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Cape Town - The increased political risk that could flow from this week’s Medium-term Budget Policy Statement will in all likelihood compel the South African Reserve Bank (SARB) to refrain from cutting interest rates in November, according to BNP Paribas economist Jeffrey Schultz.
In a company note issued on Friday, Schultz said the tabling of Finance Minister Malusi Gigaba’s first mini budget clearly raised the political risk facing the South African economy.
“In our view, the budget update provides more than sufficient grounds for at least one ratings agency (to downgrade South Africa). We think S&P and potentially Moody’s may lower the country’s local and foreign currency rating to full-blown ‘junk’ status when both next review the sovereign on November 24.”
S&P currently has South Africa’s foreign currency debt rated at BB+ (sub-investment grade) and the local currency debt at BBB- (still at investment grade). It downgraded the country’s sovereign credit rating to junk status after President Jacob Zuma’s bruising Cabinet reshuffle which saw former finance minister Pravin Gordhan and his deputy Mcebisi Jonas removed from office.
Moody’s downgraded both the foreign and local currency debt rating to Baa3 – one notch above junk, but has warned a number of times that unless risks such as contingent liabilities and low growth abate, it will consider a downgrade to sub-investment grade.
Schultz said the SARB’s monetary policy committee made it clear at its previous interest rate announcement that it had not lowered interest rates due to the “deteriorating assessment of the balance of risks”.
“South Africa’s inflation picture is unlikely to change substantially between now and its last meeting of the year on November 23,” Schultz said. “We expect headline CPI for October to have moderated back to 4.9% year-on-year from 5.1% in September.”
Fin24 earlier reported that inflation increased to 5.1% for September, with average prices increasing by 0.5% between August and September. Inflation increased by 0.3 of a percentage point from the 4.8% annual rate reported in August.
Schultz pointed out that although macroeconomic fundamentals alone (a large negative output gap, lower CPI and reduced external account funding needs) continue to count in favour of further modest rate cuts, “shaky domestic politics” and uncertainty over the extent of market blowback from a looming sub-investment grade credit event could mean the SARB will most likely only revisit the scope for rate reductions after the ANC conference in December.
“By January the monetary policy committee will also have a better handle on the macro-political situation, not to mention the outlook for the rand.”
BNP Paribas is of the view that the SARB’s estimate of potential capital outflows of between $8bn to $10bn from the bond market, should a junk rating occur in November, is perhaps overdone.
“This is premised on our view that active investors with a noninvestment grade mandate could pick up some of the slack here.”
BNP Paribas forecasts that CPI inflation could average below 5% next year amid climbing long-bond yields, which will continue to make South Africa’s real yields look very attractive.
“As such, we don’t think that the currency or bond market reaction will be as severe in the medium term and, in the event of a more positive political outcome emerging in December, could bring rate cuts back in vogue from January 2018.”
There is therefore scope for two more 25 basis-point rate cuts in January and March 2018, respectively.
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