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EXTRACT: Investing in vicious times

Sep 06 2018 10:04
Mariam Isa

South Africa’s economy has run aground and prospects of a quick recovery from the recession this year are poor as the country’s new leadership grapples with the costs of a decade of mismanagement, emerging markets are taking a beating and the global backdrop is deteriorating in the face of a deepening trade war. 

News that economic output contracted in the second quarter of this year was not completely unexpected, but the depth of the downturn shocked financial markets, sending the rand into a new tailspin and making interest rate hikes this year inevitable as currency weakness fans inflation.

Economists scrambled to revise their growth forecasts for 2018 to below 1% as hopes that output would accelerate beyond last year’s pedestrian pace were quashed. 

News that investment contracted for the second consecutive quarter added urgency to the government’s drive to get business back on board after a breakdown of trust in former President Jacob Zuma’s administration. 

But there is a good chance that the grim news will be a wake-up call for the ANC as it juggles the conflicting demands of getting business back on board with badly needed structural economic reforms and boosting popular support ahead of next year’s general election.

“We are still dealing with an overflow from the Zuma years – this is legacy,” says Standard Bank chief economist Goolam Ballim. 

“SA’s economy is deeply mired but it is not on the edge of a precipice of deep structural collapse. The irony is that this may be the low point.”

It’s hard to see how government will find the money this year to pay for a big overshoot in its public sector wage bill, a new bailout package for state-owned enterprises (SOEs) and measures to stimulate the economy, particularly as the unexpected slowdown in growth will lead to lower tax revenues.  

Plans to accelerate land reform will inevitably drain more resources from government finances and the lack of clarity around how the emotive process of expropriation without compensation will work has quashed prospects of an immediate pick-up in private sector investment.  

Paradoxically, the very visible process of rooting out corruption in the upper echelons of government and booting out those responsible has worsened the pessimism which gripped the country after it became clear that there would be no quick fix to its problems after the ousting of Zuma in February.

Concern is mounting that some of the pledges which President Cyril Ramaphosa is making may be unaffordable, with both domestic and foreign investors putting plans on hold until after next year’s election – when it should be more clear whether planned economic reforms remain business-friendly.

Treasury will inevitably miss its budget targets and debt forecasts for this year but even if this is the case, it is unlikely that a credit rating downgrade is imminent from Moody’s Investors Service, the only global agency which still has SA’s foreign debt at investment grade.

In mid-August, Moody’s published a note saying that although “fiscal slippage” was likely in SA this year, it still expects medium-term targets to remain within reach, given the government’s track record of operating within spending ceilings.

An escalating crisis in emerging markets is compounding the economy’s woes, with contagion from countries like Turkey and Argentina triggering capital outflows and currency depreciation. 

The rand plummeted to R15.62 against the dollar on 5?September, its weakest level in two years.

The currency should claw back some of its losses in the near term, as the latest sell-off was mainly a reflection of “fast money” shedding South African assets, but much depends on events elsewhere in emerging markets, says Rand Merchant Bank currency strategist John Cairns. 

“At the moment it’s a vicious cycle,” says Isaah Mhlanga, executive chief economist at Alexander Forbes. 

“Business expects growth to be weak so they are holding back on new investment, which weakens the economy further – the policy environment is very uncertain at the moment.

“Foreign investors aren’t willing to kickstart SA’s economy, they want to participate in it. It means the onus is on local investors. But not much will happen before the election.”

No date has been announced, but the election will take place in April. “We can debate this at the edges but the reality is that it’s ugly out there,” says Khaya Gobodo, managing director at Old Mutual Investment Group.  

“It will be tough in the next two quarters but once we get through the election, life could look very good – we could see a strong snapback if Cyril gets a real mandate. And I think business will come to the party.”

This is an extract of the cover story that originally appeared in the 13 September edition of finweek. For the full story, including stock picks for the current economic environment, buy and download the magazine here.

rand  |  economy  |  south africa  |  recession
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