President Zuma has resigned and Deputy President Ramaphosa has assumed the mantle. What’s next?
President Zuma resigned before a no confidence vote was to be held today. Clearly, the writing was on the wall as the ANC had finally united in trying to push Zuma out. Parliament quickly appointed Deputy President Ramaphosa to serve as President until next year’s general elections.
Ramaphosa should quickly announce a cabinet shuffle that jettisons all remnants of the Zuma years. These include but are certainly not limited to Mineral Resources Minister Zwane and Public Enterprises Minister Brown. Yet the most important one that should be replaced is Finance Minister Gigaba. He was brought on to replace David van Rooyen, who was himself installed after the controversial decision last year to fire Pravin Gordhan.
Yet we believe that the ANC remains deeply divided. Ramaphosa was elected ANC leader in December by a very narrow margin. Ramaphosa and the ANC must now decide whether to pursue corruption charges against Zuma or to simply move on. We suspect many in the ANC would be caught up in any investigations of so-called “state capture.” Is the ANC leadership ready to go down this path?
Ramaphosa used his first speech today to pledge a strong effort on fighting corruption. We suspect he will stress this again in his first State of the Union speech. A dawn raid on the Gupta compound yesterday was itself a very strong statement. Prosecutors said today that Ajay Gupta, one of the three brothers thought to have corrupt links to Zuma, is now a “fugitive from justice” after he failed to turn himself in to police.
The country itself remains divided. The two main opposition parties refused to vote for Ramaphosa as President, despite pushing for Zuma’s ouster. The opposition Democratic Alliance and Economic Freedom Fighters had wanted early elections to be called, as they clearly wanted to hold a vote now before Ramaphosa had a chance to increase support for the ANC.
There is no date in set yet, but national elections will be held in Q2 2019. In the past, the elections have been held in April (1994, 2004, and 2009), May (2014), and June (1999). That does not give Ramaphosa very much time to boost public support for the ANC.
Parliamentary seats are awarded proportionately to the party’s share of the popular vote. Lawmakers are chosen from party lists. Note that the President of South Africa is not directly elected by voters, but is instead chosen by a parliamentary vote. If the ANC wins the 2019 elections, Ramaphosa would remain President of South Africa.
We say “if” because the ruling ANC has seen its share of the popular vote fall in every election since the end of apartheid. The ANC only got 54% of the vote in the 2016 municipal elections, down from 62% at the last national election in 2014. A sub-50% showing next year would be a disaster for the ANC, to state the obvious. This outcome is a realistic possibility and yet given how dysfunctional the ANC became under Zuma, we think markets might welcome an opposition win.
Corruption will remain one of the country’s biggest challenges. South Africa scores low in the World Bank’s Ease of Doing Business rankings (82 out of 190 and down from 74 in 2017 and 72 in 2016). The worst components are starting a business and trading across borders, while the best are protecting minority investors and paying taxes. It does slightly better in Transparency International’s Corruption Perceptions Index (64 out of 176 and tied with Montenegro, Oman, Senegal, and Suriname).
The economy is still sluggish. GDP growth is forecast by the IMF to accelerate modestly to 0.9% in 2018 from an estimated 0.7% in 2017. It sees growth remaining steady at 0.9% in 2019, but much will depend on what Ramaphosa does. The IMF is more pessimistic than the government, which sees 1.1% growth in 2018 and 1.5% in 2019. GDP rose 0.8% y/y in Q3, the weakest rate this year. Whilst Ramaphosa has pledged to boost growth, his hands will be tied by the need to rein in widening budget deficits.
Price pressures have slowly fallen, with CPI rising 4.7% y/y in December vs. 4.6% in November. January data will be reported next Wednesday and is expected to ease to 4.5% y/y. If so, this would be the lowest rate since April 2015 and would put inflation right at the middle of the 3-6% target range. Core inflation is also at cycle lows, but PPI inflation is picking up modestly.
This supports the case for lower rates, and we believe the South African Reserve Bank is likely to resume its easing cycle in 2018. The central bank started the easing cycle last July with a 25 bp cut to 6.75%, but has been on hold since. If the rand remains relatively firm, we think another 25 bp cut to 6.5% is likely at the next policy meeting March 28.
Fiscal policy remains an open question. We think President Ramaphosa should replace Finance Minister Gigaba with a credible alternative who delivers an aggressive budget statement on February 21. At his mid-term budget speech in October, Gigaba acknowledged the bleak outlook but offered little in the way of solutions. The deficit forecast for FY2017/18 was raised to -4.3% of GDP from -3.1% previously, while the FY2018/19 forecast was raised to -3.9%. Indeed, the Finance Ministry raised its deficit forecasts and cut is growth forecasts for the next three years.
The external accounts are likely to worsen. Low commodity prices have hurt exports, but the sluggish economy has helped reduce imports. Those trends have now reversed, though exports were recovering faster than imports as 2017 ended. The current account deficit was an estimated -2.6% of GDP in 2017, and the OECD expects it to widen to -3.6% in 2018 and -3.8% in 2018.
Foreign reserves have risen to record highs but vulnerabilities remain. At $50.5 bln in January, they cover 5 ½ months of imports and are about equal to the stock of short-term external debt. Thus, the country is vulnerable to shifts in sentiment and so-called hot money. Note that government debt held by non-residents has risen from 4.4% of GDP in 2007 to 17.6% of GDP in 2017.
The rand continues to outperform. In 2017, ZAR rose 10% vs. USD and was behind only the best performers KRW (+13%), MYR (+11%), and THB (+10.5%). So far in 2018, ZAR is up 6.5% YTD and is the best EM performer. Next best are MXN (+6%) and COP (+5%).
Our EM FX model shows the rand to have VERY WEAK fundamentals, and so it should start to underperform. USD/ZAR is making new lows for this year and is trading at levels not seen since February 2015. We think most of the good news has already been priced into the rand, and that further gains below the 11.50 area will be difficult near-term.
South Africa equities continue to underperform. In 2017, MSCI South Africa was up 19% vs. 34% for MSCI EM. So far this year, MSCI South Africa is up 1% YTD and compares to 4.5% YTD for MSCI EM. This underperformance should continue, as our EM Equity model has South Africa at a VERY UNDERWEIGHT position.
South African bonds have outperformed recently. The yield on 10-year local currency government bonds is -39 bp YTD. This is the best performer and is just ahead of the next best performers Russia (-38 bp), Brazil (-37 bp), and Peru (-36 bp). With inflation likely to remain low and the central bank likely to resume cutting rates, we think South African bonds can continue to outperform.
Our own sovereign ratings model showed South Africa’s implied rating rising a notch to BB/Ba2/BB, reversing last quarter’s drop. Finance Minister Gigaba’s October mid-term budget statement did not prevent a S&P downgrade in November to BB, and its new BB+ local currency rating led to ejection from Barclays Global Aggregate Index.
The loss of investment grade from Moody’s seems inevitable, but Zuma’s exit has bought the country some time. Still, we believe Moody’s and Fitch’s ratings of Baa3 and BB+, respectively, are seeing continued downgrade risk. Moody’s put the country on review for possible downgrade back in November. If Moody’s were to downgrade it this year, South Africa would be ejected from Citi’s WGBI.