Macro economic commentary – August 2017

Author: Ntsekhe Moiloa.

A silver lining in the midst of South Africa’s slow economy is that since the early 2008 peak, household debt as a percentage of disposable income has steadily declined from nearly 90 percent to close to 70 percent. This trend has given consumers capacity to spend if prices improve, yet it will be constrained to some extent by one of the factors that have enabled a broad deleveraging: more stringent credit lending standards. Other constraints to a firm recovery in the economy include subdued confidence and a soft employment market.

One advantage of lower consumption expenditure is its contribution to keeping the trade deficit in check, which has, in turn, led to one less point of pressure on the currency. Examining the trade balance figures more closely we note that year-on-year exports are up5.1 percent while imports are down 1.8 percent. The positive year- to-date trade surplus of ZAR 117.7 billion reflects in good part a weakness in demand.

Now would have been an ideal opportunity for infrastructure-focused spending on the part of government, as well as private investment spending by companies. Yet th government has over the years spent on the basis of an over-optimistic outlook for the economy with the result that debt and contingent debt have risen to a value equal to more than half of GDP. That has forced a slow-down in government borrowing with the constraint on government spending hopefully being balanced by looser monetary policy from the SARB.

Researchers from the Bureau of Economic Research have, since 1988, surveyed manufacturing firms on constraints to growth and whether short-term interest rates are an indicator of the ease of obtaining finance; or whether they are experiencing a shortage of raw materials; or a shortage of skilled labour; or whether the political climate curtails their appetite to invest. From 2010 onwards, all of these factors apart from the political climate have trended sideways while concern about politics has trended decisively upwards. Currently more than three-quarters of manufacturing businesses cite politics as a constraining factor on their willingness to invest. While 2017 is not a national election year, it is arguably a more important year than 2014. The ANC contest to elect a successor to President Zuma may be the most fiercely contested in the party’s history.

Against this backdrop the demands placed on state resources makes it less likely that government can reign its expenditure pattern in a meaningful way, despite the severe limits the state is facing. Mid-month, Moody’s notified government that it would not release a statement regarding the country’s credit rating. While that won South Africa some breathing space, it did not alleviate other pressures on the South African government. Funding is a key challenge for the state and an even bigger challenge for SOE’s at present. While July is a month in which the government’s coffers are drained as a result of coupon payments, the market did not expect the revenue shortfall to be as severe as it was. After collecting ZAR 15.4 billion more than it spent in June, the state spent ZAR 92.2 billion more than it received in July. The market had expected the deficit to be about ZAR 66.1 billion – a difference that amounts to more than half a percent of GDP.

Government’s efforts at plugging these holes have elicited a range of bewildered responses. Various fundraising initiatives, such as contemplating the use of the assets of the giant Government Employees Pension Fund to essentially fund the employer, have struggled to gain support. All of this leads to intransigence and a constant focu on reacting to wildfires rather than proactively plotting a path of development and growth. As it reacts to each crisis the government inexorably moves closer to a state of intransigence with its own people. Within the current context this manifests in the political elite trying to advance projects that are unwanted or unjustified- a prime example being SAA. This past month there was much mention of National Treasury’s plans to sell its stake in Telkom to keep South African Airways afloat. Although much pilloried for its Telkom share sale plans, National Treasury is desperate. After Standard Chartered, Citigroup is the latest bank to refuse to roll over a loan to South African Airways. The refusal to extend the repayment period on ZAR 1.5 billion in debts means that National Treasury is the nearest backstop to keep the national carrie in the air. To fund this coming cash call, National Treasury plans to sell a large part of its stake in Telkom in an attempt to quickly raise ZAR10 billion to initially settle ZAR
6.8 billion that will be due at the end of September. Failure to settle the ZAR6.8 billion would trigger cross-defaults on other debt, totalling a further ZAR 7.8 billion.

The extent of the Treasury’s desperation can perhaps be seen first in the sweetener that it offered the market in the last switch auction of August; destination bonds were offered 5 to 7 basis points higher than prevailing levels, effectively losing the Treasury some ZAR120 million in potential inflows just to lure in more interest from investors. Secondly, National Treasury issued a SENS announcement in the last few days of August to the effect that it would increase its auction volumes in inflation linked bonds because it had not achieved its cash targets in terms of money raised from such instruments this year. And thirdly, South Africa’s finance minister admitted to leaders of the labour federation, COSATU, that the government was contemplating tapping into the retirement savings of government employees to help plug fundin shortfalls. Notwithstanding these developments the new finance minister will have the opportunity to assuage the broader public that he and his team at National Treasury have palatable solutions when he delivers his maiden Medium Term Budget Programme Statement in October. Contemporary evidence of a stronger third quarter economy could help his case but viewed from a global perspective, any gains in the current quarter might be short-lived.

Across the globe in China, the consensus has been that President Xi Ping would work to keep its economy growing strongly ahead of the 19th Congress of the ruling Communist Party. The consensus has morphed into a rule called the Xi Put or the Congress Put, but it is less clear whether economic strength at all costs will be enforce after the Congress.

For the present time, those countries that are able to remain focused on their economic strategies are reaping rewards. The news out of Japan this past month is that the country’s economy registered a 4 percent annualised growth rate in the second quarter of this year. It is the sixth consecutive quarter of economic expansion and the longest such streak in over a decade. The early reading is that Abenomics – a form of quantitative easing – is taking hold. Why would that be? A fair question considering Japan has been functioning on ultra-low interest rates for nearly three decades. The key take outs highlighted below, form an important part of the narrativ surrounding the question of SA’s growth prospects in the years ahead.

The aim of the first leg of Abenomics was to reduce nominal and real rates which resulted in a decisive weakening of the yen. A weak yen has historically been good for the all-important export market but the strong quarterly return came in spite of continuing weakness in export performance. Since early2013 when Shinzo Abe came to power, the yen has weakened from the mid-90s to about 110 yen to the USD at present. What the interest policy signal did achieve was to fire up the stock market, making people less worried about the value of their savings and therefore more inclined to spend. Indeed second quarter GDP expansion was materially supported by private consumption spending (up 0.9 percent quarter-on-quarter) as well as business consumption (up 2.4 percent quarter-on-quarter).

The second leg of Abenomics was fiscal policy, and more specifically, an intention to spend massively in government consumption and on infrastructure investment. Stimulus via infrastructure investing is nothing new in Japan. As an indication of how aggressive public investment has been, consider that it was up 5.1 percent in the quarter. Seen in the context of a gross debt-to-GDP ratio of250 percent the extent of this impulse is even more courageous. One of the reasons why Japan has been able to do this is its huge dollar reserves which put its net debt at a more manageable 128 percent. But its scope to expand the program remains limited as reflected in

the seminal work by Rogoff and Reinhart whose research suggests 120 percent as an upper bound to sustainable gross debt.

The logic behind this approach to fiscal stimulus is partly a function of the country’s output gap which is estimated at a narrow 0.8 percent. What this means is that whatever little growth Japan is achieving, the economy is at full steam. That in turn means the economy needs investment in additional capacity.

The third and final leg of Abenomics was structural reform. It is really the success of this leg that will distinguish Abe’s efforts from previous efforts to accelerate growth within the economy. While many of these reforms are fairly standard the one that makes us sit up is the promise of increasing flexibility in the labour market. Whatever its shortcomings, Japan has a better story to tell. It is a story of moving forward. South Africa would do well to combine both foci, emphasising good governance and encouraging investment to drive its own economy.