Category: SA Economy

Second quarter GDP, announced on 3 September, was disappointingly smaller than the quarter before. The news sent the rand immediately weaker and the cost of servicing SA debt higher. The rand declined not only against the US dollar but also weakened against other emerging market currencies. This indicated SA-specific rather than global forces at work. And the spread between RSA yields and their US equivalents widened taking SA dollar denominated debt further into high yield, junk territory. SA dollar debt with five years to maturity offers investors about 2.5 percentage points more than US debt of the same duration. Investment grade debt would offer only about 1.5 percentage points more than US Treasury Bonds.

Some of the weakness in the USD/ZAR exchange rate and weakness in the rand against its emerging market peers has been reversed in recent days, as has the upward pressure on RSA and emerging market risk spreads.

What then can be done to reverse the vicious circle in which SA finds itself, the slow growth that drives capital away, weakens the rand that adds to inflation? And leads seemingly inevitably to still slower growth in spending and output? Faster growth by the same market logic would do the opposite: attract capital, strengthen the rand and the Treasury and lower inflation.

South Africa clearly has a supply side problem. We are not producing enough (adding enough extra value) to generate additional incomes. The reasons for this failure may seem complex but I would argue that it is the result of policies that focus primarily on who benefits from the output produced, rather than on how to raise the levels of output, incomes and employment. In other words, redistribution undertaken or feared at the expense of output and incomes. South Africa needs to impress the world and its own citizens that we will care about raising output. The revised mining charter, to be made public soon, gives the timely opportunity to demonstrate a new pragmatic economic approach, one intended to attract rather than repel capital on internationally competitive terms.

But South Africa not only has the problem of too little supply. It also suffers much from too little demand. Too little demand was exacerbated in the Q2 GDP estimates by a large decline in the demand to hold inventories. Without the reduction in inventories of R14bn in constant prices, growth in GDP in Q2 would have been 2.9% higher. Reducing stock piles and goods and services in production to satisfy demands rather than increasing the output of them may however point to more rather than less output to come.

But even leaving aside declining investment in inventories or volatile quarterly changes in agricultural output – that could easily reverse themselves – the growth in final demand by households, firms and government is running well below even our limited potential supplies of good and services. And has been doing so for many years now. That is to say interest rates have been too high to match demand and potential supply even growing slowly. Interest rates have a predictable effect on the willingness of households to spend (out of after-mortgage payment income) and the willingness of firms to spend to satisfy those demands. Their influence on prices is much less predictable.

The link between interest rates, the exchange rate and inflation is highly unpredictable, given the forces that drive the exchange rate. That take their cue mostly from global rather than South African events. Indeed as the market has revealed the relationship between growth, inflation and interest rates is not what standard theory might predict. Slower growth leads to a weaker rand, more inflation and still higher interest rates that depress demand and growth further. The impact of less demand on prices is vitiated by the likely impact of the weaker exchange rate on prices.

Thus raising interest rates in response to rand weakness exaggerates the business cycle rather than smooths it. The Reserve Bank should have reduced interest rates much faster and sooner than it has, to help match weak levels of demand with potential supply. The best it can now do for the economy is to surprise the market by not raising rates. And then over the course of the next few years, if demand remains as weak as it has been, to reduce them without then being thought soft on inflation. This would help take SA closer to a virtuous circle of faster growth and less inflation and give the economy some head room to undertake the supply side reforms that are essential if its growth potential is to be raised permanently. 13 September 2018

Parsing the GDP estimates and calling for more realism about them

The SA economy has now recorded two quarters of negative growth: it is in recession. The decline in real GDP of -0.7% in quarter 2 came as something of a surprise, enough to send the rand significantly weaker. Which in itself makes the growth outlook even less promising given the implications of a weaker rand for more inflation and higher interest rates. That the rand was weaker for South African rather than global reasons was apparent in the performance of the rand compared to other emerging market exchange rates. The rand by time of writing, 16h30 on 4 September, was 2.85% weaker vs the US dollar and only slightly less, 2.2% down on our nine emerging market currency basket.

The logic in the market reactions to the surprisingly low GDP growth estimates seems clear enough – slow growth adds risk to the fiscal outlook. It may encourage the rating agencies to downgrade SA debt further so encouraging capital outflows form the RSA debt market, hence the weaker rand. Though it should be appreciated RSA dollar denominated five year bonds were already trading in junk territory before the GDP release.

