Today’s local elections are being held even as a series of corruption scandals and a worsening economic outlook have taken a toll on the ANC’s popularity. Big ANC losses would risk a shift towards more populist policies ahead of the 2019 national elections, which would further weigh on already poor fundamentals.
South Africa is holding local elections today. Over 200 parties are contesting 8 metropolitan areas, 205 local councils, and 44 municipalities. Results are determined by a mixed system, with some local councilors elected directly and some appointed by their parties. Final results won’t be announced until August 7.
The African National Congress (ANC) was the top party in the last local elections in 2011, winning 7 metropolitan areas and 198 local councils. The main opposition party Democratic Alliance (DA) won 1 metropolitan area and 18 councils in 2011. The newest opposition party Economic Freedom Fighters (EFF) did not contest that 2011 vote, since it was only formed in 2013 by breakaway ANC youth leader Julius Malema.
The most recent Ipsos polls show the ANC with 54% support nationwide, down from 62% it won in the 2014 national elections. That was down from 66% in 2009, and continues a steady erosion of ANC support. If the trend is sustained, the ANC would win less than 60% in 2019, something that has never happened since the end of apartheid. The DA won 22% of the national vote in 2014, while the EFF won 6%.
Looking at the local races themselves, polls suggest the ANC could lose control of the metropolitan areas of Pretoria, Johannesburg, and Port Elizabeth. The DA currently controls one, Cape Town. Both the DA and EFF have said they are open to coalitions with each other but not with the ANC. Today’s elections should show continued gains by these two opposition parties.
If the ANC loses big, then it may swing towards more populist policies in an effort to boost its popularity and stop defections to the EFF. We think any upward pressure on the budget deficits would speed up downgrades from the ratings agencies. Both gross government debt and total external debt rose to more than 50% of GDP this year, and both are seen climbing further in 2017 as the deficits pile up.
The economy is stagnant. GDP growth in 2016 is forecast by the IMF at 0.1%, and seen accelerating modestly to 1% in 2017. GDP contracted -0.2% y/y (-1.2% q/q annualized) in Q1. Unemployment was 26.6% in Q2, near the record high of 26.7% in Q1. The ANC may push for more fiscal stimulus ahead of the 2019 elections in a bid to improve its popularity.
Price pressures are still increasing, with CPI rising 6.3% y/y in June. This is the highest rate since March still above the 3-6% target range. Yet due to the stagnating economy, the central bank has kept rates steady for two straight meetings (May and July) after its last 25 bp hike back in March took the policy rate to the current 7.0%. The central bank next meets September 22, and probably does not want to hike again. A lot can happen between now and then, but we think the ultimate deciding factor then will be the rand.
Fiscal policy has remained surprisingly prudent. Several rounds of fiscal tightening have been seen, but the Finance Ministry fiasco suggests President Zuma is tiring of austerity. Again, a big ANC loss would likely see it swing towards more populist parties, which would boost expenditures and widen the budget deficit.
The external accounts bear watching. The current account gap stood at -5% of GDP in Q1 and has risen three straight quarters, so we see risks of wider than expected deficits ahead. Foreign reserves remained steady, around $46 bln in June. They cover 4 months of import and are only about 1.2 times larger than short-term external debt. This makes South Africa particularly vulnerable to swings in market sentiment and hot money flows.
The rand has outperformed this year after a poor 2015. In 2015, ZAR lost -25% vs. USD. This put it amongst the worst performers ARS (-35%), BRL (-33%), COP (-25%), and RUB (-20%). So far this year, ZAR is up 10.5% YTD and is lagging only the best performer BRL (+21%) and ahead of the next best performers RUB (+10%), CLP (+7.5%), and SGD (+5.7%). Our EM FX model shows the rand to have VERY WEAK fundamentals, so this year’s outperformance doesn’t seem warranted.
USD/ZAR appears to have made a near-term bottom near 13.78 on Monday. Retracement objectives from the post-Brexit drop come in near 14.50 (38%), 14.73 (50%), and 14.95 (62%).
South African equities have generally outperformed. Last year, MSCI South Africa was -2% while MSCI EM was -17%. So far in 2016, MSCI South Africa is +9% YTD and compares to +8.5% YTD for MSCI EM. This outperformance should ebb a bit, as our EM Equity model has South Africa at a VERY UNDERWEIGHT position.
South African bonds have outperformed this year. The yield on 10-year local currency government bonds is about -109 bp YTD. This is behind only Brazil (-450 bp), Indonesia (-182 bp) and Peru (-158 bp). With inflation likely to continue rising and the central bank still in hawkish mode, we think South African bonds will start underperforming.
Our own sovereign ratings model gives South Africa an implied rating of BB/Ba2/BB. This is well below actual ratings of BBB-/Baa2/BBB- and suggests significant downgrade risks. Moody’s Baa2 rating is most out of line, but our base case is that the nation will be downgraded to sub-investment grade by at least one of the agencies by year-end.