NO TIME FOR COMPLACENCY

The external environment is becoming trickier for a vulnerable emerging market like SA, and is increasing the clamour for the government to accelerate reforms to get growth going

t would be easy to mistake this year’s better-than-expected growth figures, record current account surplus and revenue windfall as evidence that SA has staged a powerful recovery from the pandemic.

In fact, excluding technical base effects and the external support provided by the commodity boom — much of which has been due to China’s quick rebound from the pandemic — SA’s recovery has been weak.

Recently, global growth has begun to stutter, due to energy shortages in China and persistent supply chain blockages. These are placing upward pressure on global inflation and have dragged down key industrial and precious metal prices. The latter have underpinned SA’s robust export performance and improved its fiscal fortunes this year.

Though this hasn’t pulled the rug out from under SA’s economic recovery, it does highlight the extent to which the country remains hostage to shifts in global sentiment and demand.

External conditions are becoming “a little more worrying”, says Standard Chartered chief economist Razia Khan.

Global challenges, including rising oil and gas prices, could create heightened pressures for SA, she warned during a recent Sunday Times national investment dialogues webinar. While Khan foresees that there will be ongoing demand for commodity exports for the global green reset, she urges SA not to take its positive terms of trade for granted.

SA’s export commodity prices have partly bounced back from their big sell-off in September, but are still down 21% from their record peak in mid-May, according to Absa’s rand-denominated export commodity price

Iindex (made up of platinum group metals, iron ore, coal and gold). Absa senior economist Peter Worthington says though commodity prices are still supportive of SA’s recovery, the balance of risks is now tilted to the downside after the recent (and with expected future) hiccups in global growth.

BNP Paribas economists Jeff Schultz and Burak Baskurt believe that SA’s record terms-of-trade gains have likely peaked. They warn that by next year the country will once again be running current account deficits.

Their worry is that this could present challenges for rand assets at a time when global central banks are poised to begin unwinding the excessive monetary policy accommodation of the Covid era.

In fact, this is already happening, as markets increasingly reject the consensus narrative that the surge in global inflation is merely transitory and prepare for the US Federal Reserve to start tapering asset purchases.

What it means: Stuttering global growth, rising inflation and tighter monetary policy could challenge SA’s recovery in 2022

The International Monetary Fund (IMF) now expects global growth to moderate slightly this year. It warned in its updated World Economic Outlook (WEO) report last week that “the risks and obstacles to a balanced global recovery have become even more pronounced”.

Chief among these is that global inflation may prove stickier than originally thought. While the IMF still expects price pressures to subside in most countries in 2022, its conviction appears to be wavering as oil and gas prices soar into the northern hemisphere’s winter and concern over supply backlogs of manufactured goods grows.

“Supply disruptions are lasting longer than expected with surveys of delivery times pointing to historic delays,” says

IMF chief economist Gita Gopinath. “While the rapid increase in demand played a large role earlier on, in recent months pandemic-driven disruptions and congestion in ports appear to be a bigger driver.”

The WEO says rising commodity prices and supply chain bottlenecks are pushing up headline inflation rates. Given the unprecedented nature of the current recovery, this has raised questions about how long supply will take to catch up with accelerating demand.

The good news is that long-term inflation expectations are well anchored in most countries. But economists still disagree about how enduring the upward pressure on prices will be.

These uncertainties are fuelling worries that inflation could persistently overshoot central bank targets and de-anchor expectations, leading to a self-fulfilling inflation spiral. If so, it could cause a rapid rise in interest rates and a sharp tightening of financial conditions, derailing the global post-Covid recovery.

The WEO includes simulations of several extreme scenarios, which show that prices could rise significantly faster than the IMF’s baseline forecasts on continued supply chain disruptions and large commodity price swings, or if inflation expectations become de-anchored.

Policymakers must, therefore, walk a fine line between remaining patient in their support for the recovery and being ready to act quickly if these risks materialise.

