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The jump in global economic growth in 2021 into 2022 and to date, and the availability of cheap capital, have been a huge boost for commodity prices and corporate profits. As the outlook for growth dims and the US Federal Reserve unwinds dollar liquidity, expect commodity prices and earnings growth to decline.
The most benign expectation is that the profit headwind that so supported tax revenues in the fiscal years ending March 2021 and March 2022 is waning. This is already evident in analysts’ expectations, which reflect a decline in earnings growth across major sectors.
The most realistic expectation is that SA will have to deal with a negative terms-of-trade shock in the coming 12 to 18 months — that is if policymakers fail to engineer a “soft landing” in the global economy and we get a marked recession instead. While desirable, “soft landings” are often not achievable at a country level, let alone a global scale. Individual country economies are incredibly complex and policy co-ordination near impossible at the best of times.
It is doubtful that authorities could engineer anything resembling a soft landing with the US tightening aggressively, China in a property market bind, and Europe a political-economic mess. This makes a negative terms-of-trade shock likely in my opinion.
Dimmed global growth
SA’s export commodity basket prices rose from Covid-19-crisis lows and remained high throughout 2021. Prices spiked on commencement of the war in Ukraine in February. Export commodity prices have since declined and are now 23% below their March peak. In the meantime oil, the key import commodity for SA, has softened. The price of the near contract for Brent oil has fallen 13% from the $128 a barrel reached in the immediate aftermath of Russia’s invasion of Ukraine. The terms-of-trade impact of these price moves has been negative.
The pressure on SA’s export commodity basket should continue on a dimming outlook for global growth in the short term, and the withdrawal of dollar liquidity, and the Fed continues to tighten policy in the medium term. How oil responds is more difficult to discern. Under normal circumstances, oil prices would be subject to the same gravity as the rest of the commodity complex. However, that market can defy fundamentals when geopolitics are in play.
This is such a time. Hopefully Opec agrees to increase output soon and/or prices start to reflect dampening global demand. A further surge in prices does seem unlikely, but an oil price that is unresponsive to changes in demand would make things worse.
The profit headwind that so supported tax revenues in the fiscal years ending March 2021 and March 2022 is waning.
The impact of these commodity price adjustments and their negative feedback into monetary policy, growth, company profits and tax revenue could be the defining feature of SA’s economic story in the months ahead. Fiscal revenues surprised to the higher side by a quarter of a trillion rand over the past two fiscal years.
This was largely because of the super profits booked by commodity and associated companies, helped along by liquidity-enhanced financial sector profits. Aggregate corporate earnings growth over the last two years has been the highest it’s been in decades, and the fiscus benefited. The coming period will be characterised by a reversal of these trends and tougher fiscal choices.
The National Treasury has looked better than competent in the past two years. Its team has been able to show better-than-expected deficit outcomes for two years running, in the most difficult economic environments. SA’s credit-rating outlook was recently revised to stable from negative by S&P, one of the most hawkish credit-rating agencies looking at SA on the street.
Even though the Treasury’s expenditure estimates lack credibility, its forecasts for tax revenue are conservative. That, together with the much higher inflation, could keep fiscal outcomes on an even keel this year. However, the picture becomes muddier as we move beyond the immediate future. The tide might be turning, and the risks are building.
• Lijane works in fixed income sales and strategy at Absa Corporate & Investment Banking.
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Published by Arena Holdings and distributed with the Financial Mail on the last Thursday of every month except December and January.