to look past the current peak period of political and policy uncertainty. In July, the leading indicator jumped to its highest since February, indicative of the first green shoots of an economic recovery.

• Medium-term Budget Policy Statement (MTBPS): Due on Wednesday, 25 October. It will be Finance Minister Malusi Gigaba’s first budget and likely to be the most difficult budget of recent times. Due to weak economic growth, the budget deficit is deteriorating, expected to rise to an estimated 3.9% to 4.3% of GDP by the end of the 2018 financial year (FY 2018) well above the initial target of 3.1%, tabled in February’s Budget. (See Bottom Line for further analysis).

* Visit Fin24's Mini Budget Special Issue for all the news, views and analysis.

• Producer price inflation (PPI): Due on Thursday, 26 October. PPI is expected to increase from its year-on-year rate of 4.2% in August to around 4.8% in September due to steep increases in petrol and diesel prices during the month. However, subsiding food inflation is likely to return PPI to its softening trend over following months.

Technical analysis

• In order to return to its medium-term appreciating trend of the past 18 months the rand needs to break through key resistance at R13.00/$, which if broken would target further gains to R12.50/$ and thereafter R12.00/$. A range of R13.00-14.00/$ is more likely signalling a gradual and controlled depreciation in the rand.

• The US dollar index has tried but failed to break through a major 30-year resistance line suggesting the three-year bull run in the dollar may be over.

• The British pound has broken above key resistance at £1.30/$ promoting further near-term currency gains to a target range of £1.35-1.40/$.

• The JPMorgan global bond index is testing the support line from the bull market stemming back to 1989, which if broken will project further sharp increases in bond yields.

• The US 10-year Treasury yield has failed to break below key resistance at 2.0% raising the probability that the multi-year bull trend in US bonds is over.

• The benchmark R186 2025 SA Gilt yield is trading in a tight trading range of 8.5% to 9.0%. A break above 9.0% is required for the yield to move decisively higher towards the 10.5% target level.

• Key US equity indices, including the S&P 500, Dow Jones Industrial, Dow Jones Transport, Nasdqaq and Russell 2000, have simultaneously set new record highs, confirming a bullish outlook for US equity markets.  

• The Brent oil price has broken above key resistance at $50 and likely to remain in a trading range of $50-60 over the foreseeable future. Base metal prices are in a bull trend confirmed by copper’s increase above key resistance at $6 000 per ton.

• Gold has developed an inverse “head and shoulders” pattern, which indicates further upward momentum and a test of the $1 400 target level.

• The break above 54 200 on the JSE All-share index projects an upward move to 60 000 marking a new high for the JSE.

The bottom line

• The National Treasury's MTBPS to be delivered on Wednesday will be Finance Minister Malusi Gigaba’s first budget and likely to be the most difficult budget of recent times.

• The budget deficit is deteriorating, expected to rise to an estimated 3.9% to 4.3% of GDP by the end of the 2018 financial year (FY 2018) well above the initial target of 3.1%, tabled in February’s Budget.

• Although expenditure has only exceeded the February Budget forecast by a modest amount tax revenue has slipped by an estimated R38bn to R45bn annualised. The tax revenue shortfall is attributed partly to lower “tax buoyancy”. Tax buoyancy fell to 0.88 in FY 2017, which means that for every 1% increase in GDP growth tax revenues increased by just 0.88%. This is sharply lower than the tax buoyancy of 1.47 in FY 2016.

• The biggest culprit is weak GDP growth. The initial budget projected year-on-year growth in tax revenues of 10.6% but this would require GDP growth of 2% to 2.5%, well above the current rate of growth. For 2017 the respective growth forecasts from the Reserve Bank, IMF and World Bank are 0.6%, 0.7% and 0.6%.

• The national debt will grow as a consequence of the rising budget deficit. South Africa’s gross debt as a percentage of GDP has risen sharply from 43.7% in FY 2014 to an initially projected 52.9% in FY 2018, more than doubling since FY 2009. The actual outcome may be even worse with the debt to GDP ratio potentially hitting 55% by next year.

• The biggest challenge will be the increased funding requirements of state-owned enterprises (SOEs). The National Treasury has previously stated that any support for SOEs will be made in a “deficit-neutral” manner. Financial markets will look out for any deviation from this pledge, whether via direct allocations or increased guarantees.

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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