Time to hit the road with Ramaphosa
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Jacob Zuma was defiant until the end. Finally, faced with the prospect of a resounding motion of no confidence in Parliament, as the clock came close to striking midnight on Wednesday 14 February 2018, he resigned.
Cyril Ramaphosa’s election the very next day, unopposed, as the fifth democratic president of South Africa, marks a hopeful new beginning for our country and an opportunity to rebuild a nation damaged by years of rampant corruption and mismanagement. There is hope that President Ramaphosa will be able to provide the leadership that South Africa needs to combat corruption and manage the economy in a sensible manner to ensure growth.
Although our optimism is not unfounded, the reality is that the starting point for any recovery is not an ideal one, and clearing the corruption will not be as simple as removing Zuma. By most measures, the country is worse off now than a decade ago, when he became leader of the ANC before being elected as president in 2009.
Ramaphosa takes over at a point where the ANC is divided, and there are numerous challenges facing South Africa’s economy. Corruption is endemic, growth is negligible, debt levels are rising, and unemployment remains our core challenge. The change in leadership won’t result in immediate improvement in any of these issues, and implementing the various changes will require much hard work in the short term to deliver on the medium to long term potential.
So, what does this mean for South African investors?
To answer this question, we need to take a closer look at how this renewed optimism will affect South African government bonds and local equities, as well as our currency.
1. SA Government Bonds
Risk of downgrade
One of the key risks facing South Africa is a downgrade of our local government bonds to junk status, which would result in massive outflows from our bond market and put pressure on our currency. Following a downgrade by S&P in December 2017, Moody’s agreed to hold their investment grade rating and reassess its position after the budget is delivered today. Their three areas of concern are:
Moody’s is looking for stronger GDP growth and better fiscal discipline to halt rapidly rising debt levels. With predicted growth of 1.1% for 2018 (compared to global growth of 3.1%), and grim updates on debt projections, one hopes that the change in leadership will lead to better management of the economy, but it will take time.
Restructure of State-Owned Enterprises (SOEs)
Moody’s raised concerns about the constant bail outs of SOE’s, and pointed to governance issues within them as an issue they would be watching carefully. The replacement of Eskom’s board in January 2018 was the first indication of Ramaphosa’s faction starting to implement change and was a positive development.
Moody’s also raised concerns about the lack of policy stability in South Africa and the impact that this was having on much needed Foreign Direct Investment. While in Davos, where he represented South Africa at the World Economic Forum in his capacity as deputy president), Ramaphosa went off-script and addressed the issue, offering some assurance that policy stability has been recognised as an issue to be urgently addressed.
Considering these three issues, we would be surprised if Moody’s hasn’t gained some degree of comfort that governance of SOEs and a degree of policy stability should improve from this point forward. This should mean that while the risk of a downgrade still remains a very real possibility, the risk has reduced somewhat since S&P’s downgrade.
Inflation and Interest rates
Inflation is relatively low at 4.7%. The stronger rand means that our imports are cheaper, including oil, which has the effect of putting downward pressure on inflation. If you add the lack of economic growth and the fact that consumers are under financial pressure, it is expected that inflation is likely to remain under control. This should provide leeway for the central bank’s next move in interest rates to be a reduction. Lower inflation and lower rates are positive for local bond returns.
2. Local Equities
The improved outlook for the South African economy will more than likely have a positive effect on local SA Inc equities. These are businesses that have all, or the majority, of their operations in South Africa and therefore their success and/or profitability is closely aligned to the local economic climate. Generally, what we see in times of optimism, local business and consumer confidence increases, which translates to increased demand and investment. The JSE All Share is dominated by Rand- hedge stocks that generate a significant portion of revenues from offshore operations, so investing in SA Inc shares generally results in a higher allocation to mid-cap shares.
Apart from bonds and local equities, changes in the political climate and the potential for a positive outcome should have a positive impact on our currency. In less than two months since Ramaphosa’s appointment as the head of the ANC, the rand rose to its strongest level against the dollar in almost three years. Many have been attributing that to the Cyril effect.
In summary, Ramaphosa on the road has had a positive effect on our country’s confidence and morale in the short term. The extent of change needed and the effort required is immense given the deterioration over the past nine years, but the environment for South African assets has improved and this should benefit local investors over the medium to long term.
It’s early days, of course, but as someone remarked, “I’m daring to hope. Slowly.” As are we.