SA Inc: More questions than answers

Nomura analyst Peter Attard Montalto reflects on SA’s economic challenges, political woes and the Nenegate saga.

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We undertook several days of meetings across a wide range of actors in the policy and political space and asked three questions:

1. How stable will the budget be going forwards?

2. How real is the positive sentiment emanating from business on its interactions with government?

3. Who will win the battle between the tenderpreneurs and the rest of the ANC?

Our simple conclusions are:

1. A range of factors like unrecognised procurement savings and conservative revenue multipliers may hold the budget in check though better communication around the readiness to undertake intra-year changes and exact consolidation targets (ie, net debt in rand terms being stable) would be welcome;

2. The sentiment is real but is focused on short-term growth; business hopes for a bounce back to maybe 2 percent growth but there is no real optimism on what matters – measures to boost long-run potential growth above 2.5-3 percent; and

3. It is impossible to judge – we think Pravin Gordhan may well win the public “legal/constitutional/institutional” battle, but in the end Jacob Zuma may win the private political battle. However, it is impossible to forecast which battle will ultimately outweigh the other through until the 2017 elective conference. The complexity of the issue is beyond the scope of this trip note however, and we intend to examine it fully in a major report on South Africa’s political future.

Read: No sense of urgency in Zuma's SONA

Trips to South Africa are always to dig into specifics, but this one rapidly morphed from the usual examination of budget footnotes and annexes of the Budget Review, into the economic impacts of the Nene episode (and whether we should skew our GDP forecast one way or the other). It finally turned to something far more difficult to grasp yet important – the battle between different factions of the ANC, which is turning out to be existential for both sides. We present some of our findings but the politics are so complicated, and important, that we will devote a separate forthcoming report to them.

Budget

We praised the fiscal policy of the budget at the time of its launch for being conservative, broadly hanging together without extreme risks in the coming fiscal year, though we were less happy with the lack of microeconomic structural reforms. Analysing the budget in the hours after the Budget Speech is always very difficult, but it was not helped by a lack of clarity in the speech on what consolidation actual meant to the National Treasury.

It seems that stability in net debt in rand terms was the key consolidation metric, which led to the deficit profile that was published. This appears to be the case going forwards, with the expenditure ceiling adjusting in tandem to this aim. We see this as a credible metric to use but think it slightly misses the point given the market and ratings agency focus on gross debt, and as such could be described as a “moderately” difficult target rather than a harder target of gross debt stability.

Procurement savings were also not pencilled into the budget and, while the supposed stock stands at R25-32 billion depending on which measure is used, inappropriate procurement savings can lead to undershooting on non-interest expenditure offsetting risks to revenue and interest payments. We heard many different views on the payroll freeze from the Treasury – some shared our scepticism that this is real or any different from similar announcements in many past budgets. But that said, it was pointed out that the use of the government payroll system to centrally eliminate posts can be more effective. We have some doubts that this is true at a municipal level although it can work much better at a central government level.

The chances of larger-than-usual intra-year (ie, at MTBPS) budget changes seem to be much greater now in order to ensure stability in the consolidation profile, but this raises the questions of why such steps aren't being taken now and what political space there is to keep turning the screw more often.

Broadly though, the budget still looks very good and probably more stable going forward than it did in our initial analysis of the post-budget speech. There seems to be a broad view that there is no particular growth negativity from the budget cuts to expenditure (because cuts are mainly to unproductive and wasteful programmes) and the revenue measures are broad based and individually small in nature. However, continual squeezing of true productive expenditure on account of revenue and interest costs risks and current expenditure means the room in the budget to do “interesting” supportive things such as infrastructure expenditure remains limited.

Ratings

We were slightly concerned by attitudes towards sub-investment grade. This was typified by a statement on Bloomberg while we were in South Africa by the Finance Minister that the authorities will give avoiding junk status their “best shot”. We sense no all-out attempt to avoid a downgrade, and the views of politicians and policymakers remain too focused on fiscal matters rather than (long-term/potential) growth. Additionally, we continued to encounter objections in policymaking circles that the ratings agencies were unfair, biased, “neo-colonialist”, moving the goal posts, failing to understand South Africa etc. There is a widespread view that South Africa would be better off not overstretching itself to avoid sub-investment grade – that to do so would somehow compromise sovereignty. Investors should find these views troubling, and they reinforce our view that South Africa will end up in sub-investment grade.

