Emerging markets economist Peter Montalto of Nomura forecasts a tough year for SA’s economy in 2016, with a presidential recall of Jacob Zuma around July a possibility after a potentially poor showing by his ruling party in the May local elections.
After Zumxit, as Montalto calls the potential recall of Zuma by the African National Congress, there could be a layer of new, more left-wing policies, including an accelerated implementation of the national minimum wage.
“Markets will also need to watch nuclear tendering and parastatals,” he said. “We believe a sub-investment grade rating is possible from one agency by end-2016 for South Africa bonds, while into 2017 there are more likely to be two key agencies assigning junk ratings.
“We see no broader shifts in policy that would boost growth during the year, while the SA Reserve Bank (Sarb) attends to increasing inflationary pressures (we revise up our inflation forecast significantly to an average of 6.4% in 2016), rather than just addressing inflationary risks, which was a 2015 theme.
“We expect only 0.9% growth (vs 1.6% previously) as the economy digests the risk premia impact of the presidential reshuffle, as well as mining restructuring and the full implications of a global terms-of-trade shock.
“Following an initial ‘okay’ budget in February against such a weak growth environment, we expect much more consolidation difficulties through most of the year.”
Montalto evaluated the four pillars of the South African economy:
1. The rand (ZAR)
He believes the rand will reach R16/$ between 2016 and 2017.
Montalto believes South Africa will become a credit-driven currency moving towards sub-investment grade that stands out as a “shoe dropping” candidate for investors.
“There will likely be more volatility than in 2015, thanks to the Fed and the domestic political story. Sarb hikes likely will act as a break to a more disorderly move,” he said.
“Overall, ZAR will still likely appear undervalued on a variety of metrics and that is why the narrative change to credit and risk premia is important.
“South Africa can, in this framework, weaken further through 2016 as the downgrade story is likely to intensify and it moves closer to Brazil in markets’ minds.”
2. The economy
Montalto’s growth forecast for 2016 falls from 1.6% to 0.9%, while he sees growth of 1.8% in 2017 from 1.9% previously, with particular downside risk from strike action.
He sees risks still slightly skewed to the downside, thanks to potential wage-round related strike action through mid-2016 that may occur around the manufacturing wage round involving the National Union of Metalworkers Union of SA, with the coal and platinum wage rounds starting to kick off into year-end.
Nomura’s inflation profile is heavily driven by the shift in rand forecast from R13/$ to R16/$ at the end of 2016, he said. Core inflation breaches target in July. “Specification changes to the food price equations better capture the slow turn we have seen in food and this leads to the second higher ‘wave’ of non-core inflation through Q4 2016 and Q1 2017,” he said.
3. The Sarb
Nomura expects Sarb’s monetary policy committee (MPC) to hike the repo rate by 50 basis points (bp) to 6.75% in January. This is “to account for the sharp weakening of the currency’s risks into second-round effects, some outflow (though less than might otherwise have been expected from such a political and credit risk premia shock) and with inflation expectations grinding higher,” said Montalto.
“After that, if outflows remain moderate and orderly, the Sarb should be able to revert to 25bp moves until the second half of 2016, with core and headline inflation breaching target into a wage-round period that may cause some alarm for the MPC. As such, we see a reversion to 50bp moves to reach 8% by November 2016.”
Nomura expects a 50bp increase in January, 25bp in March, 50bp in July (taking the rate to neutral) and then 50bp in November. It sees a final hike (maybe 2x25bp) to 8.50% in the first half of 2017.
“The move before neutral will require a new framework, but we think the old one will be instructive – sensitive to growth still, but ultimately focusing on ‘inflation fear’ and risk management, looking to cut off second-round effects into core inflation and expectations,” said Montalto.
4. Fiscal policy
Nomura is not worried about the budget dynamic in the very short run and believes a VAT hike in February seems unlikely before the local elections.
“The 2016 budget in February may still broadly hang together okay, though will look increasingly frayed at the edges, with large risk holes,” said Montalto.
With Treasury’s “guerrilla warfare with other government departments to find cuts, they should be able to make additional savings needed this time at least, while allowing the deficit to expand out a little”, he said.
2016 will be a reinforcement of 2015 after the mini budget later in the year, with no space left for countercyclical fiscal policy and a market demanding real consolidation evidence, said Montalto.
He said economists will need to see if the Democratic Alliance strengthens its oversight of the budget within the National Assembly, “utilising a variety of parliamentary and legal avenues to call attention to the pace of fiscal consolidation as well as the specifics of spending. This may well include further attempts at opposition parties amending the budget.”