Insuring RSA dollar debt against default required paying a risk premium of 180bps. at the beginning of August 2018. The emerging market crisis took this risk premium to 230bps by the end of August. It is now 360bps – up from 330bps previously. The equivalent Turkish risk premium is now 580bps compared to 333bps in early August, up a mere 8bps on the day.

The GDP growth numbers themselves require careful consideration, perhaps more than they have received by the market place. Not only did highly volatile agricultural output drag the quarter to quarter seasonally adjusted annual output growth rates lower by 0.8%, but more important, a decline in estimated real inventories reduced expenditure on GDP by as much as 2.9% at an annual equivalent rate.

By definition output (GDP) is made up of value added by the different sectors of the economy. This estimate of output is by definition identical to the expenditure on this output and the incomes earned producing goods and services. Supply determines demand and demand determines supply – and gives us the national income identity- that is GDP is equal to expenditure on GDP.

This expenditure is made up of spending by households and government on consumption of goods and services and spending by firms and government on additional capital goods- known as gross fixed capital formation (GFCF). To which additional or in the case of Q2 2018 reduced investment in inventories is added or subtracted. Exports less imports are then added to make up the estimate of Expenditure on GDP (see figures 2 and 4 provided by Stats SA). This shows the contributions to the growth outcomes of the different sectors and categories of expenditure. It should be noted that net exports (exports volumes grew faster than imports and so were a positive contributor to growth in GDP in Q2. Perhaps some of these mining exports were sourced from stock piles (inventories) rather than current output- enough to reduce inventories at the rate indicated?

Farming volumes while contributing about 2.5% of all value added in Q2 2018 are inherently variable, subject to drought and flood and may not have any seasonal regularity. The real output of agriculture forestry and fishing fell at an annual rate of 29% in Q2 and was down by 34% the quarter before. In Q4 2017 the growth was as much as 39% at an annual rate and 42% p.a. the quarter before that. For a better sense of sustainable growth rates it might be better to exclude agriculture from the GDP estimates

The run down in inventories had however a much more important influence on GDP growth than farming output in the second quarter as may be seen in the table above. Less invested in inventories reduced estimated GDP growth by 2.9% p.a in the quarter. Inventories fell by an estimated over R14 billion in constant price terms, at an annual rate. Enough to take the growth estimate into negative territory with such significant repercussions and despite the positive contribution of 3.7% p.a made by exports to the GDP growth recorded

The adjustments made for seasonal effects on the change in inventories were highly significant. It is very difficult to make economic sense of the very different estimates of changes in inventories when measured in current or constant prices, or when measured each quarter or alternatively at a seasonally adjusted annual rate. According to the statistics provided by Stats SA the actual quantity of inventories in Q2 grew by R6.7bn (at constant 2010 prices) in the quarter. In current prices and at an annual, seasonally adjusted rate inventories are estimated to have declined by R7.4bn in Q2 2018, (much less than the R14b decline when estimated in constant prices). Using quarterly statistics (not seasonally adjusted) the value of inventories, measured in money of the day, increased by R11.1bn in Q2.

It takes something of a leap of faith to accept and reconcile these very different estimates of inventory changes at face value. When growth in the other components of spending is at the understandably slow rates recorded in Q2 2108, estimates of investments- less or more – in inventories take on particular significance – as they did today on their release. They should perhaps be treated with much greater skepticism than has been the case.

Yet for all these reservations about the estimates of GDP growth, the weakness of household spending cannot be gainsaid. It is by far the largest contributor to expenditure on GDP and on GDP – equivalent to 59.4% of all expenditure in Q2 2018 at current prices. The reluctance of households to spend more is at the heart of South Africa’s inability to grow faster. Without a greater willingness and ability of households to spend more the economy and its output and incomes will not – cannot grow faster.

Household consumption expenditure declined at a 1.3% annualized rate in Q2 2018- taking 0.8% off the estimated growth of -0.7% p.a. The weaker rand and the higher inflation that will accompany the weaker rand will depress household spending further. It is surely inconceivable that interest rates could be raised in circumstances of this depressed kind.

The value of the rand is beyond the influence of interest rates. Surely as much is painfully apparent after events of the past few weeks. But interest rates do effect the ability of the households to spend more. If economic logic were to prevail interest rates in SA would be reduced not increased given the negative growth outlook. And if so the growth prospects would improve – not deteriorate. If so, it might lead to rand strength not further weakness. Weakness that comes with slower growth, as we saw today. 5 September 2018

The SA economy: will it gain relief from a stronger rand and less inflation?

