Without deep changes there are few reasons for optimism in SA
• If growth continues to underperform it will lead to downgrade down the road, says economist
Over the past several weeks I have experienced a growing sense of unease. This has no doubt in part been due to poor health, but I have also battled to shake a niggling doubt in the back of my mind that as far as the country is concerned everything is not quite as rosy as it seems.
Every positive news story I’ve read about improved GDP figures, rising business and consumer confidence, a new Eskom board, the strengthening rand and even President Cyril Ramaphosa’s jogs on the Seapoint promenade and walks through the townships have somehow made me feel worse, not better about the state of SA.
It is true that there is a lot going on in SA at the moment to be worried about.
The situation with the South African Social Security Agency and payment of social grants is almost unbelievable and Ramaphosa’s new Cabinet and key institutions such as the National Prosecuting Authority and office of the public protector still hold far too many “captured“individuals for my liking. Eskom might have a new board, but it still has an old supply and distribution model.
But it’s not these things that worry me most. I’m not even that worried about the expropriation without compensation debate. It goes without saying that we can expect a good deal of noise in the run-up to the 2019 election, and to my mind the issue as presented by the ANC and EFF is more a symptom of political manoeuvring than a genuine policy shift.
What really worries me is the fundamentals. We’ve put new icing on the cake, but we baked it with rotten eggs and are hoping that no one at the bake sale will notice.
With all of these concerns floating around in my head, I was grateful to have the opportunity to chat to Ferhan Salman, a senior economist at Bank of America Merrill Lynch who covers SA and Turkey.
One often needs an outside view to provide a more balanced account of where SA really stands.
What makes Salman’s view particularly useful in the current South African context is that he spent eight years at the IMF and by his own admission is inherently “bearish”.
His take on the sudden turnaround SA has experienced is rather sobering. He says prior to the ANC conference everyone was bearish and markets were pricing in a doomsday scenario.
“People were short on the rand and external bonds were trading below their actual rating same for bonds. Everything was so cheap that we said ‘buy’.
“The risk-reward was definitely on the upside from an asset-price perspective, but now we are on the other extreme,” Salman says.
He says after Ramaphosa’s election all of the good news was priced in and the riskreward is now firmly on the downside. This explains why we have seen such a strong appreciation of the rand.
“Portfolio flows determine the short-term level of the exchange rate but in the medium term it needs to converge to the long-term fundamentals,” he says.
By his calculations the rand is about 15% overvalued and is set to reach about R13.50 to the dollar by year-end and then depreciate further.
The good news is that Salman thinks the Reserve Bank will ease rates in March. This will be welcomed by the middle class, who have been worst hit by the value-added tax increase, and will hopefully counter a contractionary budget.
However, it is unclear whether it will be sufficient to provide the growth the economy so desperately needs.
On the likelihood of a downgrade, Salman thinks Moody’s Investors Service will not downgrade SA in this round.
“The budget took sufficient measures to avoid a downgrade and there are significant improvements in governance, but it is not enough to change the dynamics in the medium term.”
This is because the likelihood of a downgrade in the medium term is dependent on growth and not fiscal policy.
“If growth continues to underperform we will see revenue shortfalls, and that will lead to a higher deficit and debt, and that will probably warrant a downgrade down the road. But if the pace of reforms is fast and the progress is good, it will be a different story.”
The difficulty with implementing structural reforms is that they are growth-negative in the short term and this makes them politically unpopular. Salman says structural reform “requires you to reallocate resources from one side of the economy to another”.
“That reallocation weighs on growth, so you need to be persistent. You need to consolidate on the fiscal front so that you can generate space so that you can actually expand with these fiscal reforms in the future,” he says.
“Reforms are difficult to implement in general, so this is not SA-specific, and this is not Ramaphosa-specific, or emerging market-specific.”
If everything goes according to plan, Bank of America Merrill Lynch sees growth edging up to 2.5% in the medium term, but this could be as high as 3% if strong reforms are introduced.
In other words, tough structural reforms could add as much as 0.5% to GDP growth in the medium term.
“This is enough for fiscal consolidation, but this will require massive effort on the government’s side.”
From his experience in other countries the difficulty is being persistent with those reforms.
Salman says we need to give the new government the benefit of the doubt, but global financiers will be watching the land reform debate and wage negotiations in June closely.
So where does that leave us? From my increasingly neurotic standpoint, SA’s growth trajectory remains uncertain and our economy remains vulnerable and exposed to external shocks.
Ramaphosa’s presidency has provided us with a window of opportunity to change the course of SA’s future, but unless he acts quickly and firmly to introduce and persist with the necessary reforms, we will find ourselves back where we were in December 2017.
THE RISK-REWARD WAS ON THE UPSIDE FROM AN ASSETPRICE PERSPECTIVE, BUT NOW WE ARE ON THE OTHER EXTREME