South Africa goes to the polls Wednesday. An ANC victory looks likely, but President Cyril Ramaphosa still must grapple with poor fundamentals and a souring global backdrop for the nation. We remain negative on South African assets.
General elections will be held this Wednesday, May 8. Results are unlikely before Friday, and there are no exit polls released. All 400 seats in parliament will be contested. Seats will be awarded proportionately according to each party’s share of the popular vote. In turn, parliament will elect the next president.
Some polls suggest the ANC’s popularity has rebounded after Ramaphosa replaced Zuma as its leader last year. Others do not. Recent polls show ANC support ranging anywhere from 51-61%. The latest IRR tracking poll suggests 53-54% would vote for the ANC, 23-24% would back the Democratic Alliance (DA), and 13-14% would back the Economic Freedom Fighters (EFF).
The ANC has seen its share of the popular vote fall in every election since 2004. The ANC only got 54% of the vote in the 2016 municipal elections, a record low and down from 62% at the last national election in 2014. Since seats are awarded proportionally to the popular vote, a 53-54% showing this week would be very negative for the ANC.
The next administration will have to deal with the same long-term structural issues as past administrations. That suggests little has been done but perhaps this is being unfair to Ramaphosa. He is clearly trying to eliminate entrenched corruption and graft in the nation and that will take years, if not decades.
A BRIEF HISTORY LESSON
Jacob Zuma was elected president of South Africa in 2009 as the ANC won 66% vote. The Democratic Alliance won 17% of the vote, while the new Congress of the People (another ANC offshoot) won 7% and the Inkatha Freedom party won 5%. Kgalema Motlanthe was chosen as Zuma’s Deputy President after serving as interim president from 2008-2009 following the resignation of President Thabo Mbeke.
Zuma was reelected in 2014 with 62% of the vote. The Democratic Alliance won 22%, while the Economic Freedom Fighters (EFF) won 6%. Former leader of the ANC youth wing Julius Malema broke off and formed the EFF in 2013 and so this was the first time it ran in national elections. Motlanthe had challenged Zuma for the ANC leadership in 2012 but was soundly defeated. Cyril Ramaphosa became Zuma’s Deputy for his second term.
After surviving numerous scandals and attempts to oust him, President Zuma resigned in February 2018 before a no confidence vote was to be held. Clearly, the writing was on the wall as the ANC had finally united to push Zuma out. Parliament quickly appointed Deputy President Ramaphosa to serve as President.
His election as president was controversial. The EFF, the DA, and other opposition parties opposed Ramaphosa’s election by parliament. Rather, they called for fresh elections that would give the next leader a true mandate. Of course, the ANC did not want this, hoping to instead allow Ramaphosa to help rebuild the party’s image before having to face the voters again. We should find out shortly if this strategy worked or not.
Growth remains sluggish. The IMF forecasts growth of 1.2% in 2019, 1.5% in 2020, and 1.8% in 2021. Growth was only 0.8% in 2018. GDP rose 1.1% y/y in Q4, while monthly data so far suggest growth decelerated slightly in Q1. As such, we see slight downside risks to the growth forecasts.
Price pressures are picking up. CPI rose 4.5% y/y in March. While inflation is still within the 3-6% target range, we see upside potential ahead. PPI rose 6.2% y/y in March, the highest since November. The weak rand should feed into both CPI and PPI inflation ahead, and so generalized price pressures are likely to continue rising.
The South African Reserve Bank (SARB) started a tightening cycle in November with a 25 bp hike to 6.75%. The vote was split 3-3. This ended a very shallow easing cycle that took the policy rate from 7.0% in mid-2017 to 6.5% in early 2018. At that meeting, its model projected more three hikes by end-2020.
At the January 17 meeting, SARB delivered a dovish hold. Its model forecast only one more hike by end-2019 and then steady rates through end-2021. At its March 28 meeting, the SARB delivered another dovish hold by cutting its growth forecasts for both this year and next whilst maintaining its projection only one more rate hike by end-2019.
Next policy meeting is May 23. If current rand weakness continues, we think SARB will have to deliver a more hawkish hold than it has in these two most recent meetings. Markets are not pricing in a rate hike currently, but we think some repricing is needed. While growth remains sluggish, we do not think SAR will stand pat if the rand were to weaken and push inflation up.
Finance Minister Mboweni’s February budget statement painted an even grimmer fiscal picture than his midterm budget review back in October. The FY2018/19 budget deficit was revised to -4.2% of GDP from -4.0% in October. The deficit is forecast to widen to -4.5% in FY2019/20 vs. -4.2% in October before narrowing back to -4.3% in FY2021/22 vs. -4.0% in October. With regards to gross national debt, it is seen peaking at 60.2% of GDP in FY2023/24. This is up from a peak of 59.6% forecast in October. Mboweni pledged to stabilize this ratio around 60% but we doubt the ratings agencies will remain patient enough.
The external accounts are likely to worsen. The current account deficit was an estimated -3.2% of GDP in 2018, and the IMF expects the deficit to widen to -3.4% this year and -3.7% in 2020. Export growth slowed noticeably last year and that has carried over into this year, leading the trade surplus to narrow sharply. As such, we see risks of larger than expected current account deficits ahead.
Foreign reserves are near record highs, but vulnerabilities remain. At $49.7 bln in March, they cover barely 4 months of imports and are only equal to around 95% of the stock of short-term external debt. Thus, the country is vulnerable to shifts in sentiment and so-called hot money. One mitigating factor is South Africa’s Net International Investment Position (NIIP), which has risen to an all-time high near 15% GDP.
The rand continues to underperform after a poor 2018. In 2018, ZAR fell -14% vs. USD and was ahead of only the worst EM performers ARS (-51%), TRY (-28%), RYB (-17%), and BRL (-15%). So far in 2019, ZAR is -1% and is ahead of only the worst performers ARS (-16%), TRY (-12%), KRW (-5%), RON (-4.5%), and BRL (-2%). Our EM FX model shows the rand to have VERY WEAK fundamentals, and so we expect this underperformance to continue.
USD/ZAR is on track to test the December and April highs near 14.75. A break above those highs would set up a test of the September high near 15.70.
South African equities continue to outperform. In 2018, MSCI South Africa was -15.4% vs. -17.4% for MSCI EM. So far this year, MSCI South Africa is up 13.7% YTD and compares to 11.4% YTD for MSCI EM. Our EM Equity Allocation Model puts South Africa at VERY UNDERWEIGHT, and so we expect South African equities to start underperforming more.
South African bonds have outperformed. The yield on 10-year local currency government bonds is -23 bp YTD. This is behind only the best EM performers Mexico (-58 bp), Russia (-55 bp), Peru (-49 bp), Brazil (-41 bp), and Malaysia (-29 bp). With inflation expected to rise and the central bank potentially tilting more hawkish, we think South African bonds will underperform more in the coming weeks.
South Africa’s implied rating fell a notch this past quarter to BB-/Ba3/BB-. Moody’s and Fitch’s ratings of Baa3 and BB+, respectively, are seeing heightened downgrade risk. Even S&P’s BB rating appears too high now.
After the underwhelming budget statement, we see downgrades ahead, including the loss of investment grade from Moody’s. Moody’s punted on the decision back on March 29, but it’s only a matter of time. Its rating is very important, as the loss of investment grade would lead to ejection from the World Government Bond Index (WGBI) which in turn would result in some forced selling of South African bonds.