Are we heading for a recession?

A slew of contrasting economic data underscores the need for an acceleration in economic growth at a time when any mistake will be ruthlessly punished under the glare of the international credit ratings agencies.

We need economic growth to counterbalance any increase in net government borrowing when we are already stretched to the limit on debt and, as the finance minister has repeatedly pointed out, we need inclusive growth for the stability of the country.

In the face of what appears to be conflicting economic data, we spoke to Johann Els, a senior economist at Old Mutual to navigate the numbers and draw conclusions about what we should expect in the next 6–12 months.

The ugly

The biggest hit to the economy in the immediate aftermath of the Cabinet reshuffle was the damage to investor sentiment. “Kicked in the teeth,” was the way that organised business felt about the reshuffle, after a concerted effort by business, labour and Treasury to improve South Africa’s perception in the eyes of the international investment community after the fiasco surrounding the firing of Nhlanhla Nene.

Not all of this good work has been undone though, as can be seen in the way the rand has held up against major international currencies. But indicators like the business confidence index, which at 40 (ten points below 50) is indicative of contractionary tendencies in the economy, and shows domestic investors are still largely negative on prospects.

In sectors like mining, where a combination of policy uncertainty (we are still waiting for the revised Mineral and Petroleum Resources Development Act despite government’s own deadline of March 31 having come and gone) and anti-business rhetoric is leading to an “investment strike” in the words of Sibanye CEO, Neal Froneman.

“Yes, mining production has been going nowhere since the platinum wage strike in 2014,” says Els, “so we are not expecting anything out of mining at this stage, despite improved commodity prices.”

The ugliest scenario for the country will depend on the outcome of reviews by Moody’s and Standard & Poors in the coming weeks following their visits to assess conditions “on the ground”. These visits are scheduled to take place this month in the case of Moody’s and next month by S&P.

A second local currency rating to “junk” (sub-investment grade) will trigger a mandatory reaction by a large portion of foreigners that own roughly 38% of our government debt. This will see them having to sell bonds and repatriate the proceeds via US dollars (where the bulk of the money originates from). Given the expected volume of sales (in excess of R100 billion) in a very concentrated amount of time (4-6 weeks) this will send the rand reeling, never mind the body blow to investor sentiment, domestic and foreign.

The longer-term effects of more expensive government borrowing will be felt at the margin at each successive presentation of the budget, where ever larger amounts of the fiscus will be dedicated to servicing interest to sustain the same level of government expenditure.

This throws a spanner in the works. “The South African Reserve Bank won’t react to any rapid depreciation of the rand, but what they will raise interest rates for is to contain inflation,” says Els, who says the spectre of a downgrade condemning the country to junk is the biggest risk to their forecast of growth in the economy over the next year.

The bad

Household credit growth is inching toward turning negative (see graph below). “It’s not the biggest driver of consumer spending, so we are not too concerned by it,” says Els. “But the way we see it, there appears to be a knock-on effect from the damage to sentiment the banks have experienced after being downgraded themselves. Since then they are being very negative and are not too interested in extending new credit lines.”

Source: Old Mutual

The other sector that has been a perpetual source of disappointment lately has been manufacturing, and if the recent sharp drop in the South African purchasing managers index (PMI) is anything to go by, this won’t be changing soon.

The PMI index which measures confidence, dropped from a reading of 50.9 (barely expansionary) to 44.7 (contractionary).

“The latest PMI figures revealed a sharp drop,” says Els, “but we think it might be an aberration. Manufacturing has been poor but we think there may be scope for an improvement.”

The other clanger out of recent data disbursements has been total vehicle sales (local and export), which plunged by 28% on a month-to-month basis. Els says it was a horrible number, but when seasonally adjusted – which takes into account the timing of things like holidays – it doesn’t look nearly as bad, and in fact, could actually be stabilising.

The good

And finally, the good.

The Reserve Bank compiles and publishes a leading economic indicator index drawn from a wide array of metrics, something which has been positive for the last seven months in a row.

“The global situation has also been positive,” says Els, meaning its been very forgiving during a time when we could use all the help we can get. “There is better global growth, its more synchronised – meaning it’s not just China, but also the US and Europe where growth is coming from. And there has been improved sentiment towards emerging markets which has helped us.”

Els also believes that a forecast of a “stable to weaker US dollar” will also create an environment which might lead to rate cuts towards the end of this year – credit downgrade risks notwithstanding.

“Due to the incredible surge in agricultural production, which we expect to see increase by as much as 80% following the end of the drought, we expect inflation to be very well contained, falling to between 4%-5% by the middle of the year. This should give the Reserve Bank the leeway to cut interest rates by 25 basis points (0.25%) likely in the last quarter of 2017.”

All things being equal, we can expect economic growth this year of 1.5%. This leans heavily on the country not being downgraded to junk status and the rand behaving itself.

Speculating on the likelihood of a downgrade, Els points out the positives: “The ruling by the Western Cape High Court in setting aside nuclear procurement as it stands is positive because it demonstrates the country’s institutional strength. Ratings agencies like that. Also, the minister of finance’s comments on the need for stimulating inclusive economic growth, and the understanding and desire to involve labour and government in that objective are also positive. But it is impossible to say at this stage what will happen.”

And that means we might just have to roll the dice.

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