The SA economy (no surprise here) continues to move mostly sideways. Growth in economic activity is perhaps still slightly positive but remains subdued. Two hard numbers are now available for the June 2018 month end: for new vehicle sales and the real supply of cash – the notes in issue adjusted for prices that we combine to form our Hard Number Index (HNI) of economic activity. Because it is up to date, the HNI can be regarded as a leading indicator of economic activity that is still to be reported upon.

Its progress to date is shown below. It shows a falling off in activity in 2016 and a more recent stability at lower levels. It is compared to the Reserve Bank’s business cycle indicator based on a larger number of time series that continued to move higher in 2016-17 but has also levelled off in recent months. The problem with the Reserve Bank series is that it is only available up to the March month end for which GDP data is also available.

We show the growth in the HNI and the Reserve Bank cycle below with an extrapolation 12 months ahead. The HNI cycle suggests growth of about 1% in 2019 while the Reserve Bank cycle is pointing lower.

It is striking how well the real cash cycle (included in the HNI) can help predict the cycle of real retail sales. Retail sales volumes gathered momentum in late 2017 stimulated it would seem by an increasing supply of real cash. This momentum has however slowed more recently as inflation turned higher in the face of a weaker rand. Retail sales have been reported only to April 2018.

The best hope for the rand and for the SA consumer is that the pessimism about emerging market growth has been overdone. If so some recovery in EM exchange rates can be expected – and that the rand will appreciate in line with capital flowing in rather than out of emerging markets. Some of these forces have been at work this week, helping the rand recover some of its losses and improving the outlook for inflation in SA. It may also if sustained even lead to lower interest rates in SA – essential if any cyclical recovery is to be had.

The importance of inflation for the business cycle is captured in this correlation table of key growth rates in SA. Inflation may be seen to be negatively correlated (and significantly so) with the growth in retail volumes and new vehicle sales. It is even more correlated (0.85) with the growth in the supply of real cash – that is in turn highly correlated with the growth in retail activity. And as may be seen, the growth in retail activity is also strongly correlated with growth the Reserve Bank’s cyclical indicator (Resbank) (0.80 correlated):

The problem for South Africa and the Reserve Bank that targets inflation, is that so little of the inflation experienced in SA is under its control. The exchange rate takes its own course – driven by global sentiment – so pushing prices higher or lower, that in turn drives spending lower or higher. Interest rates that may rise with more inflation and then fall with less inflation make monetary policy pro-cyclical rather than counter cyclical. 11 July 2018

The outlook for the SA economy depends on China

Emerging markets (EMs) and their currencies enjoyed a strong comeback in 2017, after years of underperformance when compared to the S&P 500. The JSE All Share Index kept pace with the S&P 500 in 2017 in US dollars. An EM benchmark-tracking stock would have returned over 40% in the 12 months to January 2018 while the S&P 500 delivered an impressive 26%, less than the 28% delivered to the dollar investor in a JSE tracker.

Investor enthusiasm for equity markets in general and for EM securities and currencies in particular however ended abruptly in January 2018 and waned further in April. The EM equity drawdowns since January have been depressingly large. The MSCI EM Index and the JSE have now lost about the same 16.5% of their end January US dollar values, while the S&P 500 was down by a mere 4% at June month-end.

The capital that had flooded into EMs and their currencies in 2017 has rushed out even more rapidly, presumably back to the US, so driving the US dollar higher and other currencies, especially emerging market currencies (including the rand) weaker. The rand has traded mostly in line with its peers in 2018, though it has lost ground to them recently.

It should also be recognised that the similar flows of dividends and earnings from the JSE and EMs over many years, in US dollars shown in the figure above, is not some co-incidence. It is the result of the similar economic performance of the companies represented in the two indices.

The JSE has been well representative of the EM universe taken as a whole, when measured in US dollars. Naspers, with a 20% weight in the JSE All Share Index and a close to 30% weight in the SA component of the EM benchmark, is largely a Chinese IT company. Naspers is riding on the coattails of its subsidiary Tencent, and this helps account the similar behaviour of the respective indices.

In the long run, it is past performance reflected by earnings, dividends and return on capital invested that drives equity valuations, not sentiment. Reported dividends, discounted by prevailing interest rates, do a very good fundamental job in explaining the level of an equity index over time. In the short run, expectations of future performance (sentiment), will move markets one way or another, as they have moved equity markets in the past.

