Macro economic commentary – September 2017

Author: Ntsekhe Moiloa.

Two key local developments in the past month were the release of the latest iteration of the Mining Charter, followed a day later by seemingly unwarranted comments by the Public Protector on the mandate of the South African Reserve Bank. Both events proved negative for the currency, continuing an unfortunate trend of negative news that has dented investor confidence in the South African market.

In our previous note we mentioned that South Africa faces a capital allocation mismatch – owing to a lack of policy framework – to attract FDI flows into the country. The lack of a framework has reflected a lack of certainty as political battles have been fought in government during President Zuma’s term of office. After the Mining Charter was released, the finance minister expressed the hope that his colleague at Mineral Resources would consult more broadly and involve the Finance Ministry if necessary. What those comments betrayed was a troubling lack of coordination in government, and the lack of assurance by the President as these events unfolded raised concerns about leadership.

In the aftermath of the most recent Cabinet reshuffle we highlighted the possibility of a new front opening up in the battle for influence of key institutions of State. In particular, we discussed the outlook of the new political leadership at National Treasury, making pointed reference to the possibility that it may wish to seek to reduce the independence of the Reserve Bank. A little more than half way through June, the rand lost ground as the Public Protector made comments to the effect that South Africa’s Constitution should be changed to make the central bank’s mandate one of economic growth rather than price and financial stability. The comments were made in the context of a complaint about a lifeboat that Absa Bank and its forbear, Bankorp, received between1985 and 1995. However, the complainant has pointed out that his complaint had nothing to do with the mandate of the Reserve Bank, thus, the Public Protector was “on a frolic of her own” in making those statements.

The trend unfortunately remains one of personalities in state institutions appearing to go on frolics of their own. Not long after the Public Protector’s widely criticised utterances did the Deputy Minister of Finance make similar remarks without apparently checking with his senior, the Minister of Finance. In our April note we highlighted the possibility that the Reserve Bank could be in the sights of the new political team at National Treasury, specifically saying that this team’s views “are relevant to investors to the degree that they have the potential to alter the known architecture of the South African financial sector”.

The recognition of South Africa as a good place to do business by international businesses, is not unconditional. The country has had a spotty record on industry-to- labour relations. Educational attainment is nearly two standard deviations worse than the global average yet annualised growth in the working age population is positive. The simple result is that more people are entering the labour pool with poorer than average skills to compete globally. Unsurprisingly, productivity growth in South Africa has been declining for much of the post-Apartheid period. Productivity growth globally has attracted more discussion in this past month, as economic theory suggests that the neutral rate of interest should decline as productivity slows. The origin of this idea is that over the long term interest rates will approach nominal GDP growth rates. Thus, lower productivity growth should lead to lower nominal GDP growth and therefore lower equilibrium interest rates. While that may happen initially, over time it has been observed that interest rates eventually rise, and this is how regions of the globe where long term productivity growth is low (such as Africa) also happen to have higher interest rates. Part of this may be tied to the expectation that low GDP growth will result in a country trying to inflate its way out of its debt, thus moving interest rate expectations upwards. Another part may be linked to higher interest rates needed to raise savings where low output leads to low national savings in the midst of high dependency ratios. The extent to which South Africans rely on debt to provide for themselves and their dependents is illustrated by the National Credit Regulator’s estimate that around 9.6 million borrowers had impaired credit records, out of 24.1 million credit consumers. Despite the recession in South Africa, private credit extension nevertheless grew at a faster pace in May than the median estimate of 10 economists compiled by Bloomberg.

In a sense, the South African Reserve Bank has to be concerned about interest rate expectations rising too much; productivity slow-down and negative politics can undermine perceptions of investors about the government’s management ability. Lately, the turmoil in the governing party has caused great concern among ordinary residents too. Nevertheless, foreign direct investment has now and again flowed into South Africa. For a more sustained interest in the country, we observe the importance of policy certainty. After years of parliament being accused of ineffectiveness, the National Assembly appears to be pressing the country’s executive for clearer answers. This happened at an oversight meeting with the board of Eskom. It happened again at a meeting of the Appropriations committee early in June, where it emerged that there was no consensus on how many state-owned entities (SOEs) there were, nor the policy framework in which they operated.

Without a clear understanding of its agencies and their priorities, it is more challenging for the country to understand its policy priorities. Even in matters that are well- understood to need investment such as education, the presence of programming priorities helps to sharpen the focus of efforts. A report of the Human Sciences Research Council (HSRC) to the parliamentary appropriations committee revealed that the Trends in International Mathematics and Science measure of25 participating countries showed South Africa making the strongest improvement of the cohort. To be sure, South Africa remained last in the group, but the country is closing the gap. However, the parliamentary committee noted an apparent mismatch between the tertiary degrees on offer, the enrollment patterns, and what industry required. The committee also discussed policy and fiscal programming to improve health outcomes, bringing to light the strongest proportional budgetary commitment in Africa to tackling HIV. The theme coming out of the deliberations is that while Cabinet falls into factional discord, parliament is carving a more independent path of oversight.
The ANC members are not yet so strong as to openly oppose their party president, but the Appropriations committee did take the step of empowering the HSRC to look into the efficiency of appropriations spending at SOEs. This has been identified as particularly important when the parliamentary committee has seen larger sums of appropriations being transferred from departments to the SOEs, leaving it up to an unknown number of dysfunctional SOEs to deliver the country’s developmental goals. A reinvigorated commitment to proper parliamentary oversight of SOEs is a very important economic opportunity for South Africa.

