What if Cyril loses ... economic collapse?
First published in October 2017. A catastrophic economic blow-out is not inevitable if the deputy president fails to win the December ANC election
Financial markets appear to be anticipating that Cyril Ramaphosa will win at the ANC’s December elective conference, as are many consumers and business people. This suggests that SA assets and confidence could take it extremely badly should he lose.
But just how bad is the fallout likely to be for the rand, equities and government bonds? And what about the effects on the real economy? Would all the country’s credit ratings likely be junked, causing a capital outflow shock and plunging the economy into a deep recession?
Surprisingly, the forecasts of some of SA’s leading economists as to what might happen if Ramaphosa loses are not as dire as one might expect. Certainly, domestic investment and confidence will be deeply shaken, but the most important variable will be the state of the global economy at the time.
The rand has remained relatively stable throughout 2017 and bond yields haven’t risen by much despite the breakdown in governance and the loss of SA’s investment-grade rating. This is because of the flood of money entering emerging markets in search of yield.
SA will be okay as long as global growth, Eskom and risk appetite hold up
This suggests that if the pace of global monetary policy normalisation remains sedate, allowing risk appetite to continue to favour emerging markets, and global demand continues to strengthen modestly next year, as most expect, then SA could make it through in reasonable shape even if Ramaphosa loses.
"As long as the international situation remains stable, it’s difficult to see a calamitous situation developing for SA," says Nazmeera Moola, Investec Asset Management’s co-head of fixed income.
The economics are straightforward: as long as the rand remains moderately well supported through capital inflows, domestic inflation will remain contained and the Reserve Bank will not be forced to hike rates excessively, killing growth.
Of course, domestic demand will be weaker, but as long as government doesn’t tack left towards more populist policies in the run-up to the 2019 general election, consumer spending and fixed investment shouldn’t contract outright.
Weaker domestic demand would also cap import growth, while at the same time a weaker rand should boost exports. So as long as global demand remains firm, exports should perform well relative to imports. This would put a floor under SA’s growth rate.
Investec chief economist Annabel Bishop has modelled various scenarios.
If Ramaphosa loses to victors who are unpalatable to the markets, and the status quo in terms of economic and fiscal management prevails, Bishop expects that SA’s local currency ratings would be junked, confidence and investment would be depressed, and the country would enter a recession.
If Ramaphosa loses, domestic investment and confidence will be deeply shaken, but the most important variable will be the state of the global economy at the time
SA’s 2018 growth rate would be barely positive, but as long as the global environment remained supportive, the rand would average R16.23/U$ in 2018, the 10-year government bond yield 11% and the repo rate 8.25%.
This is a bad outcome, but not a horrific one. However, if in the same scenario the global environment turned against emerging markets and there was a sharp slowdown in global growth, the situation would be dire. Expect SA’s real GDP growth rate to then average -1.5% in 2018, the repo rate to climb to 9%, the rand to R18.80/$, and the 10-year bond yield to hit 12.25%.
But if, as Investec expects, the December conference ends in a stalemate — either through a power-sharing arrangement or the victory of a compromise candidate — and the global environment remains supportive, the fallout could be fairly benign.
In this expected case, to which Investec attaches a 35% probability, government will remain hamstrung, unable to undertake economic or governance reforms. GDP growth will be weak and SA’s public finances and the financial position of state-owned enterprises (SOEs) will keep deteriorating.
But because the global environment will likely remain supportive, SA’s real GDP growth rate will average 1.2% in 2018, the rand will average R13.16/$, the repo rate will remain at 7%, and the 10-year bond yield will average 8.4%.
So, far from experiencing a catastrophic blow-out if Ramaphosa fails to win outright, Investec thinks SA could carry on muddling through in 2018 in much the same way it has these past two years.
This is not to suggest that a growth rate of 1.2% is sustainable in a country with a population growth rate of 1.7%. Most people would become poorer. Job creation would be negligible and fiscal and social tensions would mount.
If low growth and bad governance were sustained for several more years, SA would increasingly battle to pay salaries or social grants and by 2022 it would, according to IMF estimates, need a bailout. But this isn’t going to happen in 2018.
"There is no doubting the destruction to the real economy over time from ratings downgrades and ensuing rand vulnerability and policy and political uncertainty," says Citi economist Gina Schoeman. "[But] it can take some time to show up depending on the global backdrop."
There is no consensus, however, on the extent to which the rand could weaken if Ramaphosa loses.
According to a Rand Merchant Bank (RMB) survey of 320 corporate and institutional clients, most expect the rand to weaken by R1.25 against the dollar if Nkosazana Dlamini-Zuma wins, say, from R13.50/$ to R14.75/$, and to strengthen 96c on a Ramaphosa win from, say, R13.50/$ to close to R12.50/$.
"These are quite extreme predictions," says RMB currency strategist John Cairns. "Maybe these are the type of knee-jerk moves we’d see initially, but then we’d expect the rand to pull back somewhat."
Cairns’s sense is that the market is beginning to anticipate a Ramaphosa victory. This means that a win could already be factored into the current rand price. If so, there would be less of a reaction if he wins and more exaggerated moves if he loses.
But the fact that the ANC conference will take place in mid-December, when liquidity typically dries up, means that the market reaction will be amplified either way.
Bureau for Economic Research senior economist Hugo Pienaar points out that a market-unfriendly outcome in December would raise the possibility of SA’s local currency ratings being junked early in 2018.
Already, the combination of fiscal slippage and increased SOE bailouts is pushing SA towards this outcome. A bad December election would just seal the case for further downgrades.
If so, SA would be automatically ejected from the Citi world government bond index (WGBI). This could have significant financial market effects, especially on the rand and bond yields.
Citi estimates that SA would likely experience an R80bn outflow on its exit from the WGBI, though the final figure could be as high as R130bn. This, it finds, would lead to a 12%-15% dollar/rand depreciation and 1%-1.2% increase in consumer inflation over the ensuing 12 months, assuming a favourable global backdrop.
"At first glance one could argue that a WGBI exit would be very bad for the rand and bonds, but it depends to what extent yield-chasing foreigners see any short-term spike in yields as a buying opportunity, thus limiting the market correction," Pienaar says.
Which way this goes will, to a large degree, depend on the market pricing of interest rate moves in developed countries, especially the US, at that stage, he says.
The impact on the equity market is also not entirely clear. A weaker currency would boost heavyweight rand-hedge stocks, but the adverse growth implications of further sovereign credit rating downgrades would be very bad for locally focused retailers, banks and smaller industrial players, says Pienaar.
Moola believes that the future of the economy is binary. She points out that though SA’s growth consensus for next year is around 1.1%, this is just a weighted average of two opposing potential scenarios.
Growth could either be zero if the Zuma camp isn’t dislodged in December, or it could bounce up to 2.5% if the Zuma camp is dislodged, unleashing a spurt of consumer spending and private fixed investment.
"There is so much repressed demand from corporates and households that a market-and economic-friendly ANC electoral conference outcome would likely lead to a solid confidence boost in the new year," she says.
So everything hinges on the outcome of the conference and the state of the global environment.
But there is also a wild card — Eskom.
Given government’s R350bn exposure to the utility, all bets are off if Eskom experiences solvency issues next year.
It could pull SA over the fiscal cliff all on its own.
In short, South Africans should hope for the best but prepare for the worst.
A middle-of-the-road outcome, which pleases no-one but avoids a destabilising market shock, is probably the most likely scenario at this point.