The sell-off in EM equity markets is not explained by their recent performance, which has benefited from synchronised global growth. It reflects uncertainty about the prospective growth in dividends and earnings and therefore global growth rates to come. We may hope that pessimism is being overdone.

The impact of the performance of companies that operate in China, on the outcomes for EMs generally (including SA), cannot be overestimated. Not only is the direct weight of China in the equity and currency indices a large one, but China is an important trading partner for all other emerging market economies.

Therefore the ability of China to maintain its growth and trading relationships successfully and manage its exchange rate predictably and responsibly will be a vital contributor to the prospects for all EMs. Realised global growth, including growth in the US, Europe and China, will determine the outcomes for EM equity and bond markets and exchange rates. The performance of the global economy and the companies dependent upon it are as good or better than they were a year ago.

The performance of the SA economy would be assisted by a stronger rand and damaged by a weaker rand that moves inflation, interest rates and spending faster or slower. Exchange rate and inflation trends in SA are bound to follow the direction taken in all EM economies, especially China. We must hope that renewed respect for growth in China will make this happen. Our immediate economic future depends more on what happens in Beijing than in Pretoria. 5 July 2018

Our review of the state of the SA economy indicates a modest but welcome pick-up in economic activity. This was driven by lower levels of inflation particularly at retail level where even some lower prices helped spur spending by households.

Unfortunately the suddenly weak rand will reverse inflation trends and slow down spending all over again. As Mike Tyson said, everybody has a plan in the ring until they get hit in the face. Consumers have had to take another punch in the form of a weaker rand that will soon show up at the stores. They will depend on the Reserve Bank rolling with the punch: leaving interest rates unchanged to soften the blow of higher prices. The real danger is that the Bank will do the opposite and raise rates, doing nothing for the rand and only depressing spending further.

We have updated our index of the current state of the SA economy with data released for May 2018. We call it the Hard Number Index (HNI) because it relies on two hard numbers that are provided very close to the month end. The data we rely upon and combine to form our Index are new vehicle sales, provided by the National Association of Vehicle Manufacturers (NAAMSA) and the cash (notes) in circulation issued by the Reserve Bank. The note issue is a liability on the Reserve Bank balance sheet, reported soon after each month end.

These are hard numbers and not the result of sample surveys that inevitably take time to collect and estimate. A further advantage in the May releases is that they are less likely to be influenced by the Easter effect that comes at different times in March or April, and so always makes seasonal adjustments very difficult to claculate accurately for those months. The seasons of the year do make a difference to vehicle sales and even more so on demands for cash that tend to rise as consumers intend to spend more on holidays, especially at Easter and Christmas.

The current state of the economy, according to the HNI, as of the May month end, is shown in the chart below (Figure 1). The HNI is compared with the Reserve Bank Business Cycle Indicator that has only been updated to February 2018 (an especially out of date measure given that disappointing first quarter GDP estimates have already been released). The disappoinment was that in the first quarter GDP, declined at a 2.2% annual rate. the economy will have moved on – hopefully forward.

The HNI may be regarded as a leading indicator of the SA business cycle and has served very well in this regard as may be seen in figures one and two. However the two series parted company to a degree after 2016. The HNI has pointed to lower levels of activity than the Reserve Bank Indicator. However in late 2017 the HNI stabilised and picked up some momentum. These trends, when extrapolated, suggest that the economy will stabilise at its current pedestrian pace for the next 12 months.

We show the second derivative of the business cycle in figure 2, the growth in the economic indicators. As may be seen the growth in the Reserve Bank activity indicator has been slow but persistently slow in 2017 and 2018. The HNI has recently turned from negative to positive growth.

The components of the HNI have shown a different direction. Supply (and demand) for cash, adjusted for prices, has shown a welcome upward direction, and is forecast to be sustained over the next 12 months. However vehicle sales, while they have shown a modest recovery in 2017, are pointing marginally lower: down from their current annual rate of about 546 000 new passenger cars sold, to a marginally lower rate of sales of 535 000 cars forecast to be sold this time next year. See figures 3 and 4.

The pick-up in the real cash cycle was assisted by less inflation in 2017. Figure 5 compares the growth in the value of notes issued (at face value) with the slower inflation adjusted rate of growth.

