Nene bombshell shatters SA
South Africa woke up on Thursday broken by the firing of Nhlanhla Nene as finance minister by President Jacob Zuma the previous evening.
Zuma’s decision not only astounded markets, the public and – if speculation is correct – the top echelons of the ANC, but almost instantly sent the rand, a key measure of confidence in our country, to crisis levels. The currency had its biggest single fall since the events of 9/11 14 years ago, according to Bloomberg.
Borrowing costs in the bond markets leaped, and the major state-owned entities, such as Eskom, which are already battling financial crises, are expected to come under enormous pressure.
Analysts and economists predicted Nene’s firing would could push the country into a recession and reduce its investment status to junk. Interest rate increases to protect the currency are likely, as is an increase in inflation and job losses. Tax hikes in the next budget could well follow.
Nene’s removal has been viewed as an attack on the credibility of the treasury, which is seen as a bastion of good governance within the state. There are also fears that the South African Reserve Bank could be next in line.
Blunting the law
The treasury has wielded the Public Finance Management Act (PFMA) like a sword to curb wasteful and corrupt spending, and the replacement of Nene with an obscure parliamentarian, David van Rooyen, will blunt the use of the “most effective piece of legislation in combating corruption”, said Ralph Mathekga, the head of political economy at the Mapungubwe Institute for Strategic Reflection.
The move sent the rand off a cliff. The currency rapidly broke through the R15 to the US dollar mark on Wednesday night, hitting R22.88 to the British pound and R16.56 to the euro.
The bond market also slumped, with the yield on the benchmark government bond jumping from 8.8% to over 10% by Thursday afternoon.
“This is symbolic of investor sentiment, both internationally and locally,” said Mohammed Nalla, the head of strategic research for global markets at Nedbank Corporate and Investment Banking.
There are serious questions over why Zuma chose to replace the well-respected and technocratic Nene, as well as questions over the timing of the move, said Nalla.
The announcement has come hot on the heels of a credit ratings downgrade and at a time when adverse global events are looming, most noticeably the widely expected decision by the United States Federal Reserve to raise interest rates, Nalla said.
Investors are likely to be concerned about “institutional erosion”. The reason South Africa has been rated more favourably than other emerging markets has been because of the independence of the South African Reserve Bank, the treasury and judiciary, he said.
“Now we effectively chip away at the national treasury being a cornerstone of that framework.”
Nalla said the probability of South Africa sinking into economic recession next year has increased.
“This just exacerbates what is already a very difficult position for the South African economy. It may catalyse a much more aggressive reaction from the Reserve Bank in terms of rate hikes and that could possibly exacerbate the downside growth risks.”
Jannie Rossouw, the head of the school of economic and business sciences at the University of the Witwatersrand, said, with the weakening of the rand, the interest burden on South Africa would increase, as would the value of capital repayments, because all the items were priced in foreign currency.
With Nene no longer the minister, the government is unlikely to stick to its expenditure ceilings and much higher taxes can be expected next year, he said.
“Nene did not support Zuma’s expenditure plans with [SAA] and the nuclear deal,” he said.
Zuma’s administration could well increase personal income taxes to fund its spending plans, particularly given that the taxpayers are not typically ANC voters, Rossouw said.
But a critical question is how the ANC will deal with this.
“When will reasonable voices in the ANC stand up and say, ‘this is enough’?” he asked. “If they don’t speak [up], can we have any confidence in them going forward?”
Mamokete Lijane, the fixed income analyst of Sasfin Securities, said the announcement has had a major effect on the markets. “It is such a disaster … How do you trade through a crisis? We have never had to.”
In 2008, the crisis was global, but in this case the focus is squarely on South African politics.
“As a South African investor, you can’t take money offshore. They are pretty much at their limit in that regard,” she said. “It’s really negative for the fixed-income market.”
On Thursday morning, the 10-year bond yield had been repriced by 60 points, moving from 8.8% to 9.4%.
“It translates into a 4% loss in overall bond value,” said Lijane, who added that the market capitalisation of government bonds was at R1.4-trillion before, and so R56-billion in market value had been eroded in a matter of hours.
Although much of the government debt is fixed, the cost of any newly accumulated debt will be higher, she said. The rising government bond yield could raise the cost of borrowing offshore substantially and will affect parastatals such as Transnet.
“At the moment, you can’t make any firm call on what will happen … It’s a highly unpredictable situation and makes it difficult to trade when you dealing with policy decisions.”
Lijane said the market can trade when economic policy and trends are involved “but, when you add political uncertainty, there is a risk premium”.
A full-blown currency crisis cannot not be ruled out.
Christ Hart, of Standard Bank Wealth and Investment, said the rand is a critical indicator, and its movement in reaction to Zuma’s announcement is “telling you there is a huge problem with confidence in the decision. Confidence is a critical part of financial markets.”
The prospects of South Africa hitting a major rand crisis in the next few weeks are increasingly high, Hart said.
“The rand has been trending weaker now for the past four years. It could fall out of bed – 24, 25 or 30 to the dollar, pick a number,” he said.
Zuma’s decision also elicited shock from across the political spectrum. The trade union federation Cosatu, a key Zuma ally, said it was “shocked and disconcerted” by the decision.
“Minister Nene’s tenure was very short and the economic sector does not cope well with abrupt and unqualified changes,” it said in a statement. It described him as “an approachable and an engaging minister”.
