SOEs could put further pressure on budget

Cape Town - Financial demands from state-owned enterprises (SOEs) are likely to add further pressure on the Treasury’s budget, said Overberg Asset Management (OAM) in its weekly overview of the SA economic landscape.

Besides Eskom there are signs of mismanagement and likely demands for financial assistance from other SOEs including Petro SA, South African Airways, SABC and the Passenger Rail Agency of SA, according to OAM.

"Although the Treasury has stated that any financial support for SOEs would be “budget neutral” via the sale of state assets this may be easier said than done. State asset sales will meet with strong political resistance within the ANC."

Meanwhile the largest financial demand may come from the Department of Energy for its nuclear energy procurement plans. Although Minister of Finance Nhlanhla Nene has stated that the Treasury would only sign off on a nuclear deal if it is affordable the political pressure to do so will be substantial, said OAM.

• In its update on the SA economy Moody’s credit rating agency downgraded its GDP forecast for 2015 and 2016 to 1.7% and 1.9% and predicted that growth would not reach 3.0% until 2017 or 2018.

The slower growth trajectory is attributed to energy outages, infrastructure constraints, skills shortages, economic inequality, troubled industrial relations, low savings and a weak investment climate. Moody’s warned that lower economic growth could reduce fiscal revenue collection making it more difficult for the government to meet its budget deficit target.

• The Barclays manufacturing purchasing managers’ index (PMI) fell in August from 51.4 to 48.9, below the key 50 threshold which demarcates expansion from contraction. There was a broad-based decline across PMI sub-indices. The employment index fell from 46.9 to 45.2 - below 50 for a 17th successive month. The business activity index decreased from 53.2 to 48.6 and the inventories index from 60.2 to 50.9.

Although the forward-looking new sales orders index climbed from 49.8 to 50.6 the expected business conditions index which gauges conditions in the manufacturing sector six months in advance dropped sharply from 63.2 to 52.5. The overall data points to further contraction in the manufacturing sector over the second half of the year.

• Following the -6.1% year-on-year decline in July new domestic car sales fell further in August by -8.2% on the year, far worse than the -4.1% consensus forecast. Passenger car sales fell -8.1%, marking the sixth straight decline despite dealers offering attractive incentives and competitive pricing.

Commercial vehicle sales were also weak with light commercial vehicles falling -7.8% on the year, and medium and heavy commercial vehicles falling -11.2% and -17.9%. Poor business and consumer confidence are expected to keep domestic vehicle sales under pressure well into 2016.

New vehicle exports remained a bright spot with growth of 12.3% on the year although considerably slower than the 24.4% increase in July.

• According to the Absa house price index the average price for all homes increased in August by 4.7% year-on-year down from 5.2% in July.

The price increase for large homes improved from 4.4% to 4.7% while for medium-sized homes it declined sharply from 4.2% to 3.1% indicative of growing financial pressures on middle-income consumers.

The general slowdown in home prices is corroborated by the FNB home price index which decreased from 5.2% to 4.9%. The FNB estate agent survey shows a decline in the percentage of sales motivated by an upgrade to better properties and a rising percentage motivated by downscaling.

• In the past week foreign investors sold a net R1.7bn worth of domestic bonds but surprisingly, given the volatility in the rand and domestic equity markets, purchased a net R5.3bn worth of equities.

Foreign buying was especially evident in the financial sector followed by the industrial sector and to some extent the property sector, although net selling continued in the resource sector.

Foreigners’ contribution to total market traded volume remained stable at 36.5%, only slightly below the year-to-date average of 38.6%. For the year-to-date foreign net buying of bonds and equities amounts to R12.60bn and R39.31bn respectively.

South Africa political overview

• The Minister of Energy Tina Joemat-Pettersson confirmed in a briefing to parliament that the government was committed to building 9600 mega-watts of nuclear power capacity.

The minister also acknowledged that the nuclear procurement plans would have to be affordable and that a cost-benefit analysis would form part of the procurement process.

The process for selecting nuclear strategic partners was expected to be completed before the end of the current financial year ending February 2015.

The week ahead

• Third quarter RMB/BER business confidence index, due Wednesday 9 September.

The data point is published quarterly. Following a sharp decline in the second quarter (Q2) from 49 to 43 well below the key 50 threshold which demarcates expansion from contraction the BER business confidence index is expected to remain at the sub-50 level in Q3.

• July manufacturing production, due Thursday 10 September. On a month-on-month basis manufacturing production is expected to deteriorate from positive growth of 0.9% in June to a negative -0.74% in July, according to consensus forecast.