The increase in prices at retail level has been unusually lower than headline inflation in recent months. In March 2018, retail inflation was running at 1.6% compared to headline inflation that month of 3.8% that increased to 4.5% in April. This pick up in what are spending intentions, hence demands for cash, would be faster if prices were measured at retail rather than headline inflation.

Lower levels of retail inflation in 2017 owed much to the end of the drought, the recovery of the rand and the weakness of spending at retail level that gave retailers very little pricing power. The consequently lower inflation rates at retail level – sometimes deflation – undoubtedly helped stimulate extra spending at retail level in late 2017. The real money cycle is almost always closely linked to the cycle of retail sales volumes as we show in figure 6.

Retail spending has gathered momentum. Have we reached a (low) peak in the retail cycle?

The volume of retail sales in South Africa has gained momentum, off a very weak base. By March real sales were up 4.8% compared to a year before. Will this cyclical recovery in spending at retail level accelerate or fall back? The answer will depend on the future path of inflation in SA, to which short term interest rates and the cost of credit for households and firms are linked. The future path of the rand will be critical to the inflation outcomes, as we discuss below.

This growth in spending was stimulated by a sharp decline in retail inflation from early 2017 (see figure 1 below). Retail inflation in March 2016 was 7.4% and declined steadily to 1.6% in March 2018. Retail sales growth was a negative 1.7% in December 2016. Growth in sales a year later was over 5%. The real sales cycle was at a trough when the retail price cycle was at its peak in Q4 2016.

(Retail inflation is calculated as the annual change in the retail price deflator, being the ratio of retail sales at current prices to retail sales at constant prices. It has fallen far below headline CPI inflation that was 3.8% in March 2012.)

A large part of the answer to whether or not the retail recovery will accelerate or decelerate will depend on the direction of retail prices and on interest rates that will take their cue from the price trends. As may be seen in figure 1, the time series forecast is for a slowdown in sales growth from its peak and a modest pick-up in retail inflation from its recent trough. It will take rand strength to avoid these outcomes.

In figure 2 we show this clearly negative relationship (inflation up and sales growth down) over an extended period. It also shows how low the current rate of real sales growth is in comparison to the previous peak growth rates realised in 2006 and 2011. There would be little reason to regard the current rate of retail sales growth as representing a peak in the cycle – were it not for a concern that retail price inflation may have reached a cyclical trough.

The declining trend in retail and headline inflation since mid-2016 had much to do with the stronger rand. Another force acting particularly on food price inflation was the end of the drought in the eastern part of the country of 2016. The drought had pushed food price inflation to double digits. Food price inflation was 3.5% in March 2018. Inflation peaked after the USD/ZAR exchange rate had reached its weakest point in late 2015. And headline and retail inflation receded after the rand had come to strengthen on a year on year basis. Thus the future of inflation in SA will depend, as ever, on the exchange rate, given the openness of the economy to foreign trade. Exports and imports together add up to the equivalent of 60% of GDP.

We compare CPI (headline) inflation with retail price inflation in figure 3 below. We show the impact of the exchange rate on inflation in figure 4.

In figure 5 we compare the correlated movements in the USD/ZAR and trade-weighted rand. Both rand exchange rates are helpfully for inflation trends that still marginally stronger than they were a year ago, even after recent US dollar strength and rand weakness.

The key to the exchange value of the rand in the months to come (and so for the outlook for inflation) will be the behaviour of the US dollar. Dollar strength vs peers is likely to mean weakness in emerging market currencies, including the rand, as has been the case since mid-April. Dollar strength in 2014 was associated with emerging market currency weakness until mid-2016. A degree of dollar weakness, and rand and emerging market strength followed until very recently. It may be seen that since April 2018, renewed dollar strength vs the euro, yen, sterling and the Swiss franc has been associated predictably with emerging market and rand weakness.

The degree to which the rand moves independently of the other emerging market exchange rates as shown in the figures may be regarded as the additional SA-specific political events that can influence the exchange value of the rand. SA risks weakened the rand compared to other emerging market currencies in 2015 – and a diminished sense of SA-specific risks to investors strengthened the rand in a relative sense in 2016 and again in late 2017.

Thus it should be appreciated that most of what happens to the rand will reflect global forces acting on emerging market currencies generally, events over which SA has no influence. Nor are SA interest rates likely to influence the rand exchange rates in circumstances when global capital flows dominate exchange rate movements. In our view, with the Ramaphosa presidency now firmly in place, the exchange value of the rand in 2018 will be influenced largely by what happens to the US dollar and all emerging market currencies.