Where SOE reform might be an internal opportunity, an external opportunity is that tourism has been firm from countries in Europe, for example, where the reasoning is that as long as the political impasse does not spill over into violence, South Africa is a good place to visit and spend money. Travel agents in Europe report that bombings in Turkey and abductions in Thailand and Indonesia have garnered travel advisories from some European governments warning citizens against travel to those tourism destinations. For instance, the UK Foreign and Commonwealth Office makes specific mention of places to avoid in Asia Pacific countries while of South Africa it writes that “[m]ost visits to South Africa are trouble-free, but [one] should take sensible precautions to protect [one’s] safety.” Where government is considered largely competent and reliable, these warnings can come as public relations nightmares for tourism destinations because of the power they have to discourage potential tourists. The United States has simultaneously become less interesting for European leisure travelers since the election of Donald Trump as president. South Africa is importantly in the same time zone, relatively safe and not as far away as Australia and New Zealand, thereby attracting the interest of Europeans wishing to travel overseas.

Yet for these factors to solidify into stronger long-term investment interest, South Africa has to address its political own goals. It is not enough to merely present a less- worse picture than Turkey and Brazil. South Africa must make an immediate and compelling case to potential international investors and to exasperated would-be emigrants, while stronger winds buffet its trade competitors. The political leadership in South Africa also has to become more alert to the global economy. In the most

recent parliamentary question and answer session, President Zuma repeatedly suggested that South Africa’s recession is the result of a global economic slow-down. The truth is that Europe’s economy is firmer than it has been in a while and the United States is also firm but now forecast by the IMF to have slower growth in 2017 and 2018. In a slower global economy going forward, South Africa will have to have sharper reflexes anyway. The ball found itself squarely in South Africa’s court at the end of June as Fitch and the World Bank lowered their 2017 growth estimates to 0.7 percent for the country.

Also towards the end of this past month the Bank for International Settlements (BIS) published its annual report. In Chapter 3 the BIS comments on economic early warning signals, noting that a credit-to-trend-GDP gap beyond 10 percent and a rise of over 250 basis points in the debt service ratio has tended to presage financial and banking distress in more than two-thirds of the instances since the late 1970s. On those measures, the core countries in the post-2007 crisis, namely the US, Spain and the UK, do not appear worrisome as private sector deleveraging has been a part of their recovery stories. The BIS points out that banking systems in those countries are only partly done repairing. On the other hand, China, Hong Kong and Canada look at risk on both credit-to-GDP and debt service ratio bases. Hong Kong and China stand out particularly, with credit gaps of 30.3 and 24.6 respectively. On the credit-to-GDP measure alone, Indonesia, Malaysia, Thailand, Japan, Mexico, Switzerland and Turkey look vulnerable.

In our view it is increasingly clear that investment in Chinese equities has to be on a select basis, focusing on a compelling thesis that examines particular market segments rather than China as a whole. In our domestic and global portfolios, we have exposure to companies that have demonstrated strength in mobile gaming. In domestic portfolios the exposure comes through Naspers whose most significant asset is a stake in Tencent. Not only does Tencent offer mobile games but it also owns WeChat, China’s dominant messaging platform. So dominant is WeChat that it occupies the place in the communication sphere that most of the rest of the world reserves for e-mail. Remarkably, nearly 900 million monthly users make WeChat the place to socialise and conduct business. The app is even the most popular place to publish as well as to effect mobile payments. Seemingly unrelated activities come together through WeChat and that is down to Tencent having understood its market well. Even for investments in local companies, it is important to understand vagaries of foreign markets, and we have extended those insights into providing complementary exposures where we manage global portfolios. In our global portfolios, we have exposure to mobile technology through Netease which owns many of the most popular mobile games amongst younger Chinese. Both Tencent and Netease shares have done very well in2017, with Tencent helping to propel Naspers to a nearly 26 percent gain in the year-to-date. Nevertheless, so much of the performance of Naspers has been tied to Tencent that one is prompted to wonder about the health of the rest of the business.

Caution is not only pertinent to Naspers. At the end of the month, H&M disclosed that it grew South African interim sales by 32 percent; it also disclosed that global inventory was 16.1 percent of sales, representing a 27 percent increase on a year ago. As a result, the company planned to increase markdown sales to clear stock ahead of the Northern hemisphere autumn season. Local retailers have experienced negative sales growth. The developing narrative is clearly that the global economy is scheduled for a cool-down in growth. Locally, Stats SA announced that the economy shed about 48,000 jobs in the first quarter of 2017 and mining giant, AngloGold has indicated that it may add to the losses by shedding about a third of its workforce. The room for policy error has narrowed and South Africa’s political class has to sit up and take note.