The Monetary Policy Committee at the South African Reserve Bank meet next week. Nomura International expects a 50-basis point increase from the Reserve Bank. Meanwhile, the IMF has warned that it’s likely to cut South Africa’s growth prospects if there are further issues with strikes. Annabel Bishop, Chief Economist at Investec discusses what she expects to play out, and how the different scenarios will impact the country’s exchange rate and economy. The distinct impact of consumers under pressure, mingled with protracted strike action, and a recovering global environment, puts Reserve Bank Governor, Gill Marcus, in a tough position indeed. Bishop outlines the complex realities with succinct clarity, how will they affect you?
ALEC HOGG: Welcome back to Power Lunch. Nomura thinks we’re going to have half-a-percentage point interest rate increase next week. Are they on the money?
ANNABEL BISHOP: Well, we have no hike in our forecast.
ALEC HOGG: Well, I’m with you. Rather, I hope… As a member of the public, I hope you’re right rather than them. What are the two arguments?
ANNABEL BISHOP: Our point from our side is that our industrial production has actually gone into a recession. If you look at our mining, manufacturing, and electricity production, they’re all contracting on the month and indeed, they’re also contracting on the quarter – on a three-month rolling average basis, quarter-on-quarter seasonally adjusted, and that is the same metric that GDP growth is calculated on. They’ve done that for April and for May. They’re actually worse than they were in the first quarter, so if the industrial production is going into a recession, if the IMF is revising down as growth forecast and if the United States is unlikely to hike its interest rates until – at the very earliest – the second quarter of next year, there’s little need to hike interest rates.
ALEC HOGG: What about the strike? If industrial production is already under pressure, surely the Numsa strike is not going to help.
ANNABEL BISHOP: It will make it much worse and our inflation expectations are anchored, if you look at them in terms of the Reuter consensus. That’s not a concern, but the worry has been that the Rand has depreciated substantially and historically, that does mean the Reserve Bank’s inflation model does tick up its CPI forecast and that could be where Nomura is coming from.
ALEC HOGG: All right, so putting it all together: industrial production in South Africa is sliding. We have a strike, which is making it even worse but on the other hand, the Rand has been weakening and the Reserve Bank might be worried that that will bring inflation into the country.
ANNABEL BISHOP: What I would caution is that the monetary policy transmission mechanism – or in other words, a changed interest rate and the impact it has on inflation – only works on a 12 – 18 month period. There’s very little impact in six to 12 months and none in zero to six months, so it’s irrelevant what inflation comes out this year.
ALEC HOGG: But would the Rand appreciate if interest rates were to go up by the 50 basis points?
ANNABEL BISHOP: I don’t think so. I think the Rand will depreciate substantially further because foreigners have been purchasing our equities in the main and obviously, expectations of high interest rates would tend to reverse their view on equity prospects. The purchase of bonds has been very slight in comparison to the equity purchases and I do not believe that such an interest rate increase would be sufficient to increase appetites in our bonds at this stage.
ALEC HOGG: I love reading the MPC every two months because I think it gives you good insight into where the economy is. What do you think is going through Gill Marcus’ – the governor – mind?
ANNABEL BISHOP: I think she’s worried about economic growth. It’s gotten to the point where we’re starting to tip towards the one-point-five percent mark. In other words, if the Numsa strike proceeds and 10,500 firms go offline, then we are actually looking towards a one percent as opposed to a two percent economic growth rate this year, if that strike persists. That’s negative for retail sales.
ALEC HOGG: They’ve already turned down the first offer and it does appear as though the strikes are now becoming more ideological, than economic. Are you reading that, too?
ANNABEL BISHOP: I am, and I think it’s this agitation for potential emergence of a new political party ahead of the municipal elections, which is partially driving that.
ALEC HOGG: So it’s a much bigger picture, of which Gill Marcus will be very aware.
ANNABEL BISHOP: She will be aware, but I think the reality is the rating agencies are saying they’re going to downgrade us if our economic growth falls substantially further, and high interest rates will contribute towards hitting the only sector that’s creating growth – spending – on the head.
ALEC HOGG: Given that we’re now back in a rising interest rate cycle, there’s no way that we’ll have a cut in interest rates.
ANNABEL BISHOP: Unfortunately not, although that would be the best thing to stimulate consumer confidence and to stimulate appetite from foreigners into our equity market, which in turn, will translate through into Rand strength.
ALEC HOGG: The next best thing would be no further increase.
ANNABEL BISHOP: It would be no further increase and we really only could start thinking about what I think in November, once we’ve gotten through the strike action, and we understand what’s happening in South Africa. The reality of the situation is if we go too fast with our interest rate cycle, which Gill Marcus said she wouldn’t do… She said it’s going to be a moderate, protracted, and gradual upward interest rate cycle. If we go too fast on the interest rate hikes, we’re actually in danger of slipping towards one percent, if not zero. It’s a concern at the moment.