The recent strength of the US dollar is a clear danger to the rand and SA inflation. A stronger US dollar means rand weakness and more inflation in SA and at best stable short-term interest rates. More inflation and unchanged interest rates will hold back retail sales. A weaker dollar however would mean less inflation, possibly lower interest rates and continued strength in retail sales volumes.

The dollar strengthens when the US economy grows faster than other developed economies and vice versa. Relatively faster growth in the US means that US interest rates are likely to rise relatively to interest rates in Europe and Japan, so attracting flows into the dollar, as has been the case recently. More synchronised global growth is to be hoped for to restrain dollar strength and protect the rand and improve the outlook for inflation and growth in SA.

SA has little influence over the direction of the rand and hence inflation and the retail sales cycle. The best SA monetary policy can do in these circumstances is to let interest rates take their direction from the state of the economy and not the outlook for inflation – which is dominated by forces beyond interest rate influence. The danger to the economy comes from interest rate settings that react to the impact of a stronger US dollar on domestic inflation. 23 May 2018

What is in a price? And what does it all mean for our standard of living?

Automation, roboticisation and miniaturisation are changing wondrously the way we produce and consume goods and services, including the medical treatments that can keep us alive for longer and with much less morbidity. To which forces of change we could add the internet of things that connects us ever more effectively and commands so much more of our attention.

The benefits of this technological revolution that we can see and feel are not at all obvious however in the measures we use. We are informed that US productivity continues to grow very slowly. And real GDP is growing as slowly, as are wages and incomes adjusted for inflation. Apparently Americans are not getting better off at the pace they used to and are frustrated with their politicians they hold responsible.

Is our intuition at fault or the way we compare the prices of the goods and services we consume over time? All measures of output and incomes are determined in money of the day, calculated and agreed to in current prices. They are then converted to a real equivalent by dividing some sample of output or wages estimated at current prices, by a price index or a deflator. A price index measures the changes in the prices of some fixed “basket” of goods and services thought to represent the spending patterns of the average consumer. The deflator calculates the changes in the prices of the goods and services consumed or produced today, compared to what would have been paid for them a year before.

Both estimates attempt to make adjustments for changes in the quality of the goods and services we are assumed to consume. A car or a pain killer or cell phone we buy today on today’s terms may do more for us than it would have done at perhaps a lower price, or possibly a higher price (think dish washers or calculators) five or 10 years before. It is not the same thing we are making price comparisons with.

A piece of capital equipment today, robotically and digitally enhanced, is very likely to produce many more “widgets” today than a machine similarly described 10 years ago. And it may cost less in money of the day. It is a much more powerful machine and firms may well make do with fewer of them. Their expenditure on capex – relative to revenues – may well decline, indicating (wrongly perhaps) a degree of weakness in capital expenditure. The problem may not be a lack of willingness of firms to invest more, but how we measure the real volume of their investment expenditure – quality adjusted.

There is room for moving the rate at which a price index increases (what we call inflation) a per cent or two or three higher than they would be if quality changes were implied differently and more accurately. And if s,o GDP and productivity growth would appear as equivalently faster.

It is instructive that the US Fed targets 2% inflation – not zero inflation – because 2% inflation (quality adjusted) may not be inflation at all. And zero inflation may mean deflation (prices actually falling) enough to discourage spending now, to wait – unhelpfully for the state of the economy – for better terms tomorrow.

Over the past three months there have been no increases in prices at retail level in SA. The annual increase in retail prices (according to the retail deflator) fell below 2% in January 2018 and is far lower than headline inflation. (see below). The Reserve Bank would do well to recognise that the state of the economy – coupled with what the stronger rand provides businesses in SA – leaves both manufacturers and retailers with very little pricing power. Nominal borrowing costs – well above business inflation – are in reality applying a significant real burden for them. They could do with relief. 12 April 2019

It is possible to get very rich from politics in an honest and old-fashioned way. Recent SA political and economic events prove so. Had you predicted that Cyril Ramaphosa would win the ANC election in December and ascend to the presidency of SA, and bought the rand and the shares and bonds that benefit from a strong rand, you would have done very well. And you’d have done even better if you had sold those securities (including the US dollar or euro) that weaken when the rand responds to good news about SA.

