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Cape Town - While the 2018 budget projections are a long way from those achieved during the tenure of ex-Finance Minister Trevor Manuel, the country's finances have been put back onto the right path, say Overberg Asset Management (OAM) in its weekly economic and market overview.
According to OAM, the consensus view is that the budget, delivered by finance minister Malusi Gigaba, should be enough to avert a credit rating downgrade by Moody's.
Moody's is expected to announce its rating decision on or before the 23rd March.
"Averting further credit rating downgrades over the longer-term will require a sustained economic recovery. Despite limited fiscal leeway the Budget managed to preserve a growth bias," OAM said.
South Africa economic review
• Following October’s poorly received Medium-Term Budget Policy Statement (MTBPS) the 2018 State Budget returned South Africa to the path of fiscal prudence. The budget deficit is projected to decline from 4.3% of GDP in 2017/18 to 3.6% in 2018/19 and 2019/20 and to 3.5% in 2020/21. Although falling short of the 2017 Budget projection of a 2.6% deficit by 2019/20 the 2018 Budget shows a marked improvement on the MTBPS projections.
According to the Treasury, the combination of a narrower deficit, a stronger rand and lower borrowing costs will bring down the projected peak in gross government debt to 56.2% of GDP in 2021/22 and 2022/23.
Although worse than the projected peak of 52.9% in 2018/19 as tabled in the 2017 Budget it is far better than the projected peak of 63.3% in 2025/26 projected in the MTBPS. (See Bottom Line for further analysis).
• The Treasury raised its revenue projection for the new fiscal year by R36bn. The biggest contributors were from the 1% increase in value-added tax to 15%, contributing an additional R22.9bn, and from restricted fiscal drag relief contributing an additional R6.8bn. A Budget highlight is the planned reduction in government expenditure.
At national, provincial and local government level, the government projects R85bn in spending cuts over the next fiscal years. R26.3bn in 2018/19, R28.8bn in 2019/20 and R30.5bn in 2020/21. The government expenditure cuts would be more than enough to cover the increased allocations to free higher education, national health insurance, social grants, drought relief and the contingency reserve. (See Bottom Line for further analysis).
• Consumer price inflation (CPI) fell by more than expected from 4.7% year-on-year in December to 4.4% in January, below the 4.5% consensus forecast. CPI was assisted by the decline in food and non-alcoholic beverage inflation from 5.2% to 4.5% and the fall in housing and utilities inflation from 5.1% to 4.4%.
The data confirms a broad-based disinflationary trend. Core CPI, excluding food and energy, reduced further from 4.2% to 4.1%. On a month-on-month basis, which strips out the base effect of year-ago comparative levels, CPI showed benign readings at both headline and core levels, rising by a moderate 0.3% and 0.2%, respectively.
The benign outlook for inflation boosts the outlook for interest rate cuts. Amid an improving policy environment and a strengthening rand, the Reserve Bank is likely to cut the benchmark repo rate at its next policy meeting in March and perhaps in one or two additional increments by year-end.
• The Reserve Bank composite leading business cycle indicator unexpectedly slipped in December to 104.6 from 105.2 in November. While disappointing, the trend remains positive. November’s reading, unchanged from October, was at its highest since 2013. December’s decline is attributed to the decrease in the 12-month percentage change in the number of new passenger vehicles sold and the average number of hours worked in the manufacturing sector.
The drop in both categories was exacerbated by seasonal factors and likely to show a rebound in January and February. The largest positive contributions came from an increase in the number of residential building plans passed and an increase in the South African produced export commodity price index. The composite leading business cycle indicator, which signals economic activity over the next 6 to 9 months, points to a recovery in economic activity in the second half of 2018.
• A positive response to the 2018 Budget prompted a surge in foreign buying of South African bonds, reflected in net foreign investor inflows of R13.64bn in the past week. Net foreign investor inflows into South Africa’s equity market gained by an additional R3.26bn in the past week, lifting the month-to-date and year-to-date totals to R16.20bn and R25.73bn, respectively.
The year-to-date bond inflows of R9.86bn lifts the total year-to-date investor inflow to a healthy R35.58bn. Bond and equity market inflows are expected to maintain their positive trend during the year amid rising financial market optimism and positive economic policy reforms.