“To manoeuvre this economic minefield and smooth transition, we needed the stability, continuity and the experience that Nhlanhla Nene provided,” it added.
Nene’s unwillingness to open the government purse for the planned nuclear deal and his efforts to exert control over SAA, which is headed by purported Zuma confidante Dudu Myeni, are believed to be the explanations for his removal.
But in a research note, political analyst JP Landman said “the pesky constraints of the PFMA [Public Finance Management Act] are probably part of what irritates the president”.
It imposes all kinds of limits and tests on spending decisions and constitutes best-practice standards for public finance management, he added.
Paul Hoffman, the director of the Institute for Accountability in Southern Africa, said: “South Africa is moving treacherously close to putting in place all of the ingredients of a failed state. The ingredients of a failed state are essentially when the rule of law is replaced by the rule of men.
“In this case, what we have are clear indications that Nene has been fired because he is at odds with Zuma and [Energy Minister Tina] Joemat-Pettersson on the nuclear build programme. He is at odds with the presidency in relation to the purchase of a R4-billion jet. And he is at odds with the chairperson at SAA, also known to be close to President Zuma,” said Hoffman.
“For Zuma then to blandly go on television and tell the country what a fine fellow Nene is and to replace him with an unknown backbencher is not going to inspire confidence in the fiscal and economic future of South Africa. And it is really suggestive of a programme under which Zuma wants himself and those who agree with him to have hegemonic control.”
Check on spending
Hoffman said the PFMA is intended to keep spending in check. If it is flouted, it can be taken to court but would be subject to endless appeals.
“It is at the president’s discretion to hire and fire ministers,” Hoffman said. “I don’t think the firing of Nene was the right thing for South Africa. But I don’t believe it can be assailed in court.”
The independence of the Reserve Bank is now also deemed to be at risk. Peter Attard Montalto, a senior emerging markets strategist at the financial services group Nomura, said: “We can no longer view the [Reserve Bank] as sacrosanct either, but one should not underestimate the tenacity and drive of Lesetja [Kganyago, its governor] to protect the independence of the institution through any means necessary, including Constitutional Court action.”
The central bank would have a “serious fight on their hands”, he said, adding: “We must watch for mandate changes.”
The fallout from Nene’s recall has also begun to hurt South Africa’s private sector.
Bloomberg reported on Thursday that South Africa’s banking index plummeted to levels on a par with the 2008 global financial crisis.
As of Thursday morning, FirstRand fell by 10%, the Standard Bank Group by 9.1%, Absa by 9.2% and the Nedbank Group by 6.6%, according to Bloomberg.
How to ward off a default disaster in 10 days
Time is against new Finance Minister David van Rooyen, who has just 10 days to make a decision on what structure a deal between SAA and Airbus should take.
Van Rooyen, a parliamentary backbencher, was announced as the replacement for fired finance minister Nhlanhla Nene on Wednesday evening.
The shock decision to remove Nene occurred without much explanation, but is suspected to be partially connected to his rejection of a problematic deal proposed by the SAA board that would have put the finances of the airline, and the government, at risk.
Although speculation has been rife about the manner and the timing of the president’s decision, December 21 looms large: that’s the date by which SAA, with the treasury’s approval, must arrange a new deal with Airbus or pay $100-million due to the aircraft manufacturer.
As the treasury indicated when it rejected the offer put forward by the SAA board, there was an urgency to come to a decision before December 21, when predelivery payments of these millions of dollars to Airbus would be due.
As previously reported by the Mail & Guardian, the A320 contract, first negotiated in 2002, lumped SAA with an obligation to buy 10 aircraft which are suboptimal for serving the routes they were ordered for. The contract also made provision for predelivery payments, some of which SAA has paid, but others are overdue.
“To rectify this onerous contract, SAA had negotiated a swap transaction where the purchase of the remaining 10 A320s would be cancelled and SAA would instead enter into operating leases on five A330-300s,” the treasury said last week.
These aircraft would phase out another gas-guzzling fleet and would result in cost savings. There would be a cash flow benefit as Airbus had agreed to reimburse SAA for the predelivery payments that have already been paid for the remaining 10 A320 aircraft. “The net effect would have been to put the airline in a cash-positive position,” one source explained.
Nene approved this swap deal in September, but was then presented with a new plan from the SAA board to amend the structure of the deal.
The proposal entailed SAA still purchasing the A330 aircraft and entering into a sale and lease-back of the aircraft with a local lessor so that the lease would be denominated in rands (as opposed to United States dollars in the swap agreement). SAA indicated the arrangement with the local leasing company would include that company paying $100-million in predelivery payments due.
The treasury, however, concluded that, with the short amount of time left until payments came due, the risk was too high that no third party would be appointed and that SAA would be unable to afford the predelivery payment.
“A default by SAA would have severe negative consequences for SAA and could have spillover consequences for the country as a whole,” the treasury said in last week’s statement.
Any deal would have to have a section 54 clearance in terms of the Public Finance Management Act, said a source with knowledge of the details. Because any agreement requires approval from both the treasury and the chair of the SAA board, the only deal in place is the first one, by which SAA will purchase the A320 and be liable for the predelivery payments if nothing is arranged by December 21. It is understood that any new deal will also need to have a legal opinion from a recognised attorney in South Africa.
SAA spokesperson Tlali Tlali confirmed telephonically that an agreement had to be reached within 10 days, but did not respond to further questions by email at the time of going to print. – Lisa Steyn