The South African (SA) 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 showed its mettle. Can we do this again?
During his 2020 Budget Speech on 26 February, Minister of Finance Tito Mboweni again likened the country’s 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 Mboweni presented a brave and credible plan to reduce our government expenses without increasing taxes further, the arrival and spread of the COVID-19 pandemic to South African shores has dramatically changed the landscape – and the outlook.
During these challenging and unprecedented times, 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, and a realistic assessment of the local situation.
The COVID-19 virus
Coming completely out of left field, the global outbreak of the Coronavirus 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 have quickly changed into a demand shock as many countries (including South Africa) go into a shutdown to prevent the virus from spreading uncontrollably. This sudden halt in activity should cause most economies to go into a severe short-term recession by the second quarter of 2020. Hopefully activity will pick up again once the virus is either contained or a vaccine has been found. At this point it is too early to predict a timeline for either.
At the earliest, economic activity should rebound quite strongly from the third quarter onwards, but many countries would end the year with negative growth rates. This view, although subject to timing risks and changes, is based on the expectation of some sort of v-shaped recovery, as seen in previous epidemics. This is our ‘base’ case assumption.
What seems assured is that strong fiscal as well as monetary stimulus measures should support global economies in the latter part of 2020, going into 2021. Most developed countries have already responded by cutting interest rates aggressively and some developing countries have followed suit. Quantitative easing has also been re-opened by most developed countries. Measures to restore liquidity levels in financial markets have been introduced to prevent a liquidity crisis turning into a solvency crisis.
We are also seeing significant fiscal packages being announced by most countries to combat the severe hit on economic activity. The United States has just signed off on a US$2 trillion package, which represents 10% of their gross domestic product (GDP). The United Kingdom, European Union and other countries have also announced substantial packages, mainly aimed at supporting the healthcare industry, low-income workers, sick workers and small- and medium-sized businesses. Thus far, global fiscal easing amounts to about 3.3% of GDP.
Should these measures fail to work we can expect to see a much more structural decline in economic activity that lasts considerably longer. This would be our ‘stress’ case scenario.
US financial conditions have tightened the COVID-19 outbreak and more should be monitered
We are continuously monitoring the situation to access whether we are still on the ‘base’ case route or not.
The South African situation
The global backdrop as described above, as well as the lockdown the country went into at midnight on 26 March 2020, will have a devastating impact on the South African economy. The current crisis is made all the more challenging given that the country entered this period on a weak footing from a fiscal deficit perspective. Like the rest of the world, South Africa is 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 2008 global financial crisis. Then, South Africa declined by -1.5%, this time around it could be double that.
The country faces down these economic pressures with the fiscal war chest already relatively empty, so 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 the central bank to cut rates by a further 100 to 125 points this year. Fortunately, inflation is expected to remain muted, thus allowing the SARB to respond. The Central Bank has also announced some measures to ease liquidity constraints in the bond market.
It remains to be seen if the COVID-19 crisis strengthens 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 see a meaningful recovery.
Market volatility spikes amidst the COVID-19 outbreak
How are we positioned during this volatile period?
As can be seen from the chart below, market volatility has picked up to global financial crisis 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 greater economic certainty returns.
During such times of stress and uncertainty, it is critically important not to panic and to plan for the longer term. Diversification is not only key, it is absolutely essential.
Within our balanced portfolio we are underweight 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 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 the March lockdown has on dividend payouts.
Returning to the finance minister’s aloe ferox, while it is true that this plant actually prefers less water, it nonetheless requires some water (sustenance) and attention (action). So too does the South African economy. But first, the country needs to come together to deal with a health crisis that it has never experienced before. Like previous recessions, pandemics and bear markets, we will get through this one, but it requires us all to pull together and support government initiatives around the world to fight the spread of the COVID-19 virus.
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