COULD IT BE AN EXTENDED RECESSION?
Much depends on political developments and their impact on SA’s vulnerable credit ratings, say economists
South Africa faces the prospect of an extended recession if more of the country’s credit ratings are downgraded to “junk” status or there are further political shocks.
It emerged this week that South Africa has moved into its first recession since 2009. Since 1961, the country has been in recession eight times.
The data from the first month of the second quarter, April, show that the economy remains weak.
“The first activity data for the second quarter were pretty downbeat ... There is little sign of a significant recovery,” John Ashbourne, Africa economist for London-based Capital Economics, wrote in a note this week.
Mining figures for April were worse than expected and the manufacturing sector performed very poorly.
Ashbourne said a further indicator of the state of the economy will be evident when retail sales figures for April are released on Wednesday.
“This figure will be a crucial sign of whether or not things have improved,” Capital Economics said.
A recession is defined as two consecutive quarters of negative economic growth; a situation South Africa finds itself in after the local economy contracted by 0.3% in the final quarter of 2016 and by 0.7% in the first quarter of 2016.
The recession will weaken tax revenue, which will increase the government’s budget deficit and could see state debt rise, placing the country’s credit rating under more pressure.
The contraction of the economy has been accompanied by a rise in the official rate of unemployment, which hit 27.7% in the first quarter of the year. The onset of the recession could see the loss of further jobs.
The prospect of further economic contraction could become a reality if more of South Africa’s local currency credit ratings are downgraded to junk status.
This could cause billions of rands to exit the country as international investors are forced to sell their local holdings due to mandates that require their money to be invested in investment-grade assets.
Nicky Weimar, a Nedbank economist, said this week during a conference that such a situation could precipitate R100 billion in forced bond sales.
“This would completely unsettle the economy. Economic growth would come under pressure and the recession would persist.”
On the other hand, Jeffrey Schultz, a BNP Paribas economist, said he expected the latest recession to last only two quarters, partly due to the recovery in the manufacturing and mining sectors.
Schultz said the lack of growth would remain a “big credit rating” risk.
Nazrien Kader, head of Deloitte Africa Tax Services, said a recession would result in less consumption, which would in turn slow growth in value-added tax (VAT) revenue, leading to businesses paying their staff smaller or no bonuses, hurting tax collections.
National Treasury’s key target is to reduce the budget deficit from an estimated 3.4% of GDP in February 2017 to 2.6% by February 2020.
The government could be forced to either cut expenditure or raise taxes next year to meet its fiscal targets.
However, Kader said raising taxes amid a recession would be the “worst possible idea” and the government should rather cut costs and reduce wasteful expenditure.
Sandy McGregor, portfolio manager at Allan Gray, said it would be very difficult for the government to meet its fiscal targets as the economy wouldn’t be growing for the next 12 to 24 months.
Government debt, which stands at R2.2 trillion, was likely to rise, he added.
Ireland and Estonia were examples of countries that went into recession and cut expenditure and got out of their slumps fairly quickly, while France was a country that raised taxes in response to a recession, McGregor said.
Jason Muscat, an FNB senior economic analyst, said that the weaknesses in the first-quarter GDP figures were “incredibly broad-based, with only the agriculture and mining sectors expanding”.
“Our concern is that the numbers are backwardlooking, and don’t reflect the confidence shock we expect post the Cabinet reshuffle and credit downgrades,” he added.
On March 30, President Jacob Zuma reshuffled his Cabinet and fired finance minister Pravin Gordhan and replaced him with Malusi Gigaba.
The onset of the recession comes as Moody’s Investors Service was set to complete its review of South Africa’s credit rating late on Friday.
In April, Moody’s warned that it could cut South Africa’s rating if local growth weakened or there were further domestic or external shocks to growth.
Mike Brown, Nedbank CEO, said that South Africa was facing its worst time since the early 1990s.
Nedbank economist Weimar said this week that the greatest damage had been wrought on the local economy in recent times by “serious political mistakes” and an ongoing news flow indicating corruption in government.
“Has the darkest hour passed? Is the first quarter of 2017 the low point of the cycle? Much depends on political developments and their impact on South Africa’s credit ratings. Expect more political turmoil.
“National Treasury needs to do its job to avoid further damage,” Weimar said.
The domestic political landscape might deteriorate further and fiscal conditions might weaken under Gigaba, Weimar said.
Treasury said the recession would put its fiscal position at risk and undermine social service delivery.
Weimar said the government needed to restore confidence and faith in its policies.
Corruption needs to be tackled and the governance of state-owned enterprises fixed.