20th January 2020 – We have cut our GDP forecasts sharply. Persistently weak business sentiment and ongoing bouts of load shedding are constraining South Africa’s growth prospects, while the drought seems likely to have a significant negative effect this year as well. We now forecast real GDP growth of just 0.3% for 2019, 0.9% this year and 1.2% in 2021.
Inflation has probably bottomed out but is likely to remain well contained within the 3-6% target. Despite likely upside pressures from administered prices (and maybe food, as drought takes hold), demand weakness continues to nullify pricing power for market-determined prices. We believe CPI inflation is likely to print at an average of 4.1% in 2019, rising to 4.4% in 2020.
Fiscal policy is a huge problem for South Africa, with stuttering tax collections, and an apparent unwillingness of the government to cut the public sector payroll. The 2020 Budget to be presented on 26 February is key. We think the government will once again rely primarily on taxes to try to narrow the deficit, and in particular, we are making the bold call of a 1pp rise in the VAT rate.
Calling the SARB’s decisions with a divided MPC is challenging given low inflation and growth, but big looming risks. On 16 January, the MPC cut the repo rate by 25bp. We expect rates to remain on hold for the foreseeable future, but see the risks skewed somewhat in favour of more easing rather than hikes, particularly as we believe inflation could continue to be lower than the SARB’s expectations.
The ZAR is likely to weaken back up to around 15 per USD. Both our valuation models suggest that the ZAR is overvalued, which together with the prospect of significant capital outflows during the first half of the year, explains our bearish view on the ZAR during Q1.
Eskom continues to be a major source of fiscal and general macroeconomic risk. The unbundling programme laid out in the discussion paper last year on its own cannot fix the electricity sector’s challenges and the pushback against reforms at Eskom is intense. Load shedding is likely to continue and Eskom may need even more bailout money than that already allocated by the government.
Structural reforms accelerated a little towards the end of last year, although progress overall has been slow, in part due to political contestation. In 2020, the energy sector reform is by far the most important structural reform to get right, but the auction of broadband spectrum is also key.
South Africa’s political functionality continues to be hobbled by the factional battle within the ANC. It remains to be seen if President Ramaphosa’s efforts to restore constitutional governance and roll back ‘state capture’ will pay dividends sufficiently quickly. The National General Council at mid-year is a big risk for President Ramaphosa’s reform drive.
Further credit rating downgrades seem likely. In particular, we think Moody’s is more likely than not to act on its Negative Outlook and downgrade South Africa to sub-IG on 27 March.
