The macro outlook for South Africa does not look rosy. The country’s primary deficit soared to 10% of GDP in 2020 and it is expected to remain at high levels in the coming years, as the pandemic-related fiscal measures induced a strong “ratchet effect” on public expenditure. As mentioned in the Medium Term Budget Policy Statement issued by the Ministry of Finance in October 2020, “Options to stabilise the fiscus are becoming increasingly limited. Growth reforms are only expected to begin yielding results over the next several years, implying continued weakness in revenue collection over the period ahead. “ Public debt grew from 60% of GDP in 2019 to over 80% of GDP by the end of 2020. Government bond yields jumped sharply in March 2020 when the three rating agencies downgraded the country’s long term sovereign rating to junk.“Interest payments absorbing a growing share of limited public resources, which increasingly crowds out spending on social and economic investment. Debt‐service costs are now 4.8 per cent of GDP, up from 3.3 per cent in 2016/17. “ (MBTPS).
Among the three major rating agencies, Moody’s was the latest so far to downgrade the country’s LT sovereign rating from Ba1 to Ba2 on November 20, 2020. According to Moody’s, “The key driver behind the rating downgrade to Ba2 is the further expected weakening in South Africa’s fiscal strength over the medium term.” Moody’s points out to South Africa’s idiosyncratic constraints as an additional negative factor “While South Africa is not alone in having been severely affected by the crisis, its capacity to mitigate the shock over the medium term is lower than that of many sovereigns given significant fiscal, economic and social constraints and rising borrowing costs.
Moody’s questions the ability of the government to implement the structural reforms unveiled by the Finance Minister in October 2020, in the Medium Term Budget Policy Statement (MTBPS). “The coronavirus shock has intensified South Africa’s fiscal challenges and exacerbated the upward trend in its government debt burden, which predate the coronavirus crisis. Moody’s now projects government debt-to-GDP to rise to 110% by the end of fiscal year (FY) 2024 – including SOEs guarantees – equivalent to a 40 percentage point increase from FY2019.”
Any further rating downgrades are likely to increase further long term interest rates. This would be compounded by the Central Bank tightening its monetary policy to contain rising inflation and stave off the downward pressure on the rand – the latter being also a cause for the former. As a result, there is a risk of snowballing debt accumulation and unsustainable debt service which would jeopardise the country’s medium term fiscal outlook by eating away any expenditure cuts – especially on the back of unpopular wage freezes.
The risk of a sovereign default remains low as 87% of the country’s debt is libelled in rands and held domestically. Technically, the country’s central bank SARB could intervene if needed and purchase government debt. But this would nevertheless negatively impact the value of the currency. In addition, a drop in the market value of sovereign debt holdings would negatively impact the banks and other financial institutions holding government debt.
A litmus test and a few silver linings
In the short term, the litmus test will be the outcome of the negotiations conducted with the Civil service unions, as the current wage agreement expires in April of this year. “Both the upcoming decision on the final year of the current wage agreement and the upcoming wage talks pose significant risks to the expenditure ceiling.” (Govt. MTBPS). There are additional spending pressures from state‐owned companies. Several companies, including ESKOM and South African Airways, are insolvent and have insufficient funds to cover operational expenses.
There are however a few silver linings. The return of a risk-on market sentiment as the prospect for additional fiscal stimulus gets clearer in the advanced economies and as the vaccination campaigns gains pace in the world’s largest advanced and emerging economies, will translate into additional capital flowing into emerging markets in search for yield.
The country’s mining industry has benefited from rising gold and other precious metals (silver, platinum, palladium) in 2020. The likes of BHP, Anglo American, Sibanye Stillwater are well positioned to take advantage of a renewed appetite for precious metals should investors fear of surging inflation translate into increasing allocations to the yellow metal. Impala Platinum Hldgs could for its part could benefit from rising platinum prices on the back of rebound in the global automotive industry. Platinum is a key component of catalytic tubes used in ICE powered cars. In the future, It could also be used in EV batteries as an alternative or complement to Cobalt/Nickel in new generation electric batteries.
While the basic resources sector represents a third of the Johannesburg Stock Exchange (JSE) total market cap, there are many other companies with exposure across Africa and beyond making them interesting picks for investors with enough appetite to cope with the macro/fx risk. Case in point is Napsters, a diversified media and Internet holding conglomerate which made an early bet on China’s Tech giant Tencent in 2001, becoming its largest shareholder.