Cabinet reshuffle risks damaging SA's fiscal discipline

Jan 31 2017 19:31

Cape Town - Implications for the rand would not be positive if a cabinet reshuffle resulted in Finance Minister Pravin Gordhan's removal from office, according to Overberg Asset Management (OAM).

Besides undermining South Africa’s institutional strength, a change in finance minister could also jeopardise the country’s fiscal discipline, OAM said in its weekly overview of the SA economic landscape.

The rand’s volatility is largely explained by local political uncertainty. However, commodity price volatility and global financial volatility are equally important drivers of rand volatility, according to a paper prepared by the IMF.

South Africa economic review

• As anticipated, the South African Reserve Bank (SARB) kept its benchmark repo rate unchanged at 7%. However, the SARB’s accompanying statement was more “hawkish” than expected. The SARB reduced its GDP growth forecast for 2017 from 1.2% to 1.1% while leaving 2018 unchanged at 1.6%.

The SARB now expects consumer price inflation (CPI) to average 6.2% in 2017 up from a previous 5.8% and forecasts that CPI will only return to its 3-6% target range in the fourth quarter (Q4), later than the previously projected Q2.

The SARB cited the unpredictability of the rand as the main obstacle to declining inflation, stating that the rand “remains vulnerable to both domestic and external shocks.” Key risks include changes in US monetary policy, global investor sentiment towards emerging markets and local political uncertainty.

• Stats South Africa altered the weighting of the consumer price inflation (CPI) basket for the first time since January 2013. The key changes in basket weight were food and non-alcoholic beverages from 15.4% to 17.2% and transport from 16.4% to 14.3%.

With food prices expected to ease during 2017, the bigger food weighting should have a moderating effect on inflation in the months ahead. Equally, the lower transport weighting should diminish the impact of rising oil prices. The re-weighting of the CPI basket bodes well for inflation returning to within the South African Reserve Bank’s 3-6% target range by mid-year.

• Producer price inflation (PPI) unexpectedly accelerated from 6.9% year-on-year in November to 7.1% in December above the 6.9% consensus forecast and well up on 3.6% in 2015.

The biggest culprit was food price inflation, which increased 11.1% on the year and contributed 3.9 percentage points. However, with food prices contributing 25.2% of the PPI basket, producer inflation should subside in 2017 as the effects of the drought continue to fade in turn reducing pressure at the consumer price inflation level.

The week ahead

• Private sector credit extension: Due Tuesday 31st January. Growth in private sector credit extension (PSCE) is expected to slow further from 4.7% year-on-year in November to 4.6% in December exacerbated by the continued decline in household credit growth.

In the year to end November PSCE growth slowed to just 0.8% in real terms, supported by corporate credit growth while household credit extension contracted by 3.9% in real terms.

• Trade balance: Due Tuesday 31st January. The trade deficit traditionally posts a surplus in December as imports subside following festive season restocking in the prior months.

According to consensus forecast the trade balance is expected to reverse from a -R1.1bn deficit in November to a R6.0bn surplus in December. The trade deficit would narrow to around -R8bn in 2016 as a whole compared with -R52.3bn in 2015.

• Barclays manufacturing purchasing managers’ index: Due on Wednesday 1st February. The manufacturing purchasing managers’ index (PMI) is expected to increase from 46.7 in December to 47.2 in January according to consensus forecast.

After spending the whole of the second half of 2016 below 50, the key level demarcating expansion from contraction, the PMI is expected to recover gradually in 2017 amid improvement in allied industries such as mining and agriculture. Meanwhile the global PMI is rising indicative of growing trade momentum and export demand.

• Vehicle sales: Due Thursday 2nd February. The National Association of Automobile Manufacturers of South Africa (NAAMSA) expects a moderate improvement in vehicle sales in 2017. After declining in December by -15.3% year-on-year the contraction in new vehicle sales is expected to ease to -11.4% in January, according to consensus forecast.

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 key £/$1.30 level support level has been broken opening up a £/$1.20-1.24 target.

• 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 broken back above the key support level of 2.0% endangering the multi-year bull trend in US bonds.

• The benchmark R186 SA Gilt yield is now testing the key support level of 9.0% endangering the mini-bull market in bonds which has been in place since the start of the year.

• 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 crude price is well supported at $40 a barrel and having broken key resistance at $50 is targeting further gains to the next key level at $60. Base metal prices are in a bull trend confirmed by copper’s increase above key resistance at $5 000 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 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

•  Speaking at a conference on Wednesday last week Konrad Reuss, managing director of Standard & Poor’s (S&P) South Africa and sub-Saharan Africa, cautioned that South Africa’s investment grade credit rating hinged to a large extent on the country’s institutional strength. Konrad Reuss explained that S&P’s institutional assessment may be impacted by matters such as a cabinet reshuffle.

• As if on cue, renewed rumours of a damaging cabinet reshuffle rattled domestic financial markets on Friday last week and on Monday. Having traded much stronger earlier in the week, the rand fell sharply on Friday from R/$13.35 to 13.60.

• Although the rand may dip on news of a damaging cabinet reshuffle the brightening outlook for commodity markets and global financial markets may limit the rand’s downside.

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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sarb  |  pravin gordhan  |  sa economy  |  rand



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