The South African economy has faced many significant challenges in the past. Now 2020 offers a raft of headwinds in need of urgent attention. Back in 1992, when the economy contracted for three consecutive years, South Africa (SA) showed its mettle. Can we do this again?
During his 2020 Budget Speech on 26 February, Minister of Finance Tito Mboweni again likened the South African economy to the hardy, handy and healing aloe ferox plant, reminding South Africans that “the aloe ferox survives and thrives when times are tough. It wins even when it seems the odds are against it.”
Although the finance minister presented a brave and credible plan to reduce our government expenses without increasing taxes further, the arrival and spread of the Coronavirus (COVID-19) pandemic has changed the landscape dramatically.
To forecast South Africa’s growth prospects with any degree of accuracy requires a pragmatic understanding of the global backdrop impacting the country and its economy.
The COVID-19 virus
Coming completely from left field, the outbreak of COVID-19 will have a devastating impact on global growth, especially in the first half of 2020. Initial thoughts of a supply shock caused by the Chinese shutdown has quickly changed into a demand shock as many countries (including South Africa) go into a shutdown themselves to prevent the virus from spreading uncontrollably.
Hopefully activity should pick up again once the virus is either contained or a vaccine has been found. At this point it is too early to predict when this will be. Economic activity should rebound quite strongly from the third quarter (earliest) onwards, but many countries would end the year with negative growth rates. Although risks on timing is thus quite high, we do expect some sort of v-shaped recovery in global growth as experienced in previous epidemics. This is our ‘base’ case assumption.
Strong fiscal as well as monetary stimulus measures should support the economies in the latter part of 2020 and going into 2021. Most developed countries have responded by cutting interest rates aggressively and some developing countries have followed suit. Quantitative Easing (QE) has also been re-opened by most developed countries. Measures to restore liquidity levels in financial markets have also been introduced to prevent a liquidity crisis turning into a solvency crisis. Should these measures fail to work we would see a much more structural decline in economic activity that lasts a lot longer. This would be our ‘stress’ case scenario.
We are continuously monitoring the situation to access whether we are still on the ‘base’ case route or not. We are also seeing historically huge fiscal packages being announced by most countries to combat the severe hit on economic activity. The United States (US) has just signed off on a $2 trillion package, which represents 10% of their gross domestic product (GDP). The United Kingdom (UK), European Union (EU) and other countries have also announced big packages, mainly aimed at support for the healthcare industry, low-income workers, sick workers and small and medium-sized enterprises (SMEs). Thus far global fiscal easing amounts to about 3.3% of GDP.
United States financial conditions have tightened since the COVID-19 outbreak and needs to be monitored.
US Financial Conditions Index
What about South Africa?
The global backdrop as described above as well as the lockdown we are currently experiencing will have a devastating impact on our economy. We have also entered this period on a weak footing from a fiscal deficit perspective. Like the rest of the world, we are expecting a very sharp contraction of economic activity in the first half of the year, followed by a recovery in the second half of 2020 and into 2021.
Although it is very difficult to put a specific number on the contraction, it should be quite a bit worse than the recession we experienced during the 2009 Global Financial Crisis (GFC). Then South Africa declined by -1.5%, this time around it could be double that. The fiscal war chest is relatively empty, and monetary stimulus should do most of the heavy lifting. The South African Reserve Bank (SARB) has already cut interest rates by 100 basis points and we expect them to cut rates by a further 100 to 125 points. Fortunately, inflation is expected to remain muted thus allowing the Central Bank to respond. The Central Bank has also announced some measures to ease liquidity constraints in the bond market.
Perhaps this crisis would strengthen the political will within government to reduce expenditure and implement fiscal reforms in addition to the governance reforms that have been announced. If these can be coupled with economic growth enhancing reforms that lift real GDP towards 2.5%, we could begin to recover meaningfully.
How are we positioned over this volatile period?
As can be seen from the chart below, market volatility has picked up to GFC levels since the spread of the COVID-19 virus. One can expect this to continue until either contagion numbers start to fall, a vaccine is found, or more economic certainty returns.
CBOE Volatility Index (VIX)
In times of stress it is important not to panic and to plan for the longer term. Diversification is key. Within our balanced portfolio we are underweight in SA equities. We are slowly starting to reduce the underweight in weakness. Within SA equities we are defensively positioned. We are overweight in SA bonds as current real rates are very attractive.
We are overweight on offshore assets and would only look to reduce once we get more comfort that the pandemic is tapering off. While we are neutral on SA property stocks, we recognise the very attractive valuation levels but need more clarity on the impact that the shutdown might have on dividend payouts.
While it is true that the finance minister’s aloe ferox actually prefers less water, it nonetheless requires some water (sustenance) and attention (action). So too does the South African economy.