The USD/ZAR reached a recent low of R14.46 on 15 November. It is now R11.77, an improvement of about 20%. The rand has also gained 24% against the JPMorgan Index of emerging market exchange rates (FXJPEMCS), since then indicating it was South African-specific surprises rather than global forces that has driven the rand recently.

The cost to the taxpayer of issuing rand-denominated debt has fallen significantly. The yield on five year RSA bonds has fallen from 8.69% on15 November to 7.38% on 12 March that is by 1.31% or equivalent to a 16% decline in the cost of issuing new government debt of this duration. This even as US interest rates were moving in the opposite direction.

The extra yield SA has to offer investors in US Treasury bonds for five year money (the sovereign risk premium) has fallen from 206 to 139 basis points. Over the same period, enough to bring SA debt well within investment grade quality. A one per cent per annum saving on interest, given the volume of government debt to be serviced and rolled over, is worth about R6bn to the SA taxpayer (hopefully) or the recipient of extra government spending (alas more realistically).

A stronger rand means less inflation and encourages households (who do more than 60% of all spending in SA) to spend more on the goods and services to be supplied to them by SA business. And the more profitable firms in turn will then hire more workers and equipment to service their growing custom. And less inflation may bring a lower repo rate and mortgage payments to further encourage spending. Enough extra spending to at last spark a recovery in the economy that has been growing much too slowly for far too long.

These implications of the stronger rand has therefore been dramatically registered in the share market. Companies with revenues and earnings generated in SA, banks and retailers for example, have become more valuable. While companies listed on the JSE, whose main line of business is generated offshore, have lost value. An equally weighted group of 14 large offshore plays has lost about 20% of its rand value since mid-November (see figures 4 and 5 below).

By contrast the rand value of a group of 18 equally weighted large SA economy plays on the JSE has increased by about 25% over the same short period. Buying SA and selling the world on a Ramaphosa victory would have been very value adding. Simply buying the JSE – with its mix of global and SA plays would – as an exchange traded fund would do, would have been to miss the value adding bus. It is in surprising turbulent times like this that active managers earn their fees.

The government led by Ramaphosa could provide much more of the good stuff for the SA economy by delivering on the promise of better government. Better still for the economy and its growth would be less government. Officials should intervene less in the economy – and show more respect for business and market forces as the critical drivers of the economy. Government should tax business income at lower rates and avoid subsidising other businesses that survive only with government aid.

Less intrusive government and consequently lower compliance costs would allow small businesses to compete with large businesses. And, more important, to free up the market for workers that leaves so many unemployed.

Government should also show a genuine willingness to sell off rather than add capital to the companies it owns: firms that survive to protect their employees from the performance indicators that private owners would demand of them – and reward accordingly.

The cabinet should recognise that its current set of economic policies of high spending and tax – ever more intervening government – has been a primary cause of the debilitating slow growth realised in recent years. A mix of all of the above policy recommendations would deliver economic growth and votes. A still weak economy could lose the ANC the next election in 2019. 15 March 2018

The SA economy is being helped along by lower inflation at the retail level

The SA economy did surprisingly well in the fourth quarter of last year. GDP grew at an annual rate of over 3%. The demand side of the economy did just as well, growing at the same rate as supply, which was augmented by a strong seasonal recovery in agricultural output. Demands from households, which account for 60% of all spending, increased by an annualised 3.6% in the quarter, well above recent trends, while expenditure on capital goods increased even more robustly by 7.4% annualised. Imports increased significantly faster than exports, so reducing GDP growth, but found their way into increased holdings of inventories – enough to offset the impact of the growth in imports (up 23%) and the negative trade deficit on GDP. Imports add to supply – the increase in inventories adds to demand.

The strength in household spending – essential to any cyclical recovery – was reflected in a strong recovery in retail sales volumes. These were growing at close to a 6% annual rate in the fourth quarter. Such growth was assisted by low rates of retail price inflation. The prices of goods and services at retail level were largely unchanged in the fourth quarter; hence sales in constant prices were rising as rapidly as were sales measured in prices of the day. Clearly consumers were getting the benefit of the end of the drought (lower food prices) and the stronger rand and presumably strong price competition at retail level.

The figures below tell the story of price competition and its effects. Extrapolating recent trends suggests that prices at retail level will be rising at a very slow rate in the months to come. The recent strength in the rand will be adding to these disinflationary, if not deflationary pressures in the months to come and will help to stimulate household spending. A time-series forecast of retail volumes indicates that they could retain a brisk growth pace of around 6% over the next 12 months.

