Globally, we’re seeing a generally favourable scenario with forecasts gradually being increased. A growth rate of +/-3.3% for 2017 and 3.4% for 2018 is expected. The euro area’s outlook has been improving for a while and the French election result will certainly boost sentiment.
Inflation will increase quite materially this year (off a very low base) and then stabilise around 2.0% for developed economies. We anticipate the US Federal Reserve will increase interest rates twice this year, despite a relatively poor growth in the first quarter.
Of particular relevance to South Africa, Chinese growth should still be above 6% for the next two years, but understand clearly that the growth rate will steadily decline, coupled with the shift from fixed investment to consumption. While not dramatic, the growth in demand for basic commodities will also decline in unison.
Surprisingly, the outlook is a little better than directly after the cabinet reshuffle, but (unfortunately) for the wrong reasons. Growth is still low and forecast to be so for the next three years, somewhere between 0.7% and 1.5%.
The reason the outlook is a little better is that inflation will probably be lower than expected and therefore there is less pressure on interest rates to rise. Everything else being equal, there is probably a bigger chance of an interest rate cut than a rate hike. However, as we have discovered on many occasions in South Africa, “everything else being equal” is not a natural state of affairs!
Our house view at Ashburton is for interest rates to be on hold for the next year.
Unfortunately, the reason behind a better inflation and interest rate outlook is a very poor SA consumer outlook. Ironically, the reason for better news is the terrible outlook for the consumer. But I suppose that it is still good news that inflation is most likely to be lower and there is less pressure for interest rates to rise, even if it is because of “bad news”.
Again (surprisingly) there is actually some good news here as well:
- The court decision on the nuclear deal;
- The signing into legislation of the FICA bill;
- No additional proposed legislation on the banking sector;
- Continued diligence in the granting of banking licenses;
- No further resignations from the Treasury;
- Continued commitment by the new finance minister to stay on the road of discipline (we will have to see).
The rating agencies will view this positively.
Ultimately, all will eventually boil down to what happens to government finances and debt. As we all know, there is no margin of safety at all in this regard. Make no mistake the new finance minister has been given a hospital pass. The cabinet reshuffle and the harm it has caused is an already precarious situation. Tax revenue is under pressure because of the poor economy and it is virtually certain (again all else being equal) that the revenue target will not be achieved.
He only has three choices:
- Increase tax to control deficit;
- Decrease expenditure to control deficit (virtually impossible and largely symbolic);
- Or just do nothing to control deficit and get a full junk status.
If we believe the finance minister and he maintains current policy:
- Can’t really cut expenditure (no government can really do this)
- Does not want a full junk status (walk the talk)
Then guess what? More taxes are on the way:
- Don’t get too alarmed about the current talk around a wealth (or asset) tax – this is a long way off. There are already many wealth taxes in any case (estate duty, transfer tax, CGT);
- It is impossible politically to increase VAT.
So again, next year there will be very little, if any, “bracket creep” relief and even possibly a higher tax rate than the 45% currently.
But if the finance minister “walks the talk” and sticks to the budget and borrowing ceilings:
It is possible that SA will get no further credit downgrades.
Impact of cabinet reshuffle and credit downgrades
Well, to be honest, much better than what you would have expected:
- Rand about 8% down;
- Bonds 0.5% higher yield (+-4% capital depreciation);
- Growth forecasts about 0.5% lower for next two years.
The reason why?
Foreign buying. The difference in yield between SA and the developed world is very attractive.
Just think where we may be on the rand and interest rates/growth rate if the cabinet reshuffle never happened. But then again – don’t cry over spilt milk.
The true harm
The biggest impact is on sentiment.
- Companies will postpone or cancel capital expenditure;
- Consumers will postpone or cancel capital on houses – cars – big ticket items.
Foreign investors may like the yield difference, but they will be far less inclined to commit to long-term investments.
We are now forecasting that this part of the economy will actually be negative for the next two years (pre-cabinet reshuffle our estimate was zero, not good but better than negative).
While there is slightly better news on inflation, interest rates and junk downgrades:
- We will still have a very poor 2017/2018;
- AND more taxes are on the way.
But at least the finance minister is talking the talk – let’s see if he walks the talk too.
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