From hero to (almost) zero is probably a good way to describe sentiment towards South African assets in February. While a less hawkish Fed and lower US yields should have boded well for capital inflows, SA-specific factors prevented offshore investors from taking advantage of attractive relative valuations.
The focus has been on the SA government’s inability to stabilise the fiscal position and the SOEs. The resumption of load shedding amid heated discussions about how to bail-out Eskom in a manner that does not threaten the sovereign credit rating prevented the markets from capitalising on better global risk appetite.
The Fed maintained its patient stance, while Trump extended the US-China trade truce. However, Trump has threatened tariffs on auto imports from the Eurozone if a deal is not reached and he walked out of the second North Korea summit without a compromise. He has again bemoaned Fed rate hikes and the overvalued US dollar.
Yet he cannot have his cake and eat it – the dollar remains the world’s reserve currency and therefore will be biased towards overvaluation rather than undervaluation. Moreover, exchange rates are relative prices – it is not only how the US fares that matters, dynamics in the Eurozone and elsewhere will also influence the dollar. On these fronts growth has continued to disappoint, with renewed disinflation forcing central banks to increase stimulus. Only six months ago the ECB thought it would be able to hike rates in September 2019. This now seems almost laughable. To be sure, the ECB has turned more dovish in its forward guidance, projecting the first hike in 2020 and announcing a third round of targeted longer-term refinancing operations (TLTROs). The easing has pushed the German 10-year yield to 7bp, the lowest level since October 2016. We can just imagine Fed Chair Jay Powell humming The Vapors’ “Turning Japanese” to himself on the way to the March FOMC meeting.
Back on home shores the February budget received mixed reactions. The headlines were negative given further fiscal slippage. The deficit is projected at 4.5%/GDP for FY20 compared to 4.3% at the time of the October 2019 budget update. And while fiscal expansion would normally be seen as positive for short-term growth, the deterioration is largely due to the annual cash injection for Eskom, which sucks the equivalent of 0.4%/GDP per year out of the economy. The debt ratio peaks at 60% of GDP and with bond yields in excess of GDP growth (in nominal and real terms) the interest bill keeps crowding out growth-enhancing expenditure, as well as private sector borrowing in light of the domestic saving shortfall.
There were some positives. The government has started to make modest progress in curtailing the wage bill, which gobbles up 36c for every rand in state revenue collected. Encouraging for SMEs, the Treasury has upped the pace of the VAT refunds to not only clear the backlog, but to ensure more timely payments of claims.
From a market perspective the budget was on balance negative. It has not done enough to allay rating downgrade fears, the consumer will have to further tighten her belt, and the local bond market will have to absorb higher weekly issuance from April. Add on the President’s commitment to the ANC national conference resolution to nationalise the Reserve Bank and the rand has weakened to its worst levels against the US dollar for the year to date. The disappointing growth data has also not helped, with only 1.4% recorded in 4Q18 (that is 0.35% when not annualised). The silver lining to the dark growth cloud is that the current account deficit shrank to only 2.2% of GDP and so means a lower demand for external financing. From Eskom’s and by extension the government’s perspective, Nersa’s MYPD4 tariff decision was a disappointment, falling short of what Eskom needs to avoid losses. However, it is probably a positive surprise from the consumer’s perspective, having feared three years’ worth of double-digit tariff hikes.
Given the dominance of fiscal/Eskom risks, the SARB remains on the side lines. The Governor has repeatedly emphasised low inflation to support growth and reduce nominal rates. Until fiscal risks dissipate, consumers and by extension SA Inc will have to wait a bit longer for that much-hoped-for rate cut. Eskom’s turn-around plan (by 1 April) and Moody’s rating review (29 March) are key risk events, while the elections (8 May) will also influence investor appetite given the potential impact on the pace of reforms and domestic confidence.