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Peter Attard Montalto
25 Aug 2016 09:06
The market erroneously priced out political risk premia to zero in recent months, when it should have remained as high as at the start of the year. This is going to be a relatively rapidly moving story – there is political urgency now to the need for change at the national treasury, but Finance Minister Pravin Gordhan will not go without a fight and dig in.
That means, ultimately, it will be President Jacob Zuma’s decision whether to push the reshuffle button or not.
The market received a sharp wakeup call with news that Gordhan had been summoned to receive draft charges about what some allege to be a spy unit at the South African Revenue Service (Sars) when he was commissioner. This was a rude awakening for a market with zero political risk premia. The “war” suddenly was alive – again.
Before the local elections campaign got under way, there was a rough stalemate in the “war” between Gordhan and Zuma. It was then buried for the election campaign, as the focus shifted by both sides to maximising the ANC’s chances in the polls. However, the “war” was not over. The market wrongly priced out political risk premia from May to the start of August to zero, especially after the elections. The market does not understand the political dynamic in the ANC, and especially relating to Zuma’s position and power. This has left us with a situation where the market is in dire need of risk premia – the same amount we had in Q1 even – but there is still a long way to get there.
Zuma has not lost power – neither after Nenegate, when he fired finance minister Nhlanhla Nene, nor after his Constitutional Court case on Nkandla nor after the local elections. Zuma is the master of playing the ANC, and especially the national executive committee (NEC) at its own games, holding it exactly where he wants it. We still believe he has the support of at least 60% of the NEC, which, in turn, backs him in what is going on now.
Ultimately, zooming out, this is all about winning the ANC elective conference – currently scheduled for December 2017, though possibly earlier, which adds a sense of urgency. Winning the elective conference is about charting a path under a new leader, but that represents the status quo for the tenderpreneur faction, through to the ANC winning in 2019.
The route to that is a well-oiled patronage machine, which requires control over the national Treasury. Control does not necessarily mean PGxit – that Gordhan has to be gone. There are other methods of “boxing in” that have been raised, new SOE Presidential oversight panel announced on Monday chaired by Zuma that would oversee and “instruct”’ the treasury on matters relating to the parastatals.
The finance minister is a powerful position in the departments created by the Constitution and in which is vested a lot of responsibility by the Public Finance Management Act (PFMA). As such, PGxit through either his resignation or being reshuffled out, is clearly on the table.
We believe that Gordhan will fight for as long as possible to remain in position and to protect the law, the treasury, and its staff. This has been shown by his decision that he will not attend the summons meeting with the Hawks. He states his innocence in the strongest possible terms and has put the ball firmly in Zuma’s court to fire him.
The pressure he is under is mounting up – from the spy unit claims and on new investigations into tenders and contracting while he was Sars commissioner.
There is a need for speed from Zuma’s perspective and that is why we think this will move rapidly, to an arrest and charges and then to a reshuffle:
We believe that PGxit is a “live” issue, though putting a precise timeline on this cannot be done. We believe we are moving towards the endgame, however.
This kind of narrative may make no sense to investors, but we believe it can be effective internally and allow Zuma to proceed. He is taking a risk but we think there is a view in the ANC that ratings do not matter and the ANC shouldn’t be a slave to markets. Additionally, there is now a lot more political urgency to this issue than there was in December last year or H1 this year and we believe Zuma has the backing oto proceed but will only do so if he thinks he is protected.
We should not forget that a reshuffle has been seen as imminent even before the local elections to remove South African Communist Party members from Cabinet and possibly to remove Deputy Minister of Finance Mcebisi Jonas.
Fiscal Ultimately, this is not about a blowout of current fiscal policy; it’s about contingent liabilities, corrupt tendering, and inefficiencies in expenditure that prevent meaningful future consolidation.
For us, the risks around the MTBPS are still contained, partly given the treasury will be able to maintain a view of strong revenue momentum, as it has so far this year (very good buoyancy) but also as a result of reprioritisation within the fiscal ceiling, contingency reserves, and some savings already allocated. However, the pressure will be on into the budget for a greater degree of reprioritisation, a wealth tax to pay for a higher expenditure ceiling and a more general expenditure ceiling, and the revenue picture (given the lags that exist between growth and revenue), and this is likely to look worse then than at the MTBPS. We think that in long term the more likely story is a lack of consolidation as opposed to blowout.
Candidates We believe there are four candidates for finance minister that are in contention, though a new deputy could also be needed (or be reshuffled first):
The problem here, we believe, is any replacement would be appointed with the express view to facilitate tenderpreneurship and patronage. The two key boxes that need ticking are a candidate that is fiscally conservative and anti-patronage – that would uphold the PFMA. We don’t believe we can say any of candidates above tick both boxes.
The problem for the treasury is that, as an institution, it is clearly more than just the person at the top. It could find itself in an impossible situation under a new minister, say where civil servant advice is not to proceed with nuclear or not give guarantees on SAA or to block tenders that are not compliant with the PFMA but they are given political instructions to proceed. They would have a choice between leaving, resulting in a serious loss of capacity and weakening as an intuition, or stay and attempt to use the law and media to frustrate whoever is put in power.
We should remember, however, that changing finance minister is not a shortcut to Zuma getting what he wants – it’s simply the start of that process.
We would have to particularly watch for departures from the senior ranks, as well as what guarantees or memorandum appear before Parliament on parastatal issues in particular.
In May, Gordhan sounded a rallying cry that people should protect the treasury and its staff. We should remember that in the coming weeks.
Ratings We see rating agencies more likely to downgrade in this environment especially if and when institutional quality assessments are downgraded. We think S&P would react fastest straight after PGxit. Fitch might wait a little till after the MTBPS. Moody’s is a tough call, and we believe it has been consistently wrong in applying too much benefit of the doubt to South Africa and things like structural reforms, which haven’t emerged.
In particular, we highlight the local ratings convergence narrative here for all agencies but particularly S&P. This is especially important for SA dropping out of indices (which would require both Moody’s and S&P in sub-investment grade on local ratings). We believe, in line with the IMF in their recent Article IV, that around 7% of local currency fixed coupon debt stock is ratings sensitive.
SARB In this environment, market questions about the independence of the SARB start to swirl like during Nenegate.
We retain full confidence that the governor Lesetja Kganyago and deputies will aggressively seek to protect the constitutional independence of the institution through whatever means necessary, including hostile legal action in the constitutional court.
We do not see the SARB undertaking intervention of emergency rate hikes on a large selloff in the currency. It will want a political risk premia shock to be felt locally from the actions of politicians and will not stand in the way of market repricing. It would only undertake emergency action like intervention on a breakdown of the functioning of the FX market that risked financial stability. We did not meet that condition during Nenegate.
Instead, it will wait till the following MPC meeting and then hike by a large 50bp, but in effect (by not hiking some multiple of 100bp) undertake minimal action so as to offset second round effects into expectations and wages etc. but not try to backstop the market or offset first-round effects.
We continue to see two hikes to come in rates, one in November and one in March, both of 25bp. That would take us to a neutral rate of 7.50%. A more disorderly market reaction and getting stuck at higher USDZAR rates could push us into tight territory towards 8.00%.
Markets We remain confident of our USDZAR17.0 year-end call but think markets which have been caught long and wrong have a lot more to reprice, and in particular for real money to move from zero to well hedged in ZAR. Long-end bonds probably need to reprice back to, say, 10.0 at least (lower than Nenegate given lower USD rates in this risk on global environment). We worry about the wrong way round of positioning vs. Nenegate can make for more disorderly markets.
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