On this point, there is the complaint that investors and ratings agencies don't give South Africa enough time. There is a lack of urgency still or understanding of the cost of being slow or that other countries can achieve things faster. Our view that investors and ratings agencies would give time if they thought the intention and bias to action were clear (which is not the case in many areas), and many market participants quite simply judged the South African authorities had had enough time already to prove their mettle.

Read: Investing in SA's economic gloom

As mentioned, there appeared to be a lack of understanding of what really matters to the agencies, but linked to this a lack of understanding that something major needs to be generated. The way we explained it in meetings (using slightly more colourful language) was that we need to see some group being “annoyed” at policy changes to show real progress was being made and political capital was having to be spent. The fact this isn't widely understood means that South Africa’s policy-making is still in the same “balancing of forces” mode.

Below, we look at some of the issues around the reforms that have been mentioned so far. We feel too much of the focus is on relatively easy short-term measures rather than longer-term measures that the ratings agencies are really looking for.

A narrative that we are hearing more and more (but don't believe is held by many) is that there are groups in South Africa that want a downgrade as a means of securing cheaper access to private sector (foreign-owned or white-owned) assets. Such a view is problematic as it stretches the idea that tenderpreneurs are happy to have more secure access to a smaller “pie” while also increasing their cost of funding and wider business opportunities, but makes some sense given the widespread view that life after a downgrade would be manageable politically.

Reform agenda/business-government interactions

We were interested to dig down into the optimism that we had sensed on the part of the business community in the reappointment of Pravin Gordhan. How much was hope vs expectations? How much was short vs long term.

We found actually a lot is real. On the surface, there is a view that a few simple things can get South Africa out of its current post-“Nene-gate” rut. Sentiment in this sense can be engineered by government action on parastatals, by the MPRDA amendments, by fiscal policy stability and by engagement between government and business. However, dig a little deeper and this optimism seems “constrained” to put it mildly. In growth terms, what people really see is the economy growing from stall speed or “feels like recession” of 0-1 percent up to 1.5-2 percent and in the short to medium run.

We sensed much less optimism about increasing potential or long-run growth through reforms that result from the dialogue to 4-6 percent from 2.5-3 percent currently. This difference is crucial for the markets and ratings agencies to understand but often is not made in the media or market.

Discussions with policymakers confirmed for us that the National Treasury is now in charge of PR and marshalling interactions between the government and businesses, but it is not clear the wider policy circles – or indeed leadership – are on board with the need to make very tough, politically difficult reforms to education, labour, cadre deployment etc. Hence we still cannot raise long-run potential growth estimates nor remove expectations of downgrades.

We have said it before and it struck us again on this trip: all the right policies are known to the ANC, right at the very top there is an understanding of the need for prudent macro-policies and growth-boosting reforms. The problem comes from a desire to find new policies that haven't been thought of before. They do not exist! They are already on the table. Layers of politics, balancing of alliance partners, capacity constraint, a lack of urgency (even now from some quarters) and distractions and mistakes all hold South Africa back from higher potential growth.

The parastatals are important here. The type of private sector involvement and management changes proposed will be crucial – true or illusory. This is where the current political battles intersect. Business will look for “clean” involvements.

Interestingly, we found that the business community is becoming increasing dissatisfied with BBBEE. This is something of a surprise – for so long any concerns about its structure or costs were buried and seen as simply the cost of doing business in South Africa. Now, however, the costs from the ownership requirements in structuring BEE deals are being recognised as excessive, and the focus on ownership over true transformation of local communities, junior employers and junior managers is seen to be misdirected.

Politics

At the start of the year we outlined a political risk narrative that was based on the campaigning of Nkosazana Dlamini-Zuma and Cyril Ramaphosa, and the parts of the ANC and Alliance they represent, through to the 2017 elective conference. What has changed since then is the appearance of the so called “state-capture” narrative – with Nene-gate now, in retrospect, appearing at the epicentre of this.

State-capture is the takeover of an institution or a state-owned company for political and economic ends – ie, to serve the tenderpreneurs either as an organ of rent extraction or for overcoming logistical, legal or regulatory hurdles to rent extraction. National Treasury was the most obvious attempted example, where capture would mean that discretionary powers of a minister could be redirected as appropriate to the interests of the tenderpreneurs. The Department of Mineral Resources was an earlier, successful, example.

The state-capture narrative is now much more finely wound into the elective conference narrative – the latter needed for continuity and access to power.

