By Paolo Senatore , CIO and Mark Appleton Strategist at Ashburton Investments
A tough domestic environment
For some time now, the prospects for the South African economic environment have been sanguine. Economic commentators, including ourselves, have been highlighting the challenges and headwinds facing South Africa. These have included slowing growth in China with its consequent negative impact on the prices of our commodity exports, a large current account deficit, industrial unrest and the resultant impact on both mining and manufacturing production, and a weak domestic consumer outlook.
The relatively poor state of South Africa’s “balance sheet” and a large reliance on foreign capital flows led global investors to categorise the country as being one of “the Fragile Five”, an informal nickname for the grouping of countries considered to have poor credit metrics. Ratings agencies have long been poised to downgrade the quality assessment of SA debt and it was this fragility that prompted the South African Reserve Bank (SARB) to raise interest rates early in 2014. While this rate hike was largely viewed as a risk-management exercise to prevent the current account from deteriorating further, from an economic perspective, this was certainly not good news and an already struggling consumer was faced with even more of an uphill struggle.
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In addition to these interest rate increases, the prospect of rising interest rates in the US threatened to stem the capital flow benefits arising from South Africa’s relatively high interest-rate environment. This meant that even though the economy was weak, the country faced the threat of even more rate hikes. The fiscal outlook was also poor with a weak economy pressurising tax revenue. In the Medium Term Budget Policy Statement presented late last year, the newly appointed Minister of Finance indicated that National Treasury would seek ways to increase the tax take (read tax hikes) leading to an even tougher economic environment.
Source: I-Net Bridge
Oil price relief
The oil price has plunged some 60% over the past 7 months in US Dollar terms. While this article does not seek to go into reasons behind the significant drop (very much supply side related) we do try and assess the impact of what it all means from a global and South African point of view. From a global growth perspective the spending power unleashed within oil importing nations is predicted (by JP Morgan) to have the potential to boost global GDP in excess of 0.5%. The lower oil price is also largely (but not entirely) responsible for the significant decline in the global inflation trajectory which enables central banks to keep interest rates lower for longer. The US Federal Reserve may however be the exception to other central banks where interest-rate normalisation is expected to commence at a moderate pace later this year. Declining global bond yields are already reflecting these lower inflation expectations and growth assets such as equity and property are likely to be underpinned by these low risk-free yields and enhanced spending power.
Consequently, there are many positives stemming from falling oil prices for South Africa. The domestic inflation rate is likely to be significantly reduced (we anticipate an average inflation rate of around 3.5% for 2015) arguably negating the need for the SARB to raise interest rates. Added to this, the threat of higher offshore interest rates (possibly barring the US) with its’ negative capital flow implications is substantially diminished. In other words global investors are likely to continue “chasing yields” in an increasingly low yield environment. This means that the SARB will be under less pressure to raise interest rates based on what is happening offshore. The benefits to the trade balance are likely to be substantial. According to some estimates the nations’ fuel bill (at current oil and rand prices) will drop from around R230bn in 2014 to approximately R110bn in 2015. This is equivalent to 2.3% of the size of South Africa’s economy and should be supportive of the currency. Consumer savings at the petrol pump means greater discretionary spending power. In this regard, it is interesting to note that estimates for household consumption spending growth have already started to accelerate. Finally, the low oil price has given Finance Minister Nene more room to manoeuvre from a tax collection perspective. For example, an additional 60c per litre fuel levy will go a long way to satisfying his additional tax requirement. This implies that he does not necessarily have to burden the tax payer with increased taxes.
Without a doubt, the oil price benefit is a welcome relief to SA’s economic outlook given the serious challenges, particularly regarding electricity supply constraints facing the economy. For this reason, economic growth is likely to remain sub-par despite the tailwind the oil price drop represents for the economy. However, it is still expected from a domestic investment viewpoint, that low inflation and short term interest rates together with greater consumer spending power will brighten the investment return outlook for growth assets such as equity (interest rate sensitive consumer stocks in particular) and property.