After a tense period in which the three major global ratings agencies assessed the local economy, government policy and more, South Africans can head into the festive season feeling a bit more at ease, knowing that the country has maintained its investment grade rating.
The third major ratings agency, S&P Global Ratings, left the foreign currency rating unchanged at BBB- with a negative outlook. S&P cut South Africa’s local currency rating by a notch to BBB, bringing the local and foreign currency ratings closer together.
As was the case with Moody’s and Fitch, S&P expects economic growth to improve from very low levels over the next three years and is comfortable with government’s fiscal management. S&P also noted that South Africa’s institutions were strong (especially the judiciary) and that the South African Reserve Bank’s monetary policy is independent and credible.
However, as with the other two agencies, it is concerned that crucial structural reforms will be hampered by political infighting.
These reforms are needed to raise South Africa’s economic growth rate on a sustained basis and secure our investment grade rating. Fortunately, there have been a number of positive developments recently (in labour relations, energy and state-owned enterprises) and no debilitating strikes or load-shedding. But these need to be cemented and further progress is needed, especially in streamlining state-owned enterprises and finalising the mining resources act and charter.
Ratings risk remains
As it stands now, both Fitch and S&P rate South Africa only one notch above sub-investment (or junk) status. Both have a negative outlook, suggesting that the next ratings move is down.
We can therefore experience a repeat of the recent stressful period in 2017. Faster growth is needed to avoid a downgrade in future as economic growth ultimately ensures that debt levels are sustainable.
Credit ratings tend to tell the market what it already knows. Looking to 2017, the bigger risk to our bond market remains US interest rate developments, rather than credit ratings. If the US Federal Reserve hikes interest rates aggressively (by more than is currently priced in) the result is likely to be a much stronger dollar, which could result in a weaker rand, putting upward pressure on local inflation and interest rates. This would be bad for bonds and the local economic growth outlook, which has recently improved.
The US Federal Reserve (Fed) is almost certain to hike their funds rate later this month. Inflation has been rising gradually, but remains below the Fed’s 2% target. Annual US personal consumption inflation (the Fed’s preferred measure of price pressures) increased to 1.4% in October, while it was only 0.3% a year ago. Excluding the impact of volatile food and energy prices, inflation was 1.7%.
Meanwhile, unemployment fell to 4.6% in November, almost the lowest level in a decade. However, despite unemployment falling and employment growth of around 1.6% per year, wages have not responded much to the tighter labour market, growing by 2.5%.
Therefore, while the Fed is expected to increase interest rates, it is likely to do so gradually.
Deflation scare behind us
The big decline in the oil price in 2014 and 2015 contributed to the past year’s global deflation scare. In turn, this added to interest rates staying flat in the US and falling to below zero in Europe and Japan.
The oil price has now rebounded again thanks to a larger-than-expected agreed production cut by the Organisation of Petroleum Exporting Countries (OPEC) of 1.2 million barrels per day (with Saudi Arabia responsible for around half of the cut). However, the challenge for OPEC has traditionally been getting members to stick to their quotas, given the incentive to cheap (i.e. produce more at the higher price). This incentive is even greater now, given that North American shale producers will also benefit from the higher price.
Even at Friday’s closing price of $54 per barrel, the average oil price of 2016 is still lower than in 2015 ($43 vs $52). The SA Reserve Bank assumed an average oil price of $53 per barrel in 2017, so the latest move does not dramatically alter the local inflation or interest rate outlook.
The steady rand, which is now slightly stronger against the US dollar than a year ago (despite global upheaval), helps to offset the impact of the higher oil price. There will be a 20 cents per litre petrol price cut this week. Meanwhile, credit growth remains weak, especially household borrowing, confirming that there is little demand pressure on local prices. Loans and advances only grew by 5.8% year-on-year in October, down from 8.5% growth at the start of the year. Mortgage growth is only 5.4%
Oil helped the trade balance
The lower oil price in 2016 has been a factor behind the improving trade balance. South Africa posted a R4.4 billion trade deficit in October, but this was smaller than expected. October is typically a large deficit month as imports surge ahead of the festive season.
The trade deficit for the first ten months of the year was only R14 billion, compared to R60 billion over the same period last year. Over the same comparative period, the value of oil imports fell by 17%. Therefore, a sustained rise in oil prices threatens this improvement.
Global growth positive
The iron ore price, in contrast, rose to $80 per tonne last week, the highest level in two years. Iron ore is one of our main export items, along with coal, gold and platinum. The price recovery in iron ore is therefore most welcome. Coal prices have also increased strongly since the start of the year. However, gold and platinum prices have been under pressure.
Other local economic data remains mixed, but with signs of improvement. New vehicle sales rose to 47 271 units in November. While this represents a decline of around 5 000 units compared to a year ago, it also shows an increase of similar size compared to July, which appears to have been the bottom of the cycle. The Barclays manufacturing purchasing manager’s index (PMI) increased to 48.3 points in November, but remained below the 50-neutral level for the fourth consecutive month.
The local manufacturing sector is clearly still under pressure. However, the forward-looking components have improved. Sales have risen relative to inventories, suggesting firms will have to increase production, while the measure of expected business conditions in six months’ time has also increased above the 50-point cut-off level. An improvement in global manufacturing conditions is also positive. The JPMorgan Global Manufacturing PMI rose to the highest level in more than two years.
While South Africa is not as well integrated into global value chains as it could be, faster global growth bodes well as we head into 2017.
|Dave Mohr||Izak Odendaal|
|Chief Investment Strategist,
Old Mutual Multi-Managers
Old Mutual Multi-Managers