Limping economy faces uphill
If South Africa staves off a technical recession in the coming months, it will be a result of events unrelated to the country’s domestic political and policy environment.
But economists said the more important question is what happens when the lingering positive effects of a recovery end in certain sectors, such as agriculture and mining.
As Finance Minister Malusi Gigaba jetted off this week to meet international investors in the United States, economists who spoke to the Mail & Guardian were downgrading their growth forecasts for the year, or had already done so. For some, the risk of a recession in 2018 is a possibility, particularly if there are major economic policy shifts in the wake of the Cabinet reshuffle and the country fails to stem further credit ratings downgrades.
In the short term, a recovery in agriculture – based on expectations of a bumper maize crop after the good summer rains – and the pick-up in the mining sector as commodity prices have stabilised could help the country narrowly miss negative growth in the first quarter of 2017, according to Stanlib economist Kevin Lings.
During the fourth quarter of 2016, the economy shrank by 0.3%. A technical recession is defined as two consecutive quarters of negative growth.
But other factors such as weakness in manufacturing and retail sales could weigh down these positives.
In February, manufacturing production declined by 3.6% year on year. Although February retail sales saw some recovery, the sector still shrank by 1.7% year on year.
How the numbers will finally stack up remains to be seen but it is “going to be close”, said Lings.
External factors unrelated to domestic policy and the recent credit ratings downgrades could ensure that South Africa avoids an outright recession – a full year of negative growth – for 2017, he said. Most notably, these include strengthening in agricultural output as the sector recovers from the drought, further strengthening in commodity prices and improvements in the global growth outlook. This would improve South Africa’s export performance, which has already seen trade surpluses, helping to reduce the current account deficit, Lings said.
Domestic factors, such as the possibility of an interest rate cut, could rather have improved South Africa’s growth prospects, he said. But this is now off the table given the downgrades.
Lings estimated that economic growth is likely to come in at 1% or lower for this year instead of the initially forecast 1.3%.
“The bigger concern is what happens next year, ” said Lings. “That is where the risk of a recession is much more real.”
Agriculture won’t provide the same boost and a range of factors could have a negative effect. Consumer confidence could remain weak and, more importantly, the “investment recession” in South Africa’s business environment could intensify, he said. For the past five quarters, private sector fixed investment spending has been shrinking and business confidence has deteriorated.
Company balance sheets remain healthy, because South African corporates hold large cash deposits and less debt as a percentage of gross domestic product than their emerging-market peers. Long-standing concerns about policy ambiguity, among other issues, has made business reluctant to invest, Lings said.
With the changes to the ministry of finance, there is the risk of a change in economic policy direction and the potential of “radical economic transformation” superceding other established policies such as the National Development Plan, Lings said, adding that it remains to be seen how “radical economic transformation” will be defined and implemented. This has still to be decided at the ANC’s national policy conference in the middle of the year and at the elective conference in December.
But it’s fair to assume that “radical economic transformation” would likely require the government to spend more money, resulting in a failure to stick to the current spending ceiling, increased borrowing and the extension of more guarantees to state-owned entities.
This could lead to further downgrades and South Africa’s expulsion from several world bond indices, which in turn would lead to capital outflows, he said. This could trigger currency weakness, higher inflation and interest rates and the risk of outright recession, Lings said.
Given the risks, Lings said Stanlib has reduced its growth estimates for 2018 from 2% to about 1%.
According to Tinyiko Ngwenya, an economist at the Old Mutual Investment Group, given the “continued effects of base recovery”, it is too soon to say whether there will be a technical recession.
“But the key thing to highlight is that this cyclical recovery is going to be short-lived. In terms of long-term growth, we are in trouble,” she said.
At most, it is likely to continue throughout this year, after which South Africa needs to see business confidence return and private investment kick in, she said.
Before the Cabinet reshuffle and the subsequent downgrades, Old Mutual had forecast an initial growth rate of 1.7% for 2017, Ngwenya said, but it is now revising this down.
In the past five years, about R295-billion left the country because local corporates invested offshore, she said. The continued political uncertainty is weighing down private investment – a key downside risk to growth estimates.
Nazmeera Moola, co-head of fixed income at Investec Asset Management, said the key to avoiding further downgrades and resultant strains on the economy is to address the issues raised by the ratings agencies.
By the time of October’s medium-term budget, ratings agencies will need to see continued commitment to the budget deficit targets outlined in February’s budget and, if necessary, to see further cuts in expenditure, she said. Further efforts to stabilise the balance sheets of major state-owned entities, such as Eskom, will be needed, as well as assurances that nuclear procurement will not go ahead unless it was structured in a way that is affordable.
It is “not a given” that all foreign and local debt will be downgraded to subinvestment grade by all the major ratings agencies, which would result in the country’s expulsion from major world bond indices such as the Citigroup world government bond index (WGBI), Moola said.
Should this happen, the result could be the forced selling of about R120-billion. South Africa’s budget deficit is estimated at about R160-billion and it will be required to raise a total of R214-billion in debt this year.
Moola had forecast a “relatively optimistic” 1.7% growth before the reshuffle because of several positive developments, none of which “had anything to do with what we are doing locally”.
They included improved commodity prices and an expected uptick in sales volumes, improved agricultural output and an increase in tourism because of a weaker rand and the shutting down of North African destinations typically popular with European holidaymakers.
But she has reduced her growth forecast to about 1% in the wake of the downgrades and the likelihood that any positive domestic developments, such as an interest rate cut, is now off the cards.
The tailwinds of these positive factors could help to stave off a technical recession in the short term but another year of only 0.5% to 1% economic growth will “certainly feel like a recession” for ordinary people. “We might technically avoid a recession but for all intents the domestic economy is in recession,” she said.
These tailwinds will taper off over the next nine months. After that everything will depend on state policy and developments at the treasury.
Nerina Visser, an exchange traded fund strategist and adviser at eftsa.co.za, said South Africa has been flirting with recession for the past two years but for technical reasons has not experienced it yet.
“For all intents and purposes you can argue that, economically, we are in a recession even though technically it hasn’t [been] measured as such,” Visser said.
The factors buoying up economic growth – agriculture and mining – are coming off a very low base and do not mean that either sector is strong or vibrant, she said.
Factors such as declining inflation, because of a stronger rand and lower food prices, contributed to South Africa avoiding a technical recession, “but I don’t think it removes the fact that the consumer … is in an economic recession”, she added.
It is not all doom and gloom, she said, because South Africa has still retained its place in the WGBI despite a negative credit ratings trajectory, and other key bond indices such as the JP Morgan Emerging Market Bond Index don’t depend on credit ratings status.
To be excluded from the WGBI, S&P Global and Moody’s must rate a country’s local currency debt as sub-investment grade (junk status). In its recent ratings decision, S&P kept South Africa’s local debt one notch above junk, albeit on a negative watch. Moody’s has South Africa’s foreign and local currency debt at two notches above junk, although it has placed the country on review and it is likely to be downgraded.
Even if South Africa is excluded from the likes of the WGBI, there will still be an appetite for South African bonds from “risk-seeking, high-yield” investors, particularly in a world where developed market interest rates are flat or negative.
In addition, in a world in which the easy monetary policy, particularly by the United States Federal Reserve, props up the dollar money supply, that money needs to find a home, which typically goes into more risky assets, namely commodities and emerging market assets. South Africa benefits from these on both counts.