The incipient cyclical recovery identified in our last report on the state of the SA economy has been confirmed by the most recent data releases. New vehicle sales and the supply of cash to the economy at November month end both support the view that the economy is demonstrating resilience.

We combine these up to date, hard numbers (not based on sample surveys) to calculate our Hard Number Indicator (HNI) of the business cycle. As we show in figure 1 the HNI is now pointing higher after showing little momentum after 2014 and having moved lower in 2016. The annual change in this indicator (the second derivative of the business cycle) has moved into positive territory and is forecast to maintain this momentum.

The components of the HNI are shown below. The real money base, the note issue, adjusted for the CPI (to November 2017) has become less negative while the new vehicle sales have maintained an encouraging revival.

If recent vehicle sales trends are maintained, new vehicle sales would be running at a 600 000 unit rate at year end 2018. This would represent a welcome recovery from the cyclical trough of mid-2016 but would still leave sales well below the previous peak rates of 2006 and 2012-2014.

Sales volumes at retail level, excluding motor vehicles, have been reported for October 2017. They show that the retail sales cycle continues its upward momentum and is pointing to growth rates of about 3% through 2018. This growth will be assisted by the growth in demands for cash. Extra cash is still a very good coinciding indicator of retail spending intentions despite all the digital alternatives to cash in SA (see figure 4).

Perhaps a more important encouragement for households to spend more is that prices at retail level have hardly increased over the past few months. The retail price deflator has moved sideways even as the CPI continues its upward trend, though also at a more modest rate. Hence the trend in inflation at retail level is sharply lower and, if sustained, will prove a stimulus to spending (see figures 5 and 6). The key to the door of lower prices at retail level is the exchange value of the rand. The outcome of the ANC succession struggle at Nasrec this weekend will be well reflected in the rand and in turn in retail spending and inflation. 14 December 2017

The markets have been recording their judgements about the outcome of the battle to succeed President Jacob Zuma as leader of the ANC to be decided over the next few days. The prospects of Cyril Ramaphosa succeeding has been recorded in the degree of rand strength versus its emerging market peers. As we show in figure 1 below, the rand weakened in response to the appointment of Minister of Finance Malusi Gigaba in March and weakened further after he presented his mini-Budget statement in October. Since then, and despite a very critical report from the credit rating agencies and a downgrade, the rand has recovered strongly – in an important relative sense – and not only versus the US dollar.

The same improvement in sentiment is revealed in the market for US dollar-denominated RSA bonds. As we show in figure 2, the spread between the interest rate yield on five-year RSA bonds and five-year US Treasury bonds that offers compensation for extra SA risks of default, has also narrowed from 2.2% in early November to about 1.8% on 14 December.

A still more direct measure of the probabilities of one or other candidate being first past the post is provided by online sportsbook operator Sportingbet (https://www.sportingbet.co.za).

When their books first opened the odds on the various potential candidates – or those not yet identified were as shown below. The favourite was Nkosazana Dlamini-Zuma with a 42% chance of winning (1/2.4) while Cyril Ramaphosa was given only a 27% probability of winning, less than the chances of Zweli Mkhize.

The decimal odds are now as shown below. Ramaphosa is the firm favourite, given a 57% chance of winning compared to a 33% chance for his closest rival Dlamini-Zuma. The odds on any other outcome have blown out.

The volume or value of bets cast is not disclosed, but we are informed by Sportingbet that 65% of the bets and 61% of the stakes have been cast for Ramaphosa, while 21% of the bets have been placed on Dlamini-Zuma and a larger proportion (36%) of the stakes cast for her. These books will close on Saturday 16 December and we are informed by the firm, who describe themselves as operator of South Africa’s largest online sportsbook:

“Unfortunately, as part of our trading risk management policy, and as a company policy, we never disclose amounts wagered, numbers of bets, or users on any single event. I can share however that considering it’s a “novelty” (or non-sporting event) market, the bet activity and interest on this is impressive. “

There is a great deal at stake for the economy in the ANC race for the top. Clearly, judged by the markets and the odds and the politically savvy involved, there are no certain outcomes. Were therefore the favourite to win and the more decisive the victory, the stronger the rand and the lower the risk spreads – and so the chances of a strong SA economic recovery. Perhaps something those casting their votes might bear in mind. 15 December 2017