Economic and market overview - February 2019
The International Monetary Fund’s latest World Economic Outlook Update points to a weakening global expansion this year. Global growth for 2018 is estimated at 3.7% despite weaker performance in some economies, notably Europe and Asia. The global economy is projected to grow at 3.5% in 2019 and 3.6% in 2020. The global growth forecast for 2019 and 2020 had already been revised downward before, partly because of the negative effects of tariff increases enacted in the United States and China last year. The further downward revision in part reflects carry over from softer momentum in the second half of 2018 – including in Germany and Italy – but also weakening financial market sentiment as well as a contraction in Turkey now projected to be deeper than anticipated.
Risks to global growth tilt to the downside. An escalation of trade tensions beyond those already incorporated in growth forecasts remains a key source of risk to the outlook. Financial conditions have already tightened since the third quarter of 2018. A range of triggers beyond escalating trade tensions could spark a further deterioration in risk sentiment with adverse growth implications, especially given the high levels of public and private debt. These potential triggers include a “no-deal” withdrawal of the United Kingdom from the European Union and a greater-than-envisaged slowdown in China.
The main shared policy priority is for countries to cooperatively and quickly resolve their trade disagreements and the resulting policy uncertainty, rather than raising harmful barriers further and destabilizing an already slowing global economy. Across all economies, measures to boost potential output growth, enhance inclusiveness, and strengthen fiscal and financial buffers in an environment of high debt burdens and tighter financial conditions are imperatives. We’re just not sure that President Trump got this message. Or perhaps he chooses to simply ignore it.
In short, global economic momentum is slowing down and uncertainty about the macro-economic environment is on the increase. It seems as if much of this was priced into markets (albeit in the course of just one month), so any positive developments could support global equities in 2019.
The South African Reserve Bank’s Monetary Policy Committee met during the third week of January and kept interest rates unchanged at 6.75% in a unanimous decision. The decision to keep the repo rate unchanged was in line with market expectations as incoming economic data continued to point to easing inflation pressures in the near term.
Downward revision to the expected average oil price over the next two years was the main reason for the Bank reducing its inflation forecast to 4.8% (previously 5.5%) in 2019. The revised inflation forecast, together with a lower economic growth forecast for 2019 (1.7% vs. previously expected 1.9%), combined to deliver a significantly flatter implied policy rate path, and, importantly for consumers, a much-reduced risk of further rate increases.
Much has been made of President Cyril Ramaphosa’s first year in office and the jury is out on whether he could have done more if he did not have to deal with a strong Zuma faction within the ruling party. He’s been busy though; according to Fairtree Asset Management the President has achieved several milestones over the last 12 months, including:
- The removal of President Zuma in less than two months while also reinstating corruption charges against the former President,
- A Cabinet reshuffle: removing 12 implicated ministers and, most crucially, replacing the finance minister with Minister Tito Mboweni, who is very well regarded in the investment community,
- Requesting public written submission with respect to land expropriation, instituting country-wide land hearings, picking an advisory panel consisting of land, development, agriculture and law experts,
- Suspending NPA and SARS heads and appointing a new NPA head,
- Implementing changes to SOE boards (Eskom, Transnet, Denel, SA Express, Prasa),
- Securing Foreign Direct Investment – US$50bn to date secured out of the US$100bn goal over 5 years,
- Settling the public sector wage agreement for three years (at 6-7%, its lowest level ever),
- And announcing a R50bn fiscal package of reprioritisation to labour intensive sectors, and infrastructure in agriculture, rural areas and townships, as well as a R400bn Infrastructure Fund (private sector to co-invest additional R400bn).
More still must be done, as set out in the President’s State of the Nation address early in February. We cover this in more detail in our monthly commentary.
January provided some much-needed relief to investors after a tough 2018. As central banks globally became more dovish at a rapid pace, both local and global asset classes performed well. This is despite ongoing trade tensions between the US and China, major uncertainty surrounding Brexit and one of the longest US government shutdowns. South African Listed Property stocks also made a comeback in January. After losing more than 25% in 2018, the listed property sector was the best performing local asset class for the month.
Global Equities also had a positive month after a terrible December. Emerging market equities (up 8.8% in US dollar terms) managed to outperform their Developed Market peers (up 7.8% in US dollar terms) as investors’ risk appetite increased. The MSCI All Country World Index ended the month up 7.9% in US dollar terms. US dollar weakness during January masked some of this performance to local currency investors.
South African Multi-Asset High Equity Funds delivered an average of -2.1% to investors during the last 12 months with their low equity counterparts ending up 2.6%.
Commentary – What is the real state of the nation?