The week ahead
• Private sector credit extension: Due on Wednesday 28th February. Private sector credit extension (PSCE) is likely to have shown a slight lift in January from December’s 6.72% year-on-year growth, helped by the combination of recovering business and consumer demand and an easing in lending standards.
• Producer price inflation: Due on Wednesday 28th February. Producer price inflation is expected to have reduced from 5.2% year-on-year in December to 5.1% in January, pulled lower by the effect of a strengthening rand on imported prices.
• Trade balance: Due on Wednesday 28th February. The trade balance is expected to have returned to a deficit in January following the bumper R15.7bn surplus in December. January is traditionally a poor month for the trade balance as importers re-stock their inventories post the December festive season.
• New vehicle sales: Due on Thursday 1st March. The year-on-year decline in new vehicle sales is likely to have slowed from 8.9% in January to 7.8% in February, according to consensus forecast, assisted by strong external demand and a recovery in domestic confidence.
• Absa manufacturing purchasing managers’ index: Due on Thursday 1st March. The Absa manufacturing purchasing managers’ index (PMI), after recovering strongly in January from 44.9 to 49.9 is expected to have posted a further gain in February, regaining the expansionary 50-level. The 50-level has eluded the PMI for eight straight months.
Technical analysis
• Having broken key resistance levels at R/$12.50 and R/$11.70 , the rand has returned to its appreciating trend, targeting a break below R/$11.00 over coming months.
• 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 £/$1.35 promoting further near-term currency gains to a target range of £/$1.40-1.50.
• 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 decisively above key resistance at 2.5%, targeting the next key resistance level at 3.0%. A break above long-term resistance at 3.6% would indicate an end to the multi-decade bull market in bonds.
• The benchmark R186 2025 SA Gilt yield has broken below key resistance at 8.6%% indicating a new target trading range of 8.0-8.5%.
• Key US equity indices, including the S&P 500, Dow Jones Industrial, Dow Jones Transport, Nasdaq 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 $60 and likely to remain in a trading range of $60-70 over the foreseeable future. Base metal prices are in a bull trend confirmed by copper’s increase above key resistance at $7 000 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 in the JSE All Share index above key resistance levels at 56 000 and 60 000 signal the early stages of a new bull market.
Bottom line
• The Budget’s moderate fiscal consolidation should be enough to avert a Moody’s credit rating downgrade. By averting a Moody’s downgrade, South Africa will avoid exclusion from the World Government Bond Index.
While Fitch and S&P Global have South Africa’s local and foreign currency credit ratings at non-investment grade, Moody’s is still one notch above non-investment grade. Moody’s has already cited positive credit-related developments since the ANC elective conference in December. Its rating decision is expected on or before 23rd March.
• However, averting further credit rating downgrades over the longer-term will require a sustained economic recovery. Despite limited fiscal leeway the Budget managed to preserve a growth bias.
• The Davis Tax Committee assessed that although the VAT increase would lift inflation over the near-term, it is less damaging to economic growth over the longer-term than increases in personal income tax and corporate tax rates.
Inflation may increase by around 0.1 percentage points over the next four quarters but not by enough to deter the Reserve Bank from cutting interest rates. South Africa’s corporate tax at 28% is already high by international standards. The UK has cut its corporate tax rate from 30% to 19% and the US from 35% to 21%.
• The Budget announced the pending approval of six special economic zones (SEZs). These SEZs would attract investment through additional tax incentives.
• The Budget assumes the public-sector wage bill will rise at an annual average rate of 7.3% over the next three years. A more moderate public-sector wage increase after the expiry of the current wage agreement in March 2018 would boost the economy’s growth potential by facilitating a shift away from consumption towards capital investment.
• Effective implementation of structural reforms could increase potential GDP growth from 1.5% to around 4%, according to the Budget.
• President Ramaphosa pledged in the State of the Nation Address to “intervene decisively to stabilise and revitalise state-owned enterprises (SOEs).” The Budget highlighted recent interventions at SOEs, noting that some SOEs could be restructured via equity investments.
• While the Budget’s projections are a long way from those achieved under ex-Finance Minister Trevor Manuel’s tenure when a budget surplus facilitated tax cuts, credit rating upgrades and government-led infrastructure spending, the country’s finances have been put back onto the right path without prejudicing the country’s medium-term growth potential.
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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