A weak purchasing managers’ index suggests the negative trend will be maintained in August. On a year-on-year basis the contraction manufacturing production is expected to worsen from -0.4% to -2.67%.

• July mining production, due Thursday 10 September. Mining production growth is expected to remain positive although showing a declining trend from 1.1% month-on-month in June to 0.7% in July according to consensus forecast.

On a year-on-year basis the pace of mining production growth is expected to decline from 4.0% to 1.6% as the low base effect associated with last year’s platinum strike washes out of the data.

Technical analysis

• The rand remains below successive support levels suggesting a continuation in the rand’s depreciation. Although the rate of the rand’s depreciation is accelerating, there is no sign yet of panic selling or capitulation. This stage needs to be reached before a reversal in the rand’s move can occur.

• 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.

• Despite the recent uptick in bond yields 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 above key resistance levels of 2.0% and 2.2%. However, there is unlikely to be a major bear trend in US bonds as the deleveraging phase is still in its early stages.

• The benchmark R186 SA Gilt yield is testing support at 8.70% which if broken could open a new target of 9.5%.

• The MSCI World Equity index has broken downward from a rising wedge formation which has been intact since the 2008/09 global financial crisis. It is unlikely that the downward move is over as the correction so far is too small for a bull market of the magnitude and duration of the 2009 to 2015 bull market. The downside target for the MSCI World Equity index is 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 can be expected in the next year. The next major wave down will complete the 16-17 year secular bear market that started in 2000. The secular bottom should occur around June 2016.

• The S&P 500 has broken down from a rising wedge pattern, which is traditionally a trend-changing pattern. The break below the 2070 level confirms a reversal of the upward trend. A further negative signal is that the Dow Jones Transport Index, traditionally a lead indicator for the broader market, is leading the broader market lower on the downside.

• Brent crude’s break below the key $50 support level suggests a continuation of the weakening long-term trend. Copper is regarded a reliable lead indicator for industrial commodity prices and barometer of global economic growth. It has broken below the key $5 300 support level suggesting further downside ahead.  

• Despite recent advances, gold is in a protracted bear market signalled by rapid declines through successive support levels at $1 300, $1 250 and $1 100. Gold’s next target is $1 000 which is likely to be breached before the bear market ends.  

• The All-share index has broken below its bull market support level which has been intact since 2009. The downside target for the index is 41 000.

Bottom line

• The -1.3% quarter-on-quarter annualised GDP contraction in the second quarter jeopardises the Treasury’s budget deficit target for the 2016 financial year.

The Treasury’s budget for the current financial year was premised on its forecast of 2% GDP growth in 2015 and 2.6% in 2016, which now seem well off the mark. Leading economic indicators suggest further contraction in GDP in the third quarter due to load shedding, declining commodity prices, weak export demand, and falling household consumption.

• Given that economic contraction will cause tax revenues to be lower than expected the Treasury will have to scale back its expenditures in order to meet its 2016 budget deficit target of -4.1% of GDP. Unfortunately the risk of expenditure over-runs is high.

To begin with, the public sector wage deal including fringe benefits was far higher than budgeted, amounting to a total increase of 10% in year one compared with the Treasury’s 7.7% forecast. In rand terms the 3-year public sector wage deal is R66bn more than envisaged.

• Financial demands from state-owned enterprises (SOEs) are likely to add further pressure on the Treasury’s budget. Besides Eskom there are signs of mismanagement and likely demands for financial assistance from other SOEs, including Petro SA, South African Airways, SABC and the Passenger Rail Agency of SA.

Although the Treasury has stated that any financial support for SOEs would be “budget neutral” via the sale of state assets this may be easier said than done. State asset sales will meet with strong political resistance within the ANC.

Meanwhile the largest financial demand may come from the Department of Energy for its nuclear energy procurement plans. Although Minister of Finance Nhlanhla Nene has stated that the Treasury would only sign-off on a nuclear deal if it is affordable the political pressure to do so will be substantial.

• Amid slowing tax revenues and growing demands for state expenditure the risk is high that the Treasury will be unable to meet its budget deficit targets both in the 2015 and 2016 financial years. Sovereign debt, which has already increased from 26% of GDP in financial year 2009 to 46.2% in 2015, will have to rise further in order to fund the growing budget deficit.

• The national budget deficit is scrutinised more closely than any other variable by the credit rating agencies. The rating agencies have been specific in their warnings that any wavering in fiscal prudence would result in further credit rating downgrades.

READ: Downgrade alert for SA

Rating downgrades would be the death knell for the rand, which has already lost -17% against the dollar since the start of the year.

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* 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.