Thematic view: Navigating South Africa’s foggy economic outlook

Market and economic highlights:

• Probably the most important topic at this stage of the cycle is a potential recession in the US. The majority of market participants are calling it the most-anticipated US recession in history, yet this recession continues to evade its “eventual” fate. Most analysts and strategists, like myself, continue to sound the “not if, but when” mantra as a broad range of Conference Board leading indicators (link) are signaling an imminent slow-down in the US and with only the labour market showing some resilience. The St Louis Fed (FRED) also looks at a range of lagging indicators of a US recession which signal whether the US is in recession, and even among those indicators, only the labour market remains buoyant.
• The South African Reserve Bank opted to keep the repo rate on hold at 8.25%, a move welcomed by most market participants. The rand/dollar exchange rate strengthened after the interest rate decision, supported by a broad range of positive developments in South Africa, including the decision by Russian President Vladimir Putin to not attend the BRICS summit in person this month. The European Central Bank, Bank of England and the US Federal Reserve Federal Open Market Committee (FOMC) both decided to hike rates by 25bps (0.25 percentage points).
• China announced an economic stimulus package that is expected to kick start the Chinese economy. A broad range of emerging market stock indices benefited from the news as the globe braces for a broad-based economic slowdown driven by economies in Europe and the US. The specific initiative and implications of the economic stimulus package remain to be seen, but the Chinese economy looks set to prop up the global economy this year.
• Russia exited the Ukraine Black Sea grain deal that enabled exports of Ukrainian agricultural products, a move that has had a marginally negative impact on global food prices. The deceleration in food prices has been a major source of the deceleration in headline inflation globally and for this reason, the Black Sea grain deal collapse presents an upside risk to food inflation. This, coupled with the building of a potential El Niño climate pattern, could heighten the food inflation risk.

Thematic view: Navigating South Africa’s foggy economic outlook

The decision by the South African Reserve Bank to keep interest rates on hold offers a welcome reprieve for interest rate-sensitive consumers, especially considering the compound effect that falling inflation and non-rising interest rates has on consumer spending power. Chart 1 below shows how restrictive monetary policy, proxied by the differential between CPI inflation and the repo rate, is in South Africa. The difference between CPI and the repo rate is at its highest since 2008/2009. The situation is not different from what is happening in the developed world. The difference between CPI and the Federal funds rate in the US is also restrictive and at its highest levels since 2008/2009 (see chart 2 below).

Chart 1: SA repo rate minus SA inflation

Chart 2: Federal funds rate minus US CPI

Among other reasons, the strength of the currency seen in July was partly due to the anchoring of the credibility of the central bank. As shown in chart 3 below, through to the end of July, there had been a sustained appreciation in the rand/dollar exchange rate (although that has unwound somewhat during the first week of August following a benign outlook for Chinese growth and its contribution to global growth *discussed below). Charts 4 and 5 show that inflation is back within the central bank target range, in stark contrast with most developed markets. In addition, inflation expectations are anchoring lower, with the Reserve Bank itself estimating inflation to be around the mid-point of the range within the next 12 months. Key upside risks to inflation are the exchange rate, volatile oil prices and agricultural markets. The Reserve Bank seemingly has accounted for that, as its inflation expectations are marginally higher in comparison to our in-house view. 

Chart 3: Rand/dollar exchange rate

Chart 4: Last inflation prints, and the SA Inflation trajectory based on Investec Wealth & Investment model

Chart 5: SA Inflation relative to other countries

With the latest repo rate decision and inflation print, we have seen a shift in interest rate expectations. The market now expects the Reserve Bank to start cutting interest rates in the first half of 2024 (see chart 6 below).

Chart 6: Interest rate expectations in South Africa

The performance of the rand in July was good news for inflation expectations. A variety of factors had a positive impact on the rand which are ultimately reducing the risk premium attached to South Africa and the currency. The clouds appear to have cleared, although there are hints of fog on the horizon. Rand strength, should it be sustained, will be disinflationary and, given the general decline in food and energy prices, this will be enormously positive for consumers, and in particular lower-income consumers who are more leveraged to those expenditure items in their consumption baskets. We will continue to watch the currency closely as the beginning of August has proven difficult for the rand to hold onto gains made in July.

Despite some good news, some realities warrant some consideration.

Chart 7 below shows that broad-based growth is expected to be slow across our major trade partners - the US, Germany and the UK, among others. There is also significant scope for consumption demand to dissipate globally. This could have a significant impact on the performance of South Africa’s exports and the local economy.

Chart 7: Sample of global GDP growth expectations

The US and Europe account for around 35% of our exports (see chart 8 below) and a weak growth environment in those geographies would be negative for demand for our exports, and therefore negative for GDP growth. This reality is even more concerning given the recent performance of commodity prices globally, including a basket of commodities which our mining companies are significantly exposed to. This could significantly hamper the profitability of our mining companies, which are a significant source of revenue for SARS. This will stifle the government’s ability to deliver services, provide social financing, and service debt.

Chart 8: SA foreign trade by country/continent

As we kick off earnings season, it has been discouraging to read the extent to which logistics constraints and energy insecurity are impacting the relative performance of these companies. Falling commodity prices, weak growth among our trading partners and export incapacity are set to substantially impact revenues in our mining sector. There has been anecdotal evidence of this in our tax revenues from mining companies.

Chart 9: SARS Revenues from mining companies

We recall work done in March (Chart 10 below) on the relative impact of exports on GDP growth. If our exports were up 20%, we would expect an uplift to GDP growth of around 7%. The opposite is true for weak exports and we would thus expect a weaker GDP outcome.

Chart 10: Exports and GDP growth in South Africa

That said, we do not underappreciate the extent of the work being done by Transnet management in resolving logistics issues, as demonstrated by the finalisation of the agreement with the International Container Terminal Services Incorporated (link) and ongoing work in securing rail lines and improving operational capacity at our ports and railways.

One potential source of better news for exports and the economy would be the extent to which China implements an economic stimulus package. But the acceleration of the Chinese economy may provide an inflationary headwind as commodity prices and Chinese demand pick up, although this may be offset by weaker demand in the West. This presents a conundrum, but perhaps promoting employment and propping up domestic industry is worth greater consideration without tipping the inflation scale. That said, the inflation scale in this case is mostly influenced by an exogenous factor, namely the Chinese stimulus package.

But as we have said before, one route out of this predicament would be the loosening of monetary policy sooner rather than later. The interest rate lever could stimulate local demand when global demand is set to weaken. Consumption accounts for around 60% of GDP and, as such, incremental downward adjustments to interest rates could bolster consumption and stimulate GDP growth. Given South Africa’s deep-rooted employment problem, the economy needs to grow at a pace where broader industry can remain profitable and create jobs. Cutting interest rates could also simultaneously reduce the interest burden for corporates which in turn may stimulate private gross fixed capital formation (capital investment) too, another important input for GDP growth. The last point is that government debt will benefit from lower short-term interest rates and lower inflation expectations, and have a positive impact on the government’s interest repayments on the government debt and ultimately be a positive for our debt-to-GDP ratio and trajectory, given a stagnant GDP growth environment.

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