Joining the Zuma dots: Firing Pravin set to deny jobs for 500 000 – a year.

Azar Jammine is the second economist to drop his GDP forecast as a direct result of the impact from SA president Jacob Zuma’s firing of his finance minister. Jammine now projects economic growth down half a percentage point for the next few years – a loss of around R30bn in foregone economic expansion a year. That may even turn out to be turn out to optimistic. Peter Attard Montalto dropped his annual GDP growth projection by a full percentage point. Both these economists’  forecasts translate into very weak growth in new jobs. With SA’s population expanding at 1.5% a year, arithmetic tells us unemployment will now, at best, continue rising by 500 000 people annually for some years to come (the population now expands by presuming 825 000 people a year). This is a reverse no country of SA’s size cannot afford. Especially when you look past the official unemployment rate of 26% and include the disheartened masses who are excluded because they have given up looking for a job. That puts SA’s real unemployment rate at a crisis level of 36%. The major point Jammine makes in his reflective piece below is the biggest impact of Zuma’s actions is on business confidence and, hence, their job-expanding fixed investment. When the business sector doesn’t create jobs, nobody does. If you thought education was expensive, try ignorance. – Alec Hogg 

By Azar Jammine*

Much of the discussion surrounding the adverse impact of the Cabinet reshuffle and the S&P downgrade of the country’s credit rating to junk status is centred around the exchange rate. This is somewhat misdirected. Ironically, a weaker exchange rate is actually beneficial for certain exporters and paves the way for domestic production to take some of the demand away from imported goods and services.

Azar Jammine
Dr Azar Jammine is a leading South African economist.

Secondly, a depreciating currency tends to boost the prices of Rand hedge equities and in this way helps those who are fortunate enough to have exposure either directly or through their pension and retirement funds to such equities.

Also, a rise in long-term interest rates contributes towards boosting the returns of pension and retirement funds. It is therefore not totally unequivocal as to the extent to which a weaker currency would contribute towards lowering economic growth. The same cannot however be said about capital investment.

The reduction in business confidence brought about by the events of the past week is the biggest threat to economic growth, impacting as it is likely to do on capital investment and to some extent also on consumer spending.

Impact on capital investment the biggest source of concern

As was seen in 2016, the most adverse impact of political uncertainty and turmoil relates to capital investment.

In 2016, economic growth came in at a mere 0.3% despite the fact that household consumption expenditure grew by nearly 1%, government spending by 2% and the trade balance improved sharply, with exports growing much faster than imports. The reason why overall economic growth lagged so far behind was because of an almost 4% decline in capital investment.

One fears that the most recent shock to business confidence will reverberate through the economy with a further decline in capital investment and in this way depress economic growth. Furthermore, the impact is likely to be felt over a period of time.

Pravin Gordhan, former South African finance minister, right, speaks as Mcebisi Jonas, former South African deputy finance minister, left, looks on during a news conference in Pretoria, South Africa, on Friday, March 31, 2017. Photographer: Waldo Swiegers/Bloomberg

In fact, the impact on 2017 growth compared with earlier expectations might be relatively minor compared with the effect on growth in 2018 once capital investment decisions have been set aside. We had been forecasting GDP growth of 1.5% for the South African economy in 2017, but the figure is now likely to fall back slightly to around 1.1%.

The bigger decline is likely to be the reduction in growth of nearly 2% next year and the year thereafter, to figures closer to 1%.

In particular, those sectors of fixed investment which are driven proportionately most heavily by the private sector are likely to feel the effects of poor business sentiment most acutely. This would include residential building, non-residential building and purchases of several types of machinery and equipment.

On the other hand, some areas of capital investment which are boosted by spending by government and parastatal organisations, may well reap some benefit. Conversely, the rise in the interest bill on government debt means that government will have that much less available other things equal with which to fund such expenditure on “radical economic transformation”.

South African president’s radical economic transformation. More magic available at www.zapiro.com

At the same time, if the rise in the interest rate on South African government bonds were to be limited to the 0.5% or so which has occurred thus far, the R1.5bn to R2bn increase in the government’s debt servicing costs pale into insignificance in comparison with the potential loss of investment from reduced business confidence.

Initial impact on inflation and interest rates not that great

Insofar as consumer spending goes, the impact of recent events is likely to be most negative in respect of the forecast of growth in consumption of durable goods. These tend to be big-ticket items and even though interest rates might not rise much, if at all, in the foreseeable future, the increased fear of such an event is likely to put a dampener on the proclivity with which consumers wish to buy cars and appliances and homes for that matter.

In addition, to the extent that the Rand has weakened as a result of the credit rating downgrade and even before that, it likely to push up inflation, especially of imported goods or goods carrying substantial imported components, most notably durable goods.

Read also: How world sees SA: Reach for airbags – Zumicon to plunge SA into recession, rand to plummet

It should be noted, however, that at the current exchange rate, the inflationary impact of the fall in the Rand thus far is likely to be muted. All that has happened is that the gains made by the Rand during the first few months of the year have been neutralised and the currencies back to where it was a couple of months ago.

If the Rand were to remain where it is right now, it would not result in a massive increase in inflation compared with what most economic forecasts had foreseen. On the contrary, the majority of economic forecasts had indeed built in the likelihood of some currency weakness to go hand in hand with political turmoil in the run-up to the ANC’s elective conference in December. At the current exchange rate, there is still little likelihood of any increase in domestic interest rates any time soon.

Heavy impact would emerge if further downgrades were forthcoming

The really significant negative impact on economic growth would only emerge in the event of further credit rating downgrades. In the event that all three credit rating agencies were to have South African government bonds on a junk status, there would be large-scale sales of such bonds because the country would fall out of the World Government Bond Index (WGBI).

This would force those investment funds tracking the WGBI to sell-out of South African bonds in order to rebalance their bond portfolios to look like the international benchmark. The Rand would stand to depreciate a lot further than it has done hitherto. Then and only then will there be increased fears of rising interest rates and sharply higher inflation.

Read also: Quantifying cost to SA of firing Gordhan – over R250bn and rising

The impact on both capital investment and consumer spending would be that much more severe. The danger with such an outcome is that it could degenerate into a snowballing downward spiral of reduced economic growth, lower government revenue, increased chances of a breach of budget deficits, resulting in further credit rating downgrades and so on.

Much has been said of the fact that amongst leading emerging markets, all of Brazil, Russia, Colombia and South Korea went into recession after their credit ratings were reduced to junk status. In South Africa’s case, such a scenario would also loom in the event of the cascading effect of further credit rating downgrades materialising. Unfortunately, recent events do not provide too much confidence that such a scenario will necessarily be avoided.

New economic forecasts being prepared for clients

In light of the above scenarios, we are busy working on new economic forecasts which we hope to provide to clients in the next fortnight to incorporate the impact of recent events. Initial work on this base case scenario points to a reduction of around 0.5% in economic growth in each of the next few years compared with our previous forecasts, driven more than anything by proportionately steeper downward revisions of fixed capital formation growth.

It should be borne in mind that even our previous forecasts had incorporated some element of political instability in that we had the Rand/Dollar exchange rate depreciating to more than R14 to the Dollar over the course of this year. Accordingly, the revision of inflation and interest rate forecasts at this stage does not warrant major adjustments.

  • Dr Azar Jammine is the chief economist of Econometrix.
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