Macro Economic Commentary – August 2020

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Author: Morotola Pholohane


The Great Depression of the 1930s lasted for around ten gruelling years. Its ‘echo’ during the period of the coronavirus pandemic appears likely to be short-lived, although it is too soon to say for sure. Health experts are wary of a second ‘wave’ of the virus, citing previous viral outbreaks, particularly the three waves of Spanish flu in 1918. There is reportedly rapid progress being made towards the discovery of a vaccine, and governments everywhere are closely monitoring the infection curve to avoid further spikes and, consequently, further lockdowns. The road to economic recovery is unclear. Interest rates are at ultra-low levels, and the return environment seems to be disconnected from the struggles of the real economy.


The South African Reserve Bank’s (SARB) leading business cycle indicator increased to 2.7 percent month-on-month in June, following a decrease of 4.9 percent in May; this tracks the easing of level four lockdown to level three. Indeed, the economic data have been improving with each lowering of restrictions. The manufacturing production, retail sales, and new car sales data are on an upward trend, but on the whole remain in negative growth territory. Until such time as lockdown restrictions are altogether lifted, economic activity will remain constrained. The number of bankruptcies reported in July was 50 percent lower, compared to the same period in 2019. However, with deterioration in payment behaviour, the return of load-shedding, and further contraction in the economy, more businesses are expected to be in distress and therefore likely to file for bankruptcy soon. A true sign of the severity of the economic environment has been the low uptake of the crisis loans established to help small and medium-sized (SMEs) businesses to weather the pandemic. According to the Banking Association of South Africa, only ZAR 13.4 billion of the initial ZAR 100 billion loan-guarantee programs has been utilised at the time of writing. Arguably, the rules attached to these loans may need to be relaxed to stimulate more patronage. The new ‘normal’ has also forced some businesses to fundamentally re-engineer their strategies to equip them for an environment of prolonged low economic growth. It is evident that until business and consumer confidence improves, demand will remain sluggish.

The Deputy Minister of Finance recently told parliament that the government is committed to re-prioritising expenditure and to moving with speed on financial reforms, with an emphasis on borrowing, directed at investments that will add to economic growth. The pace of government structural reforms has typically been languid; the current debt, which has mostly been accumulating in the last decade, is primarily the result of misallocating borrowed funds to unproductive assets. Over the past two decades (2000 to 2020), the government has spent ZAR 187 billion on bailing out and re-capitalising state-owned enterprises (SOEs). The Minister of Finance recently commented in parliament that guarantees to SOEs are currently at ZAR 481 billion. Even so, the trend of high borrowing will continue, as tax revenue is expected to disappoint on the downside. This is compounded by a steady increase in the emigration of skilled labour in recent years, thus shrinking the tax base. The loan approved with the African Development Bank is not yet mature, while the loan with the World Bank is still under negotiations; government finds the conditions of the latter loan unpalatable and has instructed National Treasury to continue to engage, hopeful that common ground will be reached.

In the meantime, government is proposing the amendment of Regulation 28 (Reg 28) in the Pension Fund Act, to make it easier for pension funds to invest in different alternative assets, including infrastructural projects. This will be an interesting development to watch, as pension funds are not currently utilising their maximum allowable exposure to alternative assets. In 2015, their investment into private equity was sitting at only 2.3 percent, according to a recent presentation by the Head of Infrastructure at the Presidency. In June, the Southern African Venture Capital and Private Equity Association (SAVCA) added their view regarding the Reg 28 amendments for private equity. In particular, SAVCA argued that private equity ought to be viewed as a separate asset class with a ceiling, and that the current upper limits ought to be increased from 10 percent to 15 percent. Until recently, there has been little investment by the institutional investor in these alternatives, mainly due to liquidity. Yet these are changing dynamics: it seems that the infrastructural fund set up at the Office of the Presidency is cognisant of the barriers obstructing the intake in alternative asset classes.

The inflation reported later in the month was 3.2 percent, which is still within the SARB’s target band and midpoint of 4.5 percent, and which the Monetary Policy Committee sees as a reasonable zone. The monetary policy has run its course, with year-to-date interest rate cuts of more than 300 basis points. With benign inflation, the SARB is likely to keep monetary policy unchanged in the coming meeting in September. It is acknowledged that the money market rates show a possibility of a 25 basis points cut; however, further scope for interest rate cuts is far from certain if the real yields have to remain positive.