“Some countries that are already facing rising inflation expectations and more persistent price pressures have had to tighten — a difficult choice amid a stop-start recovery,” IMF MD Kristalina Georgieva noted in launching the WEO.

The Fed also appears to be becoming more concerned about the upside risk to inflation, and an official announcement that it will start to taper asset purchases is expected at its next meeting on November 3.

With the Fed’s preferred measure of inflation (the personal consumption expenditure deflator) hitting 4.3% year on year in August — above the consensus expectation, and its highest level since 2008 — markets are becoming “particularly worried”, says Investec chief economist Annabel Bishop.

The resultant risk aversion has seen US treasury yields climb, pushing SA’s 10-year bond yield to 9.9% last week, from close to 9% in early September.

“SA’s bond yields are negatively affected by global financial sentiment, and particularly by the movement in the US bond market,” says Bishop. She expects further elevation in US yields to cause increased deterioration in SA bond yields, adding to the SA government’s cost of funding.

This suggests that the government will have to stick to its fiscal consolidation plan in the coming year. Certainly, if SA is set to return to running current account deficits in addition to its large fiscal deficit, then the government will have no choice but to actively restrain fiscal spending to avoid a return to larger balance of payment shortfalls, say Schultz and Baskurt.

SA’s gradual return to twin deficits — coupled with ongoing net capital outflows (equivalent to R200bn, or 3.5% of GDP, in the past 12 months) — would likely also increase the Reserve Bank’s discomfort with running negative real policy rates. As would further rand weakness.

Most emerging-market currencies, including the rand, weakened noticeably against the stronger dollar during September.

“An increasing number of countries, especially emerging markets, have started to increase interest rates to combat domestic inflation concerns, but also to try to protect against further currency weakness,” says Stanlib chief economist Kevin Lings. “This will not have gone unnoticed by the Reserve Bank.”

Right on cue, the Bank’s monetary policy review, released last week, has begun to communicate a more hawkish tone, preparing the markets for rate normalisation.

Though the Bank’s forecast is for headline inflation to average around the midpoint of its target range in the coming years, it warns that underlying price pressures may be stronger than initially thought and that delaying the start of the hiking cycle could force it to play catchup with inflation.

The review highlights that “risks to the [inflation] outlook have risen and become more broad-based, while real rates have become more negative as expected inflation has risen … These developments imply a need for interest rates to begin normalising.”

Bank governor Lesetja Kganyago cemented this message last week, when he said the country is “running out of runway”, and that delaying rate normalisation could destabilise inflation expectations.

Citi economist Gina Schoeman expects the first 25 basis point rate hike at the Bank’s November meeting. “The governor made it clear that SA was able to keep rates more accommodative than other emerging-market banks but that with inflation risks more apparent, the need to normalise is more obvious,” she says.

When you look at the growth figures, I wonder: how much deeper does the crisis have to get [before] the government gets serious about reform?

Anne Frühauf

SA’s rate path is highly debatable, however. Worthington says: “The question is not about whether higher rates are needed over the medium term, but rather about the precise timing of the first hike, the pace of subsequent hikes, and the terminal neutral repo rate.”

He expects the first normalisation hike only in March 2022, given that inflation remains relatively contained, growth subpar, and the rand slightly overvalued. However, he concedes that the risk of an earlier hike has risen.

The bigger question is what it would take to accelerate SA’s growth rate.

The consensus among private sector economists is that while SA is moving broadly in the right direction, it needs to accelerate the pace of change rapidly.

“The main concern is if reform doesn’t pick up pace, SA risks becoming unsustainable in every way,” Anne Frühauf, Southern Africa MD of consulting firm Teneo, said during the Sunday Times webinar. “When you look at the growth figures, I wonder: how much deeper does the crisis have to get [before] the government gets serious about reform?”

But if the July unrest didn’t light a fire under the government, it seems unlikely that global jitters over the rapidly rising oil price, persistent inflation and a potential slowdown in China will suddenly do so.

It should. The supportive environment of the past year cannot last; SA needs to stop dithering. Growth is all that matters now.