Financial markets are great indicators of a country’s economic health and future growth and wellbeing of its citizens, just like smoking and exercise are for humans.
It seems that South Africa’s financial indicators have decoupled from those of the rest of the emerging markets. Emerging markets are larger developing countries that are closing the gap between themselves and the advanced economies.
Depending on the data set used, the number ranges from 23 to 40 countries whose economies are growing and catching up on the 39 advanced countries in the world. The GDP they represent is about 40% of the world total, while advanced economies produce a similar amount and the other 100-plus countries make up less than 20% of the world economy.
Government’s more costly borrowing hammers services
Firstly, South African government long bonds have decoupled; this happened slowly at first, but during December 2015 they really separated from the average emerging market bonds.
During President Thabo Mbeki’s last term, the average premium South Africa paid was 1.6% (163 basis points). Since that fateful December in 2015, when then-finance minister Nhlanhla Nene was fired, the average bond premium SA pays has increased to 3.7% (366 basis points). Lately, SA rates are over 4% more than the emerging market average as tracked by the US Federal Reserve.
That means government now pays an interest rate that is over 400 basis points higher than the average rate. On the current total SA debt of R3.2 trillion this translates into about R130 billion more in interest than the average emerging market country.
Taxes must increase, or government spending must decrease.
Add the fact that Eskom bonds carry a close to 600-basis point premium and other state-owned enterprises also pay a premium, and SA pays about R170 billion a year more. That increases the price of electricity, transport and of course government services.
Interest is the fastest growing item in the government budget and is forecast to be 4.8% of GDP by 2024 or 20% of all tax revenue.
These are government forecasts and are probably conservative, as the slowing economy means higher budget deficits and more debt, and probably higher bond yields.
If Moody’s downgrades SA then this is where much of the pain will be.
Decoupling No 1: SA long bond premium more than doubles since December 2015
The long, slow detachment of the rand
A little longer in the making, but the rand has also detached from the rest of the emerging market currencies. While Argentina and Turkey have done worse than SA, the fact is that our currency has, since the end of the commodity boom, fallen out of bed.
This is not only a function of government finances but also of the current account which has remained in the red for more than a decade. But again the pain increased during 2015 and SA never fully recovered despite a smaller current account deficit.
Interestingly, since that fateful December, the net portfolio outflows have averaged R10 billion a month. If the rand index stayed close to the average emerging market currency, the price of fuel would have been about R3 cheaper today and the cost of maize, chicken and so on would have been lower; I estimate that the prime rate would have been about 50 to 100 basis points lower, as inflation would have been lower as well. Eskom’s coal contract price may also have been lower.
Decoupling No 2: The rand detaches
The JSE gets cheaper when compared with our peers
Since December 2015 and in the run up to the day Nene was fired, the JSE has never kept up the pace.
If the JSE had kept pace the total value would be about R3 trillion higher today and every one of the 12 million citizens with retirement savings would be at least 10% if not 40% better off depending on their risk profile.
Emerging markets have on average done 64% better than the JSE since 2010, but most of the non-performance took place after 2015.
Yes, think of the extra confidence from here right into the heart of the private sector. Fewer foreigners would have sold, while more would have brought SA companies, leaving 12 million people richer at least.
This is of course also painful for directors of SA companies and senior managers who get less for their stock options. The taxman also got less in capital gains taxes and the like. Maybe the JSE missed out on a few listings while every financial publication was obliged to share the sad news of SA Inc being a laggard.
Of course, the above is not only due to the firing of a minister but also corporate governance and the underperformance of the economy generally due to other factors.
Decoupling No 3: SA equity has not been rewarding to hold
The short term sadly looks very bad. A downgrade will impact bonds negatively while a further downgrade will also play a negative role (slightly less so, but still).
With Eskom on the brink the recovery may never quite happen. But if SA does fix Eskom and government’s ability to service SA improves, the recovery will be great and the potential is massive. I suspect that even small recoveries will be cheered. Headlines to that effect appear often as we are optimists by nature.
However, a full recovery from Eskom and debt traps is by no means even a 50% certainty. In fact it is far less. Partial fixes and sticky tape I see everywhere, but nothing big and sustainable
In my opinion it would be wise to hedge your bets and diversify a great deal, and of course if you go to the post office right now you will get an excellent yield that will pay a handsome interest rate.
For business however, capital will remain expensive and that will also impact future growth.