President Cyril Ramaphosa recently delivered his second State of the Nation Address (SONA) since taking office one year ago. Preceding the event, there was a lot of media speculation (in South Africa and abroad) about the likely content and tone of Ramaphosa’s speech, especially in an election year.
According to Kevin Lings, Chief Economist of Stanlib, a lot of this debate highlighted the need for government to urgently address several key challenges facing the country. These include uncertainties surrounding key economic and social policies that have been stifling private sector fixed investment, the need to accelerate the reform of key State Owned Enterprises (SOEs) such as Eskom, steps to improve the efficiency of government administration (including a reduction in the size of the cabinet and the number of government departments), embarking on the process of prosecuting people involved in corruption, initiating private/public partnerships in order to kick-start infrastructural development and further encouraging private fixed sector investment.
The local economy has struggled to achieve any meaningful growth over the past nine years, despite a relatively positive global economic backdrop. Global growth has averaged over 3% over the last decade, with emerging markets (lead by China) delivering most of this increase in economic activity. In stark contrast, the South African economy has decoupled from the performance of the world economy, averaging growth of a mere 1.6% over the past nine years and a mere 1.3% in the past four years. This underperformance is reflected in rising levels of unemployment, increasing tax revenue shortfalls, depressed levels of consumer and business confidence, a protracted fixed investment recession in the private sector and credit rating downgrades.
Stanlib’s view is that, without a sustained pick-up in economic growth, the fiscal authorities are going to find it increasingly difficult to meet their budget projections and the country will continue to face the risk of additional credit rating downgrades, rising unemployment and further social tension. Moody’s remains the only major credit rating agency to assign South Africa an investment grade rating for both its long-tern foreign debt as well as its long-term domestic debt. They will next review South Africa’s credit rating at the end of March 2019.
President Ramaphosa delivered an optimistic assessment on the outlook for the South African economy, suggesting that significant process has and will be made in key areas of economy activity, government service delivery and the functioning of society. Many of these claims can and will be challenged, especially since the undertone of his remarks do not correspond with the current performance of the economy, especially within the household sector.
In order to achieve a better economic outcome, the President indicated that government is going to focus on five urgent tasks. These are:
- Inclusive economic growth and job creation;
- Improve the education system and develop the skills that the country needs now and into the future;
- Improve the conditions of life for all South Africans, especially the poor;
- Step-up the fight against corruption and state capture;
- Strengthen the capacity of the state to address the needs of the people.
In discussing how these five broad tasks are going to be accomplished, the President presented an extremely ambitious array of initiatives ranging from increased exports of manufactured goods, more competition in industry, improved tourism, introduction of private/public partnerships, increased housing development, better education outcomes, the creation of special economic zones, reforming key State Owned Enterprises, substantially improving the ease of doing business, extending youth employment incentives, land redistribution (including land owned by government in urban areas), infrastructural development, and progress in the fight against corruption.
In Kevin Lings’ opinion, the intention of these initiatives is to be applauded, but it remains a particularly ambitious list of undertakings. This is probably to be expected two months ahead of a National Election, but clearly the risk of once-again creating unrealistic expectations that lead to further disappointment is very evident. In that regard, the speech can be criticised for simply announcing another list of tasks and initiatives without fully understanding or explaining why all the previous plans have not been fulfilled. The speech also lacks a point of focus to directly lift business confidence, investment, growth and employment.
One of the key stand-out features, according to Lings, within the President’s speech is a clear intention to restructure Eskom, acknowledging that the institution is in crisis. There appears to be an acceptance that the survival of Eskom (and probably many other SOEs) will require private sector involvement. The President indicated that:
- Where SOEs are not able to raise sufficient financing from banks, from capital markets, from development finance institutions or from the fiscus, the government will need to explore other mechanisms, such as strategic equity partnerships or selling off non-strategic assets.
- In helping Eskom, government needs to safeguard the national fiscal framework, achieve a positive impact on the sovereign credit rating, and pay attention to the rights and obligations of Eskom’s funders.
- Government needs to take steps to reduce municipal non-payment and confront the culture of non-payment that exists in some communities.
- Government will support Eskom’s balance sheet, without burdening the fiscus with unmanageable debt. The Minister of Finance will provide further details on this in the Budget Speech on 20 February.
- Eskom will develop a new business model, which will include establishing three separate entities – Generation, Transmission and Distribution – under Eskom Holdings. It is hoped that this will enable Eskom to raise funding for its various operations more easily from funders and the market.
In his final analysis of the state of the nation address, Lings concludes that the key points emphasized by the President should help improve consumer and business confidence. The focus will now shift to the content of the National Budget later this month and then the outcome of the National Election in May 2019. Hopefully, the South African economy can start to make more meaningful progress after nine years of disappointment.