SA likely to avoid a recession but not a Moody’s downgrade

It appears that South Africa will avoid a technical recession, says Miyelani Maluleke, a senior economist at Absa Bank. He was speaking at an ABSA round table discussion, attended by MoneyMarketing last month in Johannesburg.

South Africa recorded GDP in the third quarter of 2019 of -0.6%. Fourth quarter 2019 GDP will only be published on 3 March and also seems set to be weak, partly due to renewed power cuts. However, Maluleke believes that a modest recovery from the third quarter contraction is likely. He explained that the available activity data for the fourth quarter of 2019 are mixed but generally quite subdued. After a promising start to the quarter, with growth of 2.5% m/m (sa) in October, manufacturing output fell by 1.5% m/m (sa) in November. Meanwhile, mining output fell sharply by 3.5% m/m (sa) after growth of 1.7% m/m sa in October.

He believes that the severe electricity constraints in December are likely to cause further weakness on the production side of the economy. Electricity output has already fallen by 0.5% m/m (sa) in October and by 1.4% m/m (sa) in November.

“However, the demand side of the economy will provide an offset to the production side weakness, thanks in part to the ‘Black Friday’ effect, which is not fully accounted for in Stats SA’s seasonal adjustment framework,” he stated.

Encouragingly, passenger vehicle sales rose by a seasonally adjusted and annualised 27.7% q/q saar in Q4 2019. Meanwhile, constant price retail sales rose by a solid 3.1% m/m (sa) in

November after remaining about flat in October.

“Overall, we expect fourth quarter 2019 GDP data to reflect a small rebound of 0.4% q/q saar, helping South Africa to avoid slipping into its second recession in as many years,” Maluleke added.

Absa has cut its GDP forecasts sharply as weak business sentiment and bouts of load shedding are constraining the country’s growth prospects, while the drought seems likely to present a significant negative effect in 2020 as well. Maluleke said the forecast was now for real GDP growth of just 0.3% for 2019, 0.9% this year and 1.2% in 2021.

Strategist at Absa Capital, Mike Keenan, provided the round table

discussion with a bearish view on the rand.

“We believe that Moody’s is more likely than not to downgrade us on March 27, while S&P and Fitch could perhaps wait until the second half of the year,” he said, adding that he sees the rand softening to R15.16/USD by the end of Q1 20 and reaching R16.13/USD by year-end. Both Absa’s Structural ZAR model, which estimates the fair value of the exchange rates based on SA’s current account balance and the country’s interest rate differentials, and Absa’s Peer model, which compares the rand to other high-yielding and commodity-based currencies, imply the local currency is currently overvalued.

“The rand will be vulnerable to

capital outflows during the first half of this year, firstly because Moody’s is likely to downgrade South Africa’s local currency credit rating in March and this will eject SA government bonds from the World Government Bond Index. What the size of the flows will be is the billion dollar question.

“Secondly, JP Morgan is scheduled to further reduce South Africa’s bond weighting within its emerging market bond index during the first half of 2020 to make space for Chinese bonds.”

The rand could actually weaken by more than expected if the Reserve Bank cuts policy rates by more than what the market currently expects and/or if the economy falls back into recession. However, the rand may be more resilient if global volatility levels continue to subside on the back of reduced global trade tensions, which in turn could rekindle the rand’s carry trade appeal, and any further improvement in South Africa’s terms of trade might also support the local currency.

Senior Economist at Absa Corporate and Investment Banking, Peter Worthington, told the roundtable discussion that fiscal policy is a huge problem for South Africa and that the budget to be presented on the 26 th of this month is key. “We think the government will again rely mainly on taxes to attempt to narrow the deficit and, in particular, we are making the bold call for a one percentage point rise in the VAT rate. This call is perhaps a bold one, given the likely political fallout, but it is difficult to see what other options the government has. Further increases in personal income tax rates would likely damage the tax base.”

Miyelani Maluleke, Senior Economist, Absa Bank

Peter Worthington, Senior Economist: Absa Corporate and Investment Banking