Cape Town - Financial markets responded negatively to Finance Minister Malusi Gigaba's mini budget statement last week, with market pricing suggesting local currency credit rating downgrades to junk status are a foregone conclusion.
This is according to Overberg Asset Management's (OAM) latest overview of the economic landscape.
SA economic review
The Medium-Term Budget Policy Statement (MTBPS) estimates the budget deficit will rise to 4.3% of GDP in Financial Year (FY) 2018 and remain at 3.9% over the medium-term in FY 2019, 2020 and 2021, a substantial deterioration from the February Budget forecasts.
The respective forecasts made in February were 3.1% in FY 2018, reducing to 2.8% in 2019 and 2.6% in 2020. Total debt is expected to rise to 54.2% of GDP in FY 2018 much higher than the 52.3% forecast in February and continue rising to a considerable 59.7% in FY 2021.
The fastest rising category of spending over the forecast period will be debt service costs, estimated to average 11% growth per annum over the next four years. (See Bottom Line for further analysis).
The Reserve Bank Composite Leading Business Cycle Indicator, which measures expected economic conditions over the next 6-9 months, fell slightly from 97.5 in July to 97.2 in August.
However, the decline is marginal compared with the increase from 95.8 in June. Of the ten survey components, seven increased and three decreased.
The largest negative contributors were the number of residential building plans passed and a deceleration in the twelve-month percentage change in job advertising space.
The largest positive contributors were an increase in the South African produced export commodity price index and improvement in the BER’s Business Confidence Index.
Growth in Private Sector Credit Extension (PSCE) slowed from 6.0% year-on-year in August to 5.6% in September although better than the 5.3% consensus forecast. Corporate credit growth slipped from 8.2% to 7.5% with leasing finance slumping from 11.1% to 0.7%.
Household credit growth slowed marginally from 3.4% to 3.3%. Among household credit categories, unsecured credit growth slowed from 4.0% to 3.4% while overdraft growth increased from 2.4% to 4.3% signaling a pick-up in distressed borrowing. Overall credit growth remains depressed due to weak business and consumer confidence.
In the year-to-date growth in PSCE has averaged 5.8% down from an already subdued 7.5% growth in the same period in 2016.
Producer price inflation (PPI) accelerated from 4.2% year-on-year in August to 5.2% in September above the 4.9% consensus forecast. The main culprits were diesel and petrol prices, which gained in September by 11.9% and 13.5% on the year.
On a month-on-month basis, PPI increased by 0.7% with the “coke, petroleum, chemical, rubber and plastic products” category contributing 0.6 percentage points.
Although PPI is expected to return below 5% over coming months a key risk to this outlook is potential rand weakness ahead of the credit rating reviews on 24th November and the ANC elective conference from 16-20th December.
The avian flu outbreak also poses a risk to the PPI outlook. Chicken makes up the bulk of meat inflation, a key component of the food basket, which makes up 25.2% of the PPI index.
In order to return to its medium-term appreciating trend of the past 18 months the rand needs to break through key resistance at R/$13.00, which if broken would target further gains to R/$12.50 and thereafter R/$12.00. A range of R/$13.00-14.00 is more likely signalling a gradual and controlled depreciation in the rand.
The US dollar index has tried but failed to break through a major 30-year resistance line suggesting the three-year bull run in the dollar may be over.
The British pound has broken above key resistance at £/$1.30 promoting further near-term currency gains to a target range of £/$1.35-1.40.
The JPMorgan global bond index is testing the support line from the bull market stemming back to 1989, which if broken will project further sharp increases in bond yields.
The US 10-year Treasury yield has failed to break below key resistance at 2.0% raising the probability that the multi-year bull trend in US bonds is over.
The benchmark R186 2025 SA Gilt yield is trading in a tight trading range of 8.5-9.0%. A break above 9.0% is required for the yield to move decisively higher towards the 10.5% target level.
Key US equity indices, including the S&P 500, Dow Jones Industrial, Dow Jones Transport, Nasdqaq and Russell 2000, have simultaneously set new record highs, confirming a bullish outlook for US equity markets.
The Brent oil price has broken above key resistance at $50 and likely to remain in a trading range of $50-60 over the foreseeable future. Base metal prices are in a bull trend confirmed by copper’s increase above key resistance at $6000 per ton.
Gold has developed an inverse “head and shoulders” pattern, which indicates further upward momentum and a test of the $1400 target level.
The break above 54,200 on the JSE All Share index projects an upward move to 60,000 marking a new high for the JSE.
The bottom line
Financial markets responded extremely negatively to the Medium-Term Budget Policy Statement (MTBPS). Market pricing suggests the remaining local currency credit rating downgrades to junk status are a foregone conclusion. At its worst levels, the rand fell by almost 5%.
The 10-year government bond yield spiked higher from 8.8% to 9.2%. The response from Fitch credit rating agency offers little consolation.
According to Fitch, “This suggests the change in direction of policy making away from a focus on fiscal consolidation that we anticipated as a consequence of March’s cabinet reshuffle is under way and occurring faster than we had expected.”
However, the deficit overshoot had been expected due to the impact of weak economic growth on taxation revenue. The negative market response may be overdone.
The Treasury’s GDP forecasts are excessively conservative, in contrast to previous budgets, which have always been overly optimistic on growth projections.
While the budget projected nil improvement in the budget deficit over the coming three years, at 3.9% of GDP from 2019 to 2021, this is due to the extrapolation of the current weak growth environment into the full forecast period.
Previous attempts at fiscal consolidation have consistently failed due to weaker than expected economic growth. On this occasion, the budget deficit is likely to be narrower than projected in the MTBPS.
Economic growth will probably beat the Treasury’s excessively conservative forecasts.
Encouragingly, in his MTBPS address Finance Minister Malusi Gigaba confirmed a review of the government’s guarantee framework for state-owned enterprises (SOEs), making it more stringent in terms of SOE governance, boards of directors and profitability.
In a separate interview with the City Press on Friday Gigaba alluded to sweeping changes confirming that the Treasury had agreed to private sector participation for all state-owned enterprises.
In the same interview with the City press on Friday, Gigaba confirmed that the country’s nuclear build programme was neither affordable nor necessary.
Gigaba said: “We are considering a wide range of issues, including freezing salaries, not raising salaries of executives at national and provincial government and for MPs and top civil servants.” Gigaba also cited plans to sell-off shares in government companies to raise funds.
Although a bearer of bad news the mini-budget should be recognised for providing an honest assessment of the country’s fiscal position. The MTBPS recognised the deterioration in the macroeconomic environment and the increased claims from state-owned enterprises.
Financial markets appear to be discounting further credit downgrades to junk status.
It is likely that before further credit downgrades occur the rating agencies will look to the outcome of the ANC elective conference in December, which will undoubtedly affect economic and fiscal policy and therefore the 2018 Budget.
For the full report, including a look at international markets, click here.
* Overberg Asset Management (OAM) is an Authorised Financial Services Provider No. 783. Overberg specialises in the private management of local and global discretionary portfolios as well as pension products.
Information and opinions presented in this report were obtained or derived from public sources that Overberg Asset Management believes are reliable but makes no representations as to their accuracy or completeness. Any opinions, forecasts or estimates herein constitute a judgement as at the date of this Report and should not be relied upon. There can be no assurance that future results or events will be consistent with any such opinions, forecasts or estimates. Furthermore, Overberg Asset Management accepts no responsibility or liability for any loss arising from the use of or reliance placed upon the material presented in this report.
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