Historic collapse in GDP ups the ante
South Africa’s economy has grown in only three of the ten quarters that Ramaphosa has been president, highlighting the local economy’s structural weakness and emphasising that COVID-19 might be the catalyst of “second quarter economic collapse”, but it is not the cause. South Africa’s economic stresses and structural constraints have been laid bare by the pandemic, and the second quarter’s collapse in GDP has added to the pressure on President Ramaphosa and government to push ahead with long-awaited reforms.
To this end, the horrific GDP figures prompted Ramaphosa to issue a statement on Tuesday afternoon outlining the work being done by the State to promote economic growth, including its much-promised economic recovery strategy. However, while government announced a R500 billion stimulus package during the second quarter of 2020 to help sustain individuals and businesses through the crisis, some of the programmes making up the package have been caught up in delays, technical difficulties and widespread allegations of corruption. To boot, the R500 billion carried elements of “double counting”, such as the R130 billion in spending that was not stimulus but rather reprioritised expenditure, and R70 billion in tax relief that is deferral of obligations and not elimination.
The stimulus thus makes for impressive policy pronouncements but poor impact. Other constraints remain deep-rooted, including electricity supply challenges; persistent policy uncertainty surrounding the South African Reserve Bank (SARB) and land ownership; and the slow implementation of crucial reforms which hold back investor confidence and choke growth prospects. Consequently, Cannon Asset Managers has left our forecast unchanged of a 9.1% contraction in GDP for 2020.
In some good news, high frequency data releases in the third quarter – particularly the BETI index, domestic VAT receipts and Google activity data – point to recovery, even as electricity cuts push confidence even lower. The early data points to a third-quarter bounce in GDP of at least 50.0%, which is a long way ahead of the SARB’s 18.0% forecast. The small agricultural sector and the important mining sector could lead the way in this recovery, while other sectors including transport, finance and insurance are capable of quick recovery given their strong bases.
Ultimately, however, uncertainty remains high and confidence remains low. In the near term, direction will therefore come from Finance Minister Tito Mboweni’s Medium-Term Budget Policy Statement (MTBPS) scheduled for October. We anticipate a budget deficit of 13.9% of GDP for 2020/21, and we look to the MTBPS for indications on how government plans to consolidate expenditure, narrow the budget deficit, contain debt and fix ailing state-owned enterprises, especially Eskom.
Tough call for the SARB on interest rates next week
Policy direction also comes from the SARB, and the Monetary Policy Committee (MPC) meets next week to deliberate on interest rate action. On this score, the forward rate agreements (FRAs) fell by as much as 16.5 basis points (bps) across the curve over the past week, with the probability of a 25bp rate cut increasing to 44.8%, making for a “fifty-fifty” call on a rate cut.
Source: Cannon Asset Managers (2020)
Source: Cannon Asset Managers (2020)
These aspects make for a tough interest rate call given that consumer price inflation has started to lift, while recovery – even if anaemic – is underway. Moreover, the MPC has regularly pointed to interest rates as being a blunt instrument in the war on structural economic constraints.
Against this backdrop, whilst there is a strong temptation to make an “insurance call” of a 25bps cut in the repo rate, the balance of probability – even if small – points to the repo rate staying on hold for now. Even then, if the repo rate is cut next week, it goes no way in squaring up to urgently needed structural reforms and is no more than an economic Band-Aid.
All of this said, and to borrow from former British Prime Minister Harold Wilson, a week in politics is a long time – and the same holds in the volatile economic environment that has gripped this year. We are keeping our eyes firmly on the FRAs as a guide to what might transpire this time next week at the MPC which, as things stand, are calling the chance of a rate cut “fifty-fifty”.