South African Politics Are the Key Driver

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South Africa vector map

The South African Reserve Bank meets and is expected to keep rates steady.  Political developments are likely to be the main driver as the National Executive Committee of the ANC holds a meeting this week. POLITICAL OUTLOOK

The National Executive Committee (NEC) of the ruling African National Congress (ANC) will hold an extraordinary meeting May 26-28.  The committee is planning to discuss the planned no confidence motion that has been filed by the opposition parties.  Reports suggest that some members of the committee will also discuss Zuma’s removal, which the markets have taken as making his ouster more likely.

Yet we urge caution since discussing it and doing it are two different matters.  The NEC rejected Zuma’s ouster at a meeting in November.  Since then, things have materially changed after Zuma fired Finance Minister Gordhan in March.  However, it appears that most ANC lawmakers have fallen behind Zuma and are unwilling to risk a serious split in the ANC ahead of the 2019 elections.

With regards to the no confidence motion, no date has been set yet.  This is because the Constitutional Court is still considering whether to agree to an opposition party request for a secret ballot.  A secret vote would be viewed as making Zuma’s ouster more likely due to fears of reprisals in an open vote.  We acknowledge that Zuma is the most vulnerable he’s ever been right now, but our base case is that he will survive this as well.

President Zuma is not fighting to maintain his rule, since his terms end regardless of what happens here.  Term limits dictate that Zuma steps down as ANC leader in December and as president in 2019.  Rather, Zuma is fighting for his post-presidency survival.  He needs to make sure that the next leader won’t go after him and put him in jail, and so Zuma is not taking matters lightly.

Deputy President Ramaphosa represents the reformist wing of the ANC.  He is favored by the markets, while President Zuma favors ex-wife Dlamini-Zuma.  These two are the clear frontrunners now, though a lot can happen between now and December.  Note that the President of South Africa is not directly elected by voters, but is instead chosen by parliamentary vote.

Corruption remains an issue for the country.  South Africa’s score has worsened in the World Bank’s Ease of Doing Business (ranked 74 out of 190, down from 72 last year) as well as in Transparency International’s Corruption Perceptions Index (ranked 64 out of 176, down from 61 last year).  Management of state-owned companies remains in the spotlight with the controversial reappointment of Brian Molefe as CEO of power company Eskom.

ECONOMIC OUTLOOK

The economy is still sluggish.  GDP growth is forecast by the IMF to accelerate modestly to 0.8% in 2017 and 1.6% in 2018 from 0.3% in 2016.  GDP rose 0.7% y/y in Q4, while monthly data so far show in Q1 suggest some deceleration in activity.   Unemployment remains high at 26.5% in Q4, down from the 27.1% peak in Q4 but still very elevated.

Price pressures are falling, with CPI decelerating to 6.1% y/y in March from 6.3% in February.  April data will be released tomorrow, with inflation expected at 5.6% y/y.  If so, this would be the lowest rate since December 2015 and back within the 3-6% target range.

The SARB meets Thursday and could tilt its statement a bit more dovish to set the table for a potential rate cut in H2.  After its last meeting March 30, the bank signaled that the tightening cycle was over.  Indeed, one MPC member voted for a 25 bp cut then.  However, we think it’s too early to consider a rate cut.  Governor Kganyago noted earlier this month that the end of the tightening cycle doesn’t automatically translate into an imminent easing cycle.

Fiscal policy has remained prudent.  Former Finance Ministers Nene and Gordhan both enacted several rounds of fiscal tightening to limit the deterioration in the budgetary outlook.  The budget deficit was -4.1% of GDP in FY16/17.  According to Bloomberg’s survey, the budget deficit is seen narrowing to -3.2% in FY2017/18 and -3.0% in FY2018/19.  With Gordhan’s ouster, these forecasts are now subject to upside risks.

The external accounts bear watching.  Low commodity prices have hurt exports, but low energy prices and the sluggish economy have helped reduce imports.  The current account deficit was about -1.7% of GDP in 2016, and is expected by the OECD to widen to -4.2% in 2017 and -4.3% in 2018.

Foreign reserves have remained steady.  At $47 bln in April, they cover nearly 5 months of imports but are only just about equal to the stock of short-term external debt.  FDI only accounts for a fraction of the current account gap, and so this makes the country vulnerable to the vagaries of hot money flows.

INVESTMENT OUTLOOK

The rand continues to outperform.  In 2016, ZAR rose 13% vs. USD and was behind only the best performers last year were BRL (+22%) and RUB (+20%).  So far in 2017, ZAR is up 5% YTD and is closer to the middle of the EM pack.  Our EM FX model shows the rand to have VERY WEAK fundamentals, so this year’s outperformance is not warranted.

USD/ZAR has traded in a narrow 13-14 range since the end of Q1.  After breaking below 12.50 briefly in March, the news of Gordhan’s sacking saw the pair spike quickly to trade near 14 in early April.  The last major retracement objective from the March-April rise comes in near 12.94 (62%), and a break below would suggest a test of the March 27 low near 12.3125.

South African equities continue to underperform.  In 2016, MSCI South Africa was up 1% vs. 7% for MSCI EM.  So far this year, MSCI South Africa is up 10% YTD and compares to 17% YTD for MSCI EM.  This slight outperformance should intensify, as our EM Equity model has South Africa at a VERY UNDERWEIGHT position.

South African bonds have outperformed modestly.  The yield on 10-year local currency government bonds is -36 bp YTD.  This is behind the best performers Argentina (-190 bp), Indonesia (-94 bp), Russia (-87 bp), Colombia (-80 bp), Turkey (-65 bp), and Peru (-61 bp).  With inflation likely to continue falling and the central bank perhaps tilting more dovish, we think South African bonds will continue outperforming.

Our own sovereign ratings model show South Africa’s implied rating at BB/Ba2/BB.  As such, we believe actual ratings of BB+/Baa2/BB+ remain subject to significant downgrade risk.  The loss of investment grade from Moody’s seems likely very soon.  We believe a one notch cut to Baa3 is a done deal.  However, there is a small chance of a two-notch cut to Ba1.  Two notch moves are very unusual, but they have been seen in the past.