The recent Federal Open Market Committee (FOMC) statement shows unanimous approval of a newly reviewed monetary policy framework, yet makes little mention of how to achieve it. At its central bank’s annual policy symposium, the Federal Reserve (the Fed) indicated that the review was spurred by changes in the underlying conditions related to growth, productivity and inflation. The new monetary policy means that interest rates will remain low for a more extended period, and inflation may also be lower for longer. Indeed, the Fed will seek inflation that averages 2 percent over time – Fed Chair Jerome Powell’s comments were explicit on this point. It is less clear what the Fed will do to reach this goal, except that it will act if inflation rises to levels inconsistent with it. According to Powell, the policy will not be dictated by any formula, and no particular method was mentioned to determine the average inflation. What is clear is that broad and inclusive employment is more relevant than inflation. The Fed has clarified in its FOMC minutes that it will not be engaging in yield curve control, and quantitative easing is likely to continue to support market liquidity.

Concerningly, relations between the US and China continue to plunge ever lower. The confrontation is widening to encompass trade and spy planes and, underlying all, ideologies. Even if President Donald Trump loses the national elections in November to Democrat candidate Joe Biden, relations between China and the US will likely continue to deteriorate. Biden’s policy stance on China is similar to Trump in terms of technology, intellectual property, and trade; however, he is a bit lighter on tariffs that put pressure on US companies. Instead of tariffs, Biden may consider offering financial incentives to US companies to encourage bringing jobs back home to the US. In the meantime, China has released the list of technologies that now require approval from local authorities before they can be exported to the US. Biden does not intend to pull the US out of the World Trade Organisation (WTO) and may re-join the World Health Organisation (WHO), contrary to Trump’s position on these points. ‘Biden’s campaign vision is to Unite for a Better ‘Future’ and to work within the international framework, promoting less hostility and more engagement and collaboration. Perhaps, with the changing of the guard – if it happens – the US’s style of engagement with the rest of the world will be softer than the characteristically hard approach of the incumbent president.


It is well documented that most emerging markets (EMs) suffer from currency volatility as a result of vulnerabilities in capital flows. The cumulative portfolio outflows from the EM in the midst of the coronavirus pandemic have been even more severe than other recent crises, including the global financial crisis of 2008, the ‘taper tantrum’ of 2013, and China’s foreign exchange devaluations of 2015. Critically, the EM has been losing its share of global exports of goods and services as a share of gross domestic product (GDP) since 2011. The move towards protectionism around the world will further stymie globalisation, which will negatively impact EM economies. In such an environment, most EM assets underperform, relative to developed markets.

Yet it is not a one-size-fits-all story within the EM. During the EM sell-offs of 2018, countries that were highly dependent on dollar-denominated debt, such as Turkey and Argentina, were harder hit than those that were less dependent on foreign financing, such as Russia and China. It is important to recall that most EM countries were fiscally constrained before the coronavirus pandemic paralysed the world. Some EM nations have fewer problems than others, with lower debt, more fiscal space, massive reserves, and better credit ratings; they are more likely to be defensive among their EM peers. Taiwan, South Korea, and Thailand are among the countries that fare well in some of those metrics (however, Thailand has a statutory debt ceiling that may need to be reviewed to allow the country to implement significant fiscal reforms). Some EM countries have a higher level of debt denominated in their local currency and are thus less vulnerable to international shocks. Some have higher bond yields (such as South Africa, Russia, Indonesia, and Mexico), while some have higher currency volatility (such as South Africa, Thailand, and Turkey). The countries that have experienced high debt deterioration in the last decade include Argentina, Brazil, South Africa, and China. China is the largest economy within the EM; it has a higher debt-to-GDP ratio but has room to move in terms of policy, given its budgetary prudence and low external vulnerability.

Higher debt and weaker fundamentals, over and above the usual supply and demand dynamics, means that the long end of the yield curve for EMs will remain under pressure. Also, EM countries will benefit less from fiscal stimulus than will more developed nations. EM ‘carry trades’, i.e. borrowing on low-yield countries to invest in high-yielding currency, have become less popular as a result of central bank interest rate cuts putting downward pressure on bond yields. Further, ultra-low interest rates have eroded some EM risk premiums. Nevertheless, the emerging market equity exchange-traded products have recorded their first positive inflows since the beginning of 2020.


The dovish policy framework adopted by the Fed may continue to support the prevailing risk sentiment. EM countries’ assets that have less idiosyncratic vulnerability are likely to benefit from this, in particular, EM high-yielding assets. The South African scenario described above, where the fiscus has deteriorated significantly, makes it least preferred among EM countries. The Fed’s focusing on employment and more tolerance on inflation is positive for gold and stocks, but detrimental to the US dollar. In the case of a weaker dollar, EM equities benefit, given their historical negative correlation with the US dollar. Further, EM equities have previously outperformed developed market equities in most scenarios of dollar weakness.

Although we have seen stock market rallies recently, the underlying real economy still shows signs of instability, as reflected in the earnings data. This is a serious cause for concern. The financial market cannot be the economy – it is supposed to be driven by actual economic activities. Investors will have to re-think whether the rhetoric (market thesis) is matched by efficacy. Can it be that the stock market no longer requires the economy if it has central banks?