South African Reserve Bank meets Thursday and is widely expected to start an easing cycle with a 25 bp cut. Meanwhile, President Cyril Ramaphosa must grapple with poor fundamentals and ongoing corruption investigations.
Former President Jacob Zuma is being questioned this week in the ongoing corruption inquiry. He denied any knowledge of the Guptas offering former lawmaker Vytjie Mentor the Public Enterprises portfolio in return for a favorable policy move regarding South African Airways. Indeed, Zuma denied all knowledge of any of the graft and corruption accusations that have been leveled against him. The inquiry is expected to last into next year.
Zuma still has friends in high places. ANC Secretary Ace Magashule is considered a close ally of Zuma. Magashule has reportedly contradicted Ramaphosa recently and seems to agree with Zuma’s claim that he is being unfairly targeted. If nothing else, this underscores just how difficult it will be for Ramaphosa to root out corruption during his first term.
Corruption will remain one of the country’s biggest challenges. South Africa scores relatively low in the World Bank’s Ease of Doing Business rankings (82 out of 190). The worst components are starting a business and trading across borders, while the best are protecting minority investors and paying taxes. It does only slightly better in Transparency International’s Corruption Perceptions Index (73 out of 176 and tied with Morocco, Suriname, and Tunisia).
A BRIEF HISTORY LESSON
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.
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 in parliament. 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.
Ramaphosa was elected President in May with 57.5% of the vote. While this is the lowest share for the ANC in national elections, it does represent a modest rebound from municipal elections in 2016. Then, the ANC received a record low 53.9% of the vote. In this May’s election, the Democratic Alliance won 20.8% vs. 26.9% in 2016, while the EEF won 10.8% vs. 8.2% in 2016.
Growth remains sluggish. The IMF forecasts real GDP growth of 1.2% in 2019, 1.5% in 2020, and 1.8% in 2021. Growth was only 0.8% in 2018. GDP was flat y/y in Q1, while monthly data so far suggest growth accelerated modestly in Q2. However, we still see slight downside risks to the growth forecasts. SARB cuts its 2019 growth forecast at it May meeting from 1.3% to 1.0% and may cut it again at this week’s meeting.
Price pressures are stabilizing. CPI rose 4.5% y/y in May. While inflation is right at the center of the 3-6% target range, we see some upside risks ahead. PPI rose 6.4% y/y in May, just below the cycle peak of 6.5% in April. On the other hand, the relatively firm rand should help limit both CPI and PPI inflation ahead, and so generalized price pressures are likely to remain largely stable.
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. Growth forecasts for 2019 and 2020 were left unchanged at 1.9% and 2.0%, respectively. Its model projected three more hikes in the cycle that would take the policy rate to 7.5% by-end-2020.
At the January 17 meeting, SARB delivered a dovish hold. Its model forecast shifted to only one more hike by end-2019 and then steady rates through end-2021. The 2019 growth forecast was cut to 1.7% but 2020 was kept steady at 2.0%. At its March 28 meeting, the SARB delivered another dovish hold by cutting its growth forecasts for both this year and next to 1.3% and 1.8%, respectively, whilst maintaining its projection of only one more rate hike by end-2019. At its May 23 meeting, its model shifted to projecting one rate cut by March 2020 rather than the one hike previously.
Next policy meeting will be held this Thursday. A 25 bp cut to 6.5% is widely expected, though a handful of analysts see no cut and one sees a 50 bp cut. Bloomberg consensus sees only one cut through end-2020 but we see risks of a deeper easing cycle if the economy remains weak. With the rand remaining relatively firm, SARB should cut this week.
Finance Minister Mboweni will present his midterm budget review in October. Even though his February budget statement painted a grim fiscal picture, we suspect that things can get even grimmer. In February, the FY2018/19 budget deficit was revised to -4.2% of GDP from -4.0% in October. The deficit was forecast then to widen to -4.5% in FY2019/20 before narrowing back to -4.3% in FY2021/22.
Expenditures continue to outpace revenues. The 12-month deficit stood at -ZAR253 bln in May, a record high and equivalent to nearly -5% of GDP. As such, we believe some more bad news is baked in the cake for the October midterm review and could be the trigger for further ratings downgrades. The costs of the Eskom bailout are likely to weigh on the budget outlook too.
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 $49.8 bln in June, reserves 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 10% of GDP.
The rand is outperforming 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 up 3% and is behind only the best performers RUB (11%), THB (5.5%), PHP (3.3%), IDR (3.3%), BRL (3.1%), and MXN (3%). Our EM FX model shows the rand to have VERY WEAK fundamentals, and so we expect this outperformance to ebb.
USD/ZAR traded at its highest level since September near 15.7525 June 7. It has since dropped back below 14.00 and appears to be on track to testing the January 31 low near 13.2360. The 200-day MA comes in near 14.21.
South African equities are underperforming. In 2018, MSCI South Africa was -15.4% vs. -17.4% for MSCI EM. So far this year, MSCI South Africa is up 10.3% YTD and compares to 11.3% YTD for MSCI EM. Our EM Equity Allocation Model puts South Africa at VERY UNDERWEIGHT, and so we expect South African equities to continue underperforming.
South African bonds have outperformed. The yield on 10-year local currency government bonds is -61 bp YTD. This is behind only the best EM performers Brazil (-205 bp), Russia (-136 bp), Chile (-127 bp), Peru (-115 bp), Mexico (-104 bp), India (-94 bp), Indonesia (-91 bp), and Colombia (-72 bp). With the central bank likely to start an easing cycle this week, we think South African bonds will continue to outperform 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.
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.