The SA Business Cycle, a call on interest rates – which is a call on the rand. Here’s hoping for lower interest rates
The release of new vehicle sales and the note issue for February 2016 allows us to update our Hard Number Index (HNI) of the current state of the SA economy. The HNI has proved to be an accurate leading indicator of the Reserve Bank Business Cycle Indicator that is now only updated to November 2015.
The HNI for February is little changed from the January reading and indicates that the currently slow pace of economic activity is being maintained. See the figures below, where the HNI is compared to the Reserve Bank Business Cycle and extrapolated to February 2017. As may be seen below, the forecast is for but marginally higher levels of activity this time next year. The good news is perhaps that no obvious further deceleration in the pace of economic activity was recorded in February 2016.
New unit vehicle sales continued to decline slowly last month. The time series forecast is for sales to decline from the current annual rate of 607 000 units to an annual rate 582 540 new units sold into the SA market in February 2017, a decline of 6.8%. This would represent a modest cyclical decline when compared with past downturns in the vehicle cycle. This atypical, low amplitude new vehicle sales cycle will have had much to do with the current, comparatively low amplitude uptick in the interest rate cycle.
The other component of the HNI, the cash cycle, adjusted for inflation, has also turned lower, mainly the result of higher inflation. As may be seen in the chart below, current growth rates are of the order of 2% per annum and are forecast to remain at this rate, consistent with the GDP growth outlook.
The cash cycle possibly captures the influence of the informal economy. The vehicle cycle reflects the spending on capital goods, the cycle of firms and the household’s demands for consumer durables. This includes motor vehicles as well as washing machines, furniture, appliances etc that are financed with credit. Very few new vehicles are now exchanged for cash. Therefore market interest rates are possibly the largest influence on the cost of leasing (renting) a new motor vehicle.
The other important influences on the cost of ownership will be the value of any used vehicle traded in, or the residual value agreed to. The higher the residual value or the longer the repayment schedule, the lower will be the monthly rental payment. And the monthly payment may well be offset by the separately itemised charge for the motor plan. It is the highly negotiable gross monthly payment that will be the key influence on demands for new vehicles, rather than the theoretical list price, as is also the case with many other large ticket items bought by households.
Unfortunately it is this mostly theoretical vehicle list price that will rise with rand weakness and be reflected in the CPI and to which the Reserve Bank may react with still higher interest rates.
It would be a much more accurate measure, of the possibly less inflated monthly cost of owning a vehicle, were it reflected in the CPI by this leasing charge, rather than by new vehicle prices, as is the case with the CPI treatment of the cost of owning a home. This is correctly reflected in the CPI as an implicit rental charge to the owner occupier, rather than by house prices themselves. And so, the key influence on vehicle sales and house prices will be short term interest rates – though monthly payments may well be held back by more intense competition to make sales and issue motor plans.
For the sake of the motor manufacturers and dealers, and for the sake of the economy generally, the hope must be for lower, not higher interest rates. Such hopes rest with the behaviour of the rand, over which, it may be added, short term interest rates will have very little influence, judged by past performance.
The hope for lower interest rates in SA and a cyclical upswing rest with the exchange value of the rand. The rand will take its cue from the attraction of interest rates at the long end of the yield curve. Any improved flow into emerging markets will also attract funds into the RSA bond and equity market and strengthen the rand, as will any diminution of SA specific risks.
The risks of presidential intervention in fiscal policy have not dissipated, though they have declined compared from levels first reached with the dismissal of Finance Minister Nhlanhla Nene in December 2015. The risk premiums attached to RSA debt remain elevated accordingly. Furthermore, emerging market risks more generally have declined both absolutely and relatively to the SA CDS spread, as we show below. The gap between more risky emerging market debt and RSA debt has narrowed, even as both spreads have declined. The wider this spread gap, the better the SA rating. So it may be concluded that much of the recent improvement in RSA credit ratings is attributable to global, rather than SA, specific events.
The upside is that these SA risks are overstated and that President Jacob Zuma will prove them so by allowing Finance Minister Pravin Gordhan the essential freedom and authority to manage fiscal policy in the conventional way. If this happens, then the rand can strengthen further. This would help to put downward pressure on the inflation rate as well as on long term RSA interest rates. Less inflation and less inflation expected may well bring lower interest rates. The next cyclical recovery, including a recovery in the vehicle market, depends upon a stronger rand and the lower interest rates that will accompany rand strength.