ALEC HOGG: President Zuma was at Coega yesterday – and I also like reading what the Presidency puts out with their official statements – and he made some quite aggressive forecasts on economic growth, going into 2016 and forward. He was talking about five percent/five-and-a-half percent etcetera. Is the man delusional or can we get there?
ANNABEL BISHOP: We can get there only if we stop this extreme strike nature, which has become embedded, if we limit our strikes to three weeks or less, and if we actually have enough electricity supply to get there. Perhaps that’s why he’s only hanging his hat on the 2016 mark onwards, because he’s hoping Medupi comes on line before then. Of course, if the global economy picks up substantially and there is strong call for our commodity exports and lastly, if we manage to get our manufacturing sector up and running.
ALEC HOGG: But if there are interest rate hikes in between, which will knock the economic growth in the short-term, I suppose you can rebound a little bit more aggressively.
ANNABEL BISHOP: Well, the reality is these interest rate hikes are I believe, going to be spaced out to 2018 – both globally (in the monetary policy normalisation), and domestically here in South Africa. That’s why the government is talking about an extended moderate interest rate cycle. The reality is that it does cut into your forecast of economic growth from 2016 onwards, at a five percent mark if indeed, we’re going to follow what’s happening globally and look for perhaps at most, a three percent hike between now and 2018.
ALEC HOGG: It’s a lot of time and gives her quite a long period to play with. If you were a rating agency, what are you expecting to come out of the MPC, which will ensure that we don’t have another downgrade later this year?
ANNABEL BISHOP: I think the only rational call could be no change in the interest rates, because the reality is that consumers are highly over-indebted in South Africa, even with the credit amnesty that’s come through. The impairments have dropped from 48 percent to 44 percent, but that’s still very high. It’s well above what the mark was in the 2009 recession. In addition, the rating agencies are becoming increasingly worried about economic growth and given that inflation is not demand-led, it’s coming through as a consequence of exogenous impacts from Rand weakness and obviously, the higher food prices, which are driven by the exchange rate as well. The reality would be that the Reserve Bank would actually need to sit on its hands. If it cuts interest rates, I think it will contribute toward another rating downgrade because of the fear over growth prospects.
ALEC HOGG: If it rises, it raises interest rates.
ANNABEL BISHOP: It’s something I wish they would do.
ALEC HOGG: What about the Rand? Given that Nomura and I presume, others are also thinking the same way – you need to increase interest rates to protect the Rand: where do you see that going?
ANNABEL BISHOP: I think you need to be cautious and say ‘why would that protect the Rand’. Foreigners hold about 30 percent of our equities and similar for our bonds. If they have an appetite for emerging markets and you increase interest rates, they clearly would buy more and they clearly would buy more bonds. If they don’t have an appetite, which they don’t do now as globally, the portfolios are shifting because of the expectation that interest rates will normalise the United States, then you only have your equity leg left to stand on. If you want to kill the equities, clearly you go at an upward interest rate cycle. I do not believe that will protect the Rand at all.
ALEC HOGG: People at the Reserve Bank – and they have a bank of economists there as well: do they have a similar view to you? I’m sure economists share notes.
ANNABEL BISHOP: I think there’s a concern over the current account deficit, but the reality in the current account deficit is it’s partly the payments that are made for holders of our bonds and equities. The other part of it is the trade account and the trade account is firstly, oil imports so hiking interest rates is not going to change that. Secondly, in the trade deficit, you have capital goods imported from overseas for our capital expenditure program – government’s infrastructure program. High interest rate is not going to change that at all. A very small component is only consumer spending – it’s probably less than one-third. You don’t want to prejudice economic growth in the economy and employment by high interest rates, when you only have such a tiny component of the current account – less than one percent of the deficit, that you’re actually targeting. I really think the Reserve Bank needs to sit on its hands. I think more damage will come.
ALEC HOGG: All right, so we’ve had a lot of economic-speak now. As far as the public are concerned, what percentage chance would you put for a rate hike next week?
ANNABEL BISHOP: We have a 50 percent chance of no hike, and we have a 25 percent chance of a 25-basis points hike. I think if the Reserve Bank does hike, it will be 25. It definitely won’t be 50 because they’ve communicated that very clearly in their last few missives. Lastly, for a 50-basis point hike, we only ascribe a 24 percent chance.
ALEC HOGG: Annabel Bishop from Investec. She’s the Chief Economist there, giving us a very good wrap-up of exactly where Gill Marcus and her team will be assessing or focusing their attention when they get together next week.
