South Africa’s Economy Diagnosis: Welcome To Stall Speed

LAGOS (Capital Markets in Africa) – Growth in South Africa is likely to hit stall speed in 2016, at a barely positive 0.3%Y, by our estimates. Yet even as a Brexit-induced global growth shock further complicates the outlook, we see currency prospects as less concerning. The SARB is on hold for the foreseeable future, in our view.

A revised GDP data series combined with our views of economic stagnation in several developed markets in 2017 drags our South African growth forecasts toward the consensus of 0.2%Y in 2016 and 1.1%Y in 2017. Our 2016 forecast drops from 0.8%Y to 0.3%Y, while our 2017 forecast moves from 1.5%Y to 0.9%Y. We would not rule out the prospect of a full-year contraction in 2016 GDP,
although the prospect of a quarterly recession does appear to have subsided, with an encouraging set of high-frequency data in 2Q16.

We incorporate a weaker outlook for household consumption, investment and, of course, exports. Consumption growth is being held back by further weakness in consumer confidence and a worsening outlook for job creation. We believe some support for the consumer will emerge however, based on our more subdued inflation outlook and our call that the South Africa Reserve Bank (SARB) is done raising rates. However, fixed investment has slipped into recession, and our previous bear case of a full-year contraction for 2016 now seems the most likely outcome.

It’s not all bad news, however. Weakness in domestic demand is a precondition for macro rebalancing – a process which we estimate is now in its seventh year, and probably has a further 12-18 months to run. Encouragingly, we noted that, government savings swung from -0.2% to +0.3% of GDP in 1Q16, together with a much-needed build-up in household savings – to 1.1% of GDP from
almost zero in 2013. Weakness in household consumption is forcing household savings higher, in our view. However, given the deteriorating growth outlook, headwinds to the corporate gross operating surplus and savings rate are mounting. This should be partially offset by a pullback in dividend payments and employee compensation. Net-net,
our current account forecast remains unchanged at -4.3% of GDP in 2016, but improves by less in 2017, to -3.7% (-3.5% previously).

Our FX strategists remain bullish on the medium-term prospects for the USD, but have acknowledged the powerful hunt for yield dynamic that is currently benefitting emerging market currencies that offer attractive returns and are past the worst point in their macro cycles. Our colleagues now have a less bearish view on the ZAR, with USD/ZAR expected to end 2016 at 14.60 (15.30 previously) and 16.40 at end-2017 (17.20 previously). This is critical for our inflation forecasts, and implies a NEER depreciation of 9.8% in 2016 and just 1.4% next year. From an inflation perspective, this helps lower our 2017 CPI estimate, which now comes in at 5.7% (core CPI of 5.5%Y), and is tracking closer to our bull case scenario that we outlined earlier in the year. Admittedly, the risk to our near term USD/ZAR profile is skewed to the upside given recent political developments.

Both cyclical and structural factors leave us constructive on inflation prospects in 2017. In fact, our forecast is significantly more bullish than the SARB’s. We expect CPI to sustainably dip below 6% from 1Q17. We therefore believe the SARB is on hold for the foreseeable future. Given our view that the SARB will be marking down its inflation forecast in upcoming meetings, our terminal rate
forecast now drops to 7.00% from 7.25% previously.

Does this mean the SARB will initiate an easing cycle? We do not think so. In our view, the only compelling reason for the SARB to unwind the progress it has made at raising real
interest rates would be if inflation expectations were to surprise materially to the downside, or if the outlook for GDP growth is a lot worse than what is generally perceived to be the case.

Conceptually, we view the monetary policy cycle as linked to potential GDP growth, and that there is a preference to keep the real interest rate below potential GDP growth in order for the economy to exit the downswing in the business cycle. The SARB estimates potential growth at 1.4%Y in 2016 and 1.5%Y in 2017. Implicitly, this means real rates are likely to remain below 1.5%. The SARB has raised real rates in this cycle by hiking the nominal rate by more than the rise in inflation expectations (while one-year-ahead inflation expectations have risen by 20bp, to 6.2%Y, nominal rates have risen by 200bp, to 7.0%). Given the improvement in the inflation outlook we envisage, the SARB may opt to pause and allow (falling) inflation expectations to now do the work.

However, there are two important risks to this call: First, were inflation expectations to fall to 5.6%Y or lower, the current nominal repo rate of 7.0% would drive the real rate above potential GDP growth, and hence into contractionary territory. Second, if potential growth were to be revised lower, to say 1.2%Y, then a repo rate of 7.0% with inflation expectations of 5.7%Y would raise the real rate above potential GDP. In these scenarios, we believe the SARB could respond with mild policy easing.

Contributor’s Profile
Andrea Masia is head of sub-Saharan Africa macroeconomic research at Morgan Stanley in Johannesburg. Andrea joined Morgan Stanley’s fixed income division in 2007 as a junior economist covering South Africa & other Sub-Saharan African markets. Andrea is rated amongst South Africa’s most accurate forecasters by Bloomberg, and has achieved a top five rating for South African Economics in the Extel and the Financial Mail surveys. Andrea also achieved a top rating for sub-Saharan Africa Economics in the Financial Mail rankings. He previously held research roles in the banking and telecommunications sectors, and holds a Master’s degree in Economics from the University of the Witwatersrand.