Recession 'very shallow and not likely to persist' - analysts


It is official. The South African economy is in recession, the country’s first recession since 2009.

Not only did GDP contract in the second quarter by 0.7%, but the estimated 2.2% contraction in the first quarter was revised downward to an even worse contraction of 2.6%.

What has happened to President Ramaphosa’s “New Dawn”? Has it been extinguished before it could even get started or has it merely been postponed by a couple of quarters?

The analysts at Overberg Asset Management (OAM) believe the latter scenario.

The GDP contraction was not as bad as indicated in the headline number, OAM said in its weekly economic and market overview. 

Although the latest data was clearly disappointing - given that OAM had expected GDP growth of 0.6% during the second quarter - it is a very "shallow recession" and unlikely to persist into the third quarter of the year.

South Africa economic review

• The Standard Bank Financial Conditions Index declined from -0.3 in June to -0.6 in July, the sharpest decline since June 2017, signalling a tightening in financial conditions. The index, which serves as a leading economic indicator, suggests activity will remain lacklustre over coming months.

The sharp decline is attributed to a combination of rand volatility, weak domestic capital markets, rising oil prices, slow house price growth and depressed credit extension. Although showing slim gains in nominal terms, the JSE, house prices and credit extension have barely budged in real terms, after taking inflation into account.

• The Standard Bank economy-wide purchasing managers’ index (PMI) fell in July from 49.3 to 47.2. Its lowest since April 2016 and well below the key 50-level which demarcates expansion from contraction. Among the PMI sub-indices, the output index fell from 48.8 to 44.4, while the forward-looking new orders and new export orders indices fell from 49.2 to 45.3 and from 48.8 to 47.7, respectively - suggesting little relief in the near-term.

At the same time inflationary indicators increased. The input cost index rose from 52.8 to 58.2 reflecting the impact of rising oil prices and the sharply weaker rand. The output price index increased to 56.3, its highest since July 2016, confirming that higher costs are being passed-on rather than absorbed. The Standard Bank PMI mirrored a similar sharp drop in the BER manufacturing PMI, reported last week, confirming a high degree of economic uncertainty and weak activity.

• South Africa’s current account deficit narrowed in the second quarter to an annual rate of 3.3% of GDP. While still high by emerging market standards, this marks a substantial improvement on the 4.6% deficit recorded in the first quarter. In addition, the deficit in the first quarter was revised lower from an initial 4.8% and in the fourth quarter last year from 2.8% to 2.6%.

The improvement in the second quarter is attributed to a better trade performance amid rising exports and slow import demand. The goods trade balance showed an annualised surplus in the second quarter of 0.7% of GDP compared with a deficit of 0.3% in the previous quarter. The shrinking current account deficit reduces South Africa’s external financing needs and is therefore moderately positive for the rand.

• In an interview with the Financial Times, Reserve Bank Governor Lesetja Kganyago stressed that South Africa should not be placed in the same category as Turkey and Argentina, which have been hit the hardest in the current emerging market sell-off.

Referring to the independence of South Africa’s monetary policy he said: “Institutions matter. That is why we are not a Turkey, or an Argentina – or a Venezuela for that matter.” Kganyago also observed that compared with other emerging markets South Africa had less foreign-currency debt.

His remarks mirror those by S&P Global Ratings, which last week pointed out that: “In stark contrast to Turkey, South Africa is a net external creditor, and this creditor position benefits from rand depreciation.”

The week ahead

• Manufacturing production: Manufacturing production increased by 2.9% in July, boosted by growth in vehicle and parts sales, figures released on Tuesday by Statistics South Africa showed.

This was higher than the estimates of most economists, who had expected a more modest 1% rise.

• SACCI Business Confidence Index: The SACCI Business Confidence Index, which surged higher in January to its highest since October 2015, has been on a downward slide ever since due to political and policy uncertainty.

The decline is expected to have extended in August from 94.7 to 91.5 according to consensus forecast.

• Retail sales: While retail sales remain constrained by the recent increase in VAT, rising inflation and a depressed labour market, the resolution of public sector wage negotiations will have brought some relief to consumer spending.

According to consensus forecast, retail sales growth is expected to have nudged higher in July to 1.55% year-on-year from 0.70% in June.

• RMB/BER Business Confidence Index: Having slumped in the second quarter from 45 to 39 the RMB/BER Business Confidence Index is likely to have lost further ground in the third quarter, damaged by uncertainty over land expropriation, lacklustre domestic demand and the threat of a burgeoning global trade war. 

• Mining production: According to consensus forecast, the mining sector, which contributed positively to GDP output in the second quarter, is expected to have increased output in July by 2.95% year-on-year, matching its June figure of 2.85%. The sector however, is still not running at its full potential due to ongoing uncertainty over mining legislation.

Technical analysis 

• The rand has retraced 50% of its 2016-2017 appreciation against the US dollar, indicating that the spike in the rand/dollar rate to R15.50/$ in the first week of September may mark the peak in the currency’s recent decline.

• The rally in the US dollar index has reached its medium-term goal suggesting a correction from current levels. The dollar remains below a major 30-year resistance line suggesting the bull run in the dollar may be over.

