Unrest and looting add to South Africa’s list of challenges
The global spike in COVID-19 infections and emergence of the Delta strain compelled investors to question the sustainability of the global growth recovery (especially in low-vaccination countries) and the impact of this on asset prices in general.
In the case of South Africa, the drop in global risk appetite was overshadowed by social unrest in the country’s two biggest provinces. Not only did this result in the tragic loss of life, but also large-scale destruction of infrastructure and the disruption to distribution channels. While the immediate cost of the destruction is still being tallied, the longer-term negative impact on investor sentiment and much-needed fixed capital investment spending raises a concern. Moreover, both the cause and consequence of this event carry the risk of negatively impacting the country’s sovereign creditworthiness and credit ratings – and further eroding the country’s economic growth potential.
The event arguably forced the hand of President Ramaphosa to finally unveil a long-anticipated cabinet reshuffle. The most significant change, from a fiscal and market perspective, is the appointment of Mr Enoch Godongwana to replace Mr Tito Mboweni as Minister of Finance. Suffice it to say, this development fails to cause us to make any changes to our cautious investment theme and the relatively defensive market stance that flows from this. Our concern remains in place regarding the lacklustre policy efforts to lift economic growth to a sustainable higher level, as well as the execution risk to urgent fiscal consolidation.
The unrest resulted in unplanned additional government expenditure
Government responded by announcing a support package for the victims of the unrest. This includes tax breaks for businesses and the reintroduction of the social relief grant that was terminated in April. While the estimated outlay of R39 billion (comprising R34 billion in additional expenditure and R5 billion in additional tax breaks) will be funded by robust revenue collections, and thus will not reverse the fiscal consolidation, it will slow down progress. The tax revenue collection overshoot might offer a short-term reprieve, it implies a lost opportunity to reduce the speed at which government is accumulating expensive debt. A more long-term consideration is the fact that high unemployment and its devastating impact on the most vulnerable will increase pressure for the introduction of a basic income grant. The reintroduction of the social relief grant is thus likely to morph into a permanent expenditure item.
Figure 1: Firm commodity prices continue to boost corporate income tax revenue collection
Source: Bloomberg, Futuregrowth
Firm commodity prices continue to support fiscal and external trade balances
Fortunately, the strong global commodity cycle continues to offer a reprieve, both for the country’s public finances and the balance of payments. In the case of the former, the bulk of the tax revenue overshoot of the first three months of the current fiscal year is still mainly due to higher corporate income tax collection, mainly as a result of improved mining sector profitability. This specifically applies to the June data set where corporate income tax reached a record level of nearly R98 billion, representing fiscal year-to-date growth of 140% and 74% for 2020 and 2019 respectively.
The country recorded another strong external trade surplus in June with an increase to a new record of R58 billion from R54 billion in May. This bodes well for the current account which is now heading for the biggest surplus in decades and, in turn, offers significant support for the South African currency. However, we have to consider the sustainability of the strength of the global commodity cycle and thus the lasting positive impact this may or may not have. Prices already seem to have lost upward momentum, which is to be expected in light of the exceptional recovery since last year. This calls for caution, especially on the reliance of this windfall in plugging increasing government expenditure.
June inflation data confirmed that May represented the cycle peak
The June Headline Consumer Price Index (CPI) recorded a year-on-year increase of 4.9%, a touch lower than the cycle peak of 5.2% in May. While Core CPI accelerated slightly faster at 3.2% compared to 3.1% in May, it clearly remained relatively subdued. In contrast to CPI and general market expectations, the Producer Price Inflation Index (PPI) for final manufactured goods rose from a year-on-year increase of 7.4% in May to 7.7% in June. Worryingly, this was fairly broad based. Even so, the relationship between CPI and PPI has weakened significantly over the past few years and we continue to believe that weak consumer demand will limit the extent to which price increases at producer level will filter through to retail prices.
Figure 2: South Africa is in a better position, considering its relatively higher real policy rate and improved currency account position
Source: Bloomberg, Futuregrowth
The South African Reserve Bank left rates unchanged
The unanimous decision to leave the repo rate unchanged at 3.5% at the July meeting of the Monetary Policy Committee (MPC) was widely expected. While the bank left its economic growth forecast unchanged, it did express the view that the recent unrest-related events could dent investor confidence. Although its inflation forecast was adjusted upwards, the mention of better anchored inflation expectations around the mid-point of the inflation target range, together with a fragile economic recovery and a relatively stable exchange rate, enticed the MPC to state that interest rates could be kept lower for longer. The Committee once again stressed that its Quarterly Projection Model (QPM), that continues to point to an earlier start and a more prominent tightening path, merely serves as guide. Unsurprisingly, this outcome forced the Forward Rate Agreement (FRA) market to reign in its persistently bearish rate expectations.
The nominal bond market regained some lost ground following a weak start to 2021
Following some earlier intra-month volatility, the market managed to recover earlier losses, and yields retreated to better levels. As a result, the FTSE JSE All Bond Index (ALBI) rendered a decent performance of 0.83%, with the biggest positive contribution coming from bonds in the 7- to 12-year maturity band.
While inflation-linked bond yields also edged lower, this asset class again underperformed nominal bonds, as the demand for inflation hedging continued to fade in light of a more benign medium-term inflation outlook. Even so, the FTSE JSE Government Inflation-linked Index (IGOV) rendered a reasonable return of 0.47%. Both nominal and inflation-linked bonds again outperformed cash, which rendered a return of 0.29% in July.
Figure 3: Bond market index returns (periods ending 31 July 2021)
Source: JSE, Futuregrowth
// THE TAKEOUT
Early in July, the local bond market was negatively impacted by a decrease in global risk appetite and, to a lesser extent, local unrest, looting and the destruction of infrastructure. However, the market managed to regain some footing in response to multiple positive developments. The decision by the South African Reserve Bank to maintain its current supportive policy stance was widely anticipated. Nonetheless, the unanimous decision by the Monetary Policy Committee to leave the repo rate unchanged and its insistence that the market is putting too much emphasis on the Quarterly Projection Model did force interest rate bears to adjust their rate expectations lower. Confirmation that consumer price inflation has peaked and more evidence of the continued support from the global commodity cycle is lending support to both public finances and the balance of payments. As a result, both nominal and inflation-linked bonds managed to outperform cash.
