Publications
Partners
Global markets had the worst start to the year on record, with equity indices in Japan and Europe falling 10% and the S&P 500 declining 8.8% in the first two weeks of January. At the time of writing, the JSE’s All Share
Index was down nearly 14% in rand terms from its April 2015 high of 55 188.34, according to INET BFA data. A decline of 20% is traditionally seen as a bear market.
In dollar terms, the local market has fared even worse. A year ago the rand was at R11.60 to the US dollar. It breached R17.90 against the dollar for the first time in a “flash crash” in thin Asian trade on ?11 January, before recovering to around R16.65 at the time of writing. If ever there was a metaphor for SA’s parlous economic state, this was it.
As to where the rand will go from here, all bets are off. There’s talk of R19 to the dollar and worse by the end of 2016. Once it breached R16 to the dollar, the rand’s technical moorings were sundered and traders saw it as a runaway train.
A recent report by Nomura puts the rand at anywhere between R19.33 to R17.36 to the dollar by year-end, which now looks eerily within reach. The bank estimates fair value for the rand, based on one purchasing power parity (PPP) calculation, is around R12.26. But that may be some way off.
The trigger for the latest bout of bloodletting was China. It devalued its currency at the start of the year, prompting an exodus of capital and a massive sell-off of equities (see sidebar). There is concern that China’s economic ship, which has been a key driver of the global economy, is faltering.
The country reported GDP growth of 6.9% in 2015, down from 7.3% in 2014 and the slowest pace in 25 years.
In a recent note, Capital Economics suggests growth has been “closer to 4% than the 7% of the official figures”. However, it said growth seems to have stabilised in recent months, and that the collapse many were worried about in mid-2015 has not materialised.
A handy rule of thumb for currency traders is to butcher the rand each time there is an emerging-market scare. It just happens to be the most tradeable target out there. But the consequences for South Africa are dire.
The Reserve Bank will now be under pressure to stem the inflationary effects of the weakening rand by hiking interest rates this month, with further increases likely later in the year. If this happens, recession is a virtual certainty towards the middle of the year. That trashes any hope of creating jobs or boosting tax revenues. Austerity, whether we like it or not, will be imposed on SA.
All eyes on Gordhan
Finance minister Pravin Gordhan, who believes SA can avoid slipping into recession this year and says government will do everything possible to avoid a credit ratings downgrade to junk, will have to cut Treasury’s growth forecast of 1.7% for 2016 in the February Budget (the International Monetary Fund cut its growth outlook for SA to 0.7% for 2016, and 1.8% for 2017).
He is also expected to elaborate on cabinet’s measures to help boost the economy.
SA bonds are already flirting with junk status and a further ratings downgrade will confirm this.
The yields on SA bonds – the premium demanded by investors to hold local bonds rather than US Treasury bonds, which are seen as risk-free – surpassed the average for its emerging-market peers for the first time on 18 January since at least 1998, Bloomberg reported.
Dawie Klopper, investment economist at PSG Konsult, says Gordhan has one of the toughest jobs imaginable on his hands to keep everyone happy in a [municipal] election year. “There is very little room for him to manoeuvre in this Budget. The tax base is not growing and yet he has to satisfy huge demands from the electorate. The government is under huge pressure to deliver in an election year.
“Gordhan, you must remember, was minister of finance when the public sector wage bill ballooned out of control. Nearly 40% of all taxes collected now pay public sector wages.”
David Shapiro, director at Sasfin Securities, says while concerns about the Chinese economy affected all emerging markets, there is little to be optimistic about in SA.
“Two factors indicate the extent to which investment sentiment has swung against SA: the rand hitting R17 to the dollar and the crack in the bond market in December, which looks as if it is now priced for a ratings downgrade.”
Shapiro is concerned that government either does not grasp, or else does not care about, what is currently happening in the economy. “SA companies have been quietly shifting their capital abroad over the years to the point where roughly 70% of the JSE’s earnings are now dollar-based. So SA companies are less concerned about what happens here, and that is a worry.”
This is an excerpt from and article that originally appeared in the 28 January 2016 edition of finweek. Buy and download the magazine here.