• The British pound has broken back below key resistance at £1.35/$ suggesting a trading range of £1.30/$ to £1.35/$. The £1.28/$ level is expected to provide strong resistance.

• 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 is struggling to break decisively above key resistance at 3.0%. However, a break above this level is expected and would open the next target of 3.6%.

• The benchmark R186 2025 SA Gilt yield has retraced earlier weakness and fallen back below the key 9.0% level. A trading range of 8.4% to 9.0% is expected over the foreseeable future.

• Key US equity indices, including the S&P 500, Dow Jones Industrial, Dow Jones Transport, Nasdaq and Russell 2000, have simultaneously set new record highs, confirming a bullish outlook for US equity markets.

• The Brent oil price has struggled to break above key resistance at $75 per barrel, indicating a likely trading range of $65 to $75 per barrel. The outlook for base metals prices is less certain after the copper price retreated sharply from the key $7 000 per ton level. A decisive break below $6 000 per tonne would herald a bear market in copper and base metals’ prices.

• Gold has developed an inverse “head and shoulders” pattern, which indicates a price recovery and a test of the $1 400 target level.

• Despite the consolidation since the start of the year the break in the JSE All Share index above key resistance levels at 56 000 and 60 000 in December signals the early stages of a new bull market.

Bottom line

• It is official. The South African economy is in recession, the country’s first recession since 2009. A recession is defined as two consecutive quarters of GDP contraction. Not only did GDP contract in the second quarter by 0.7% quarter-on-quarter annualised but the estimated 2.2% annualised contraction in the first quarter was downwardly revised to an even worse 2.6% contraction.

• What has happened to President Ramaphosa’s “New Dawn”. Has it been extinguished before it could even get started or has it merely been postponed by a couple of quarters? We believe the latter scenario. Although clearly disappointing (the consensus forecast was for annualised GDP growth of 0.6% in the second quarter), it is a very shallow recession and not one that is likely to persist into the third quarter.

• The GDP contraction was not as bad as indicated in the headline number. On a year-on-year basis GDP managed growth of 0.5% in the second quarter and 1.5% in the previous quarter. If agriculture, extremely volatile at the best of times, is stripped out, annualised GDP would have increased by a slender 0.1% in the second quarter. Output from agriculture, forestry and fishing fell in the second uarter by an annualised 29.2% and in the first quarter by 33.6%.

By contrast the sector grew in the third and fourth quarter last year by 41.7% and 39.0% respectively. The volatility of agricultural output suggests that the sector is quite likely to rebound in the second half of the year, reversing the negative effect it has had on GDP in the first half.

• The expenditure breakdown of GDP reveals an outsized negative impact from a rundown in inventories. The massive R14bn reduction in inventories detracted a full 2.9 percentage points from annualised second quarter GDP growth. Depleted inventories eventually need restocking, which bodes well for a boost to GDP growth over coming quarters.

• On the expenditure side, exports performed extremely well, contributing 3.7 percentage points to annualised second quarter GDP growth. Exports increased in the second quarter by 13.7% quarter-on-quarter while imports increased by just 3.1%. The sharp depreciation in the rand since the start of the third quarter will have greatly enhanced South Africa’s terms of trade and the competitiveness of its exports, boosting the likelihood of an even stronger export contribution to GDP growth in the second half of the year. Since the 30th June the rand has dropped by over 12% against the US dollar.

• Encouragingly on the supply-side breakdown of GDP, mining output grew in the second quarter by 4.9% annualised a sharp improvement from the 10.3% contraction in the first quarter. Construction output grew for the first time in five quarters, rising 2.3% compared with a 1.9% contraction in the first quarter. Manufacturing shrank by 0.3% annualised but this is much better than the 6.7% contraction in the first quarter. Finance, real estate and business services grew output by 1.9% up from 1.1% in the first quarter.

• Bright notes on the expenditure side include a more moderate contraction in gross fixed capital formation (GFCF) from 3.4% in the first quarter to 0.5% in the second quarter. In addition to the stabilisation in aggregate gross fixed capital formation (GFCF), the composition of GFCF also improved, showing a moderation in government spending, which displays fiscal prudence, and a rebound in private sector spending.

Private sector spending grew by 3.1% compared with a 3.9% slump in the first quarter while government spending fell 10.1% accelerating from the 3.6% fall in the first quarter.

• Household expenditure was a soft patch with an annualised decline of 1.3% in the second quarter compared with 1.0% growth in the first quarter. Household expenditure contributes around 60% of the expenditure side of South Africa’s GDP and therefore subtracted a substantial 0.8% percentage points from annualised second quarter GDP growth.

A silver lining in the GDP numbers is that interest rates are unlikely to rise for the foreseeable future. A lack of domestic demand pressure, especially at household level, should ensure that the weaker rand has limited pass-through to higher inflation.

• GDP growth is likely to rebound in the second half of the year. The powerful detractions from agriculture output and inventory drawdowns are expected to reverse, while the sharply weaker rand will support an even stronger contribution from export performance. However, beyond the expected rebound in the second half of the year, a sustainable uptrend in GDP growth will depend on greater political and policy certainty and meaningful supply-side economic reforms.

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.

Disclaimer: 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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