Our trip convinced us that neither side has won and that, as we stated recently, the ANC is broadly in balance. What we are now experiencing is a very differentiated battle. The media presents this as “Zuma vs Gordhan” but that is simply one aspect. In reality, it's the tenderpreneurs vs the rest. This distinction is key because both Jacob Zuma and Pravin Gordhan are dispensable from their current positions in order to secure the success of either side.

As an example of this, all sides now seem to be contemplating succession after President Zuma and how their cause is best served by his exit – both the tenderpreneurs as a route to future electoral success and the rest of the ANC as a route to better policy leadership for the country. MPs appear to be shifting allegiances and becoming more reluctant backers of President Zuma, but ultimately the NEC is the body within the ANC that will decide. For now it looks more certain they will decide for the primacy of the tenderpreneur camp, but as we said above, this does not mean President Zuma will survive. The market needs to consider that “Zumxit”, as we term it, is not necessarily a positive if the status quo continues and it is done in order to facilitate that lack of real change.

It is impossible to forecast the endpoint, in part because the narrative is path-dependent, but also because the tenderpreneurs battle is being forced below the surface, in private and largely out of the media spotlight. Meanwhile, the rest of the ANC is taking the battle into the public domain. One side appears to be prepared to fight “dirty”, the other not but will resort to legal means. We think now that the tenderpreneur side may well win the political, subterranean battle. But we also are more convinced that an ever-increasing deluge of legal cases, market reaction and institutional strength means that this faction may well win the public battle – or what might be termed the legal and institutional battle. What is not certain, then, is which battle is ultimately the more important, and which will mean control of power after the 2017 elective conference.

We intend to elaborate on this much more in our forthcoming report but it is neither obvious nor a done deal that either side will win, particularly before 2017. The electoral conference will be the eventual confirmation of what has happened – of who has won.

In the meantime markets need to be aware of the complexity of the situation, the fact that only half the battle is “visible” and that press statements and news stories may be only partial reflections of what is occurring. This battle is ultimately existential for both sides, hence its importance.

As we have commented recently, there are a number of red lines that Pravin Gordhan is up against: SARS, SAA board reconstitution, appointment of a new (or reappointment of the current) National Treasury Director General, Eskom contracts, nuclear power. We need to check carefully whether new management of institutions and SOEs is simply improving operational efficiency or if procurement and rent extraction is really being addressed. Rent extraction or capture but with greater operational efficiency would not be positive for markets or ratings agencies. What might be seen as a “win” for one side may not be quite that if rent extraction continues but with a better face.

SARB

Compared with other issues, the SARB appears relatively boring.

The SARB inflation forecast looks set to pivot to an earlier but possibly higher peak, with the stronger rand than January, lower oil prices and the recent upside surprise in the CPI print (and especially food prices). But any shift in the growth or inflation narrative looks unlikely. Risk skews on macro factors remain the same, and the SARB remains concerned (maybe more so) about the second-round impacts of the drought on wages, expectations and core inflation in the long run.

The domestic issues facing the SARB totally outweigh the external narrative. Or, put another way, the greater dovishness from external factors and other central banks is offset by the increased hawkishness on domestic issues.

Going into the trip, our view was that a 25 basis point hike was possible in March but that it was far from clear whether the SARB would choose that or a 50bp hike in May. February CPI inflation will not be known by the time of the March meeting, though the low but robust growth, turns in wage data and expectations research being undertaken all seem to skew things towards a 25bp hike in March by a split vote. We, as ever, will formalise our forecast in a preview publication.

We raised the issue of real rate credibility with the SARB. We think it would struggle to keep markets onside if a currently minority view becomes more widespread in markets that the Bank wants not only an at-the-curve strategy but actually zero real rates in this environment over time. We think the SARB is partly aware of this issue and its hawkishness and “fear” around inflation will eventually overcome such concerns, but some shift in communications may be necessary. Overall, we continue to sense a strong stability in the MPC hawk-dove spectrum, in the median of the MPC and how the MPC (and SARB staff) views the world, interprets events and translates that into monetary policy. As such, we think the MPC maintains its view of the need for a hiking cycle because of the “fear” cycle of monetary policy, would not cut because of currency weakness but because of second-round effects, and wants a steady but determined cycle into tight territory. Our forecast of rates being 8.50 percent at the end of the first quarter of 2017 remains unchanged therefore.

* Peter Attard Montalto is an emerging market analyst with Nomura.

** The views expressed here do not necessarily reflect those of Independent Media

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