Peter Attard Montalto: Resistance is futile. Jacob Zuma doesn’t care, in full control

For some months already, Nomura’s emerging markets investment economist Peter Attard Montalto has painted a bearish picture for SA-optimists. He’s also been depressingly accurate. The city of London’s go-to man on the pricing of SA assets correctly forecast the firing of Pravin Gordhan; a continued expansion of the Zuptoids; and the inability of the president’s enemies to eject the corrupted president. He expects the country’s most likely future to be a continuation of a status quo where Zuma’s ex-wife gets to succeed him, the politically connected continue to plunder, the ANC continues to rule, the SA economy keeps sliding, unemployment rises still further, and the value of SA assets deteriorates. Ready to slit your wrists? Not just yet – there is a ray of hope. This most rational of beings reckons if citizens turn out in the millions on Friday to protest, then his likely scenario would change. If you didn’t already realise how much is at stake, have a close listen. – Alec Hogg

Emerging market economist Peter Attard Montalto of Nomura International

I’m with Peter Attard Montalto who’s been writing a great deal over the last few days on the shock move that happened midnight on Thursday night. Peter, did you expect Pravin Gordhan to be fired?

Yes, to a degree. I think it was always a difficult call. There were clearly going to be risks taken by Zuma to do it but I think what I also really tried to understand was, “Does it make sense for Zuma to do it? Is it part of a larger game plan around the elective conference – around ensuring succession?” I think the answer to those questions were “Yes” and therefore, it had to be on the table. That’s why I was telling investors in New York two weeks ago, when I was there. I was still getting a little push back. People were saying, “It won’t be accepted. Look at Nenegate and the way the markets reacted” and what I understood was, “Do we have confidence from the Zuma camp?” It’s hard to place. It’s hard to pin down but to a degree, I think they knew what they were doing, which ultimately, made me more confident after the recall last week. This wasn’t indeed where we were going.

You mentioned the elective conference.

Well, I think that’s what everything is ultimately about. I think that in a sense, it might be a wrong focus. They should focus more on 2019. There are risks around 2019. There’s no point in trying to maintain a … network if you’ve lost an election. But ultimately, I think the focus of the Zuma camp is solely on 2017 at the moment (maybe they’re too confident) and about winning. National Treasury is required – as part of that plan – to work magic for the Zuma camp to ensure success and to ensure the right bums are on the elective seats with the elective conference, coming up from the branch level. The right influences are a given. And I think that is as well why there is a baseline that the Zuma faction will win the elective conference because they play dirty, are willing to play dirty in a way that the opposition can’t.

Work magic.

Well I think what we are waiting for now is what happens at Treasury. I don’t believe there is going to be massive headline changes in physical policy. I don’t think the expenditure ceiling is going to go, it’s what happens below that is going to be important and also what doesn’t happen. If you think about a lot of what the breakdown of the relationship between Pravin Gordhan and Jacob Zuma was really about was the blockage of contracts and stuff like that. The peering or the shining of a torch into little dark spaces around the PMFA and contracts and stuff like that. So it’s that sort of issue is what we are going to be looking at now. Give him the benefit of the doubt for now but we much watch out very closely for those types of issues as opposed to some big massive blow up in the physical or anything like that.

The South African budget has been highly rated around the world as being the most transparent when you see the budget documentation there is just about no detail that is not able to be tracked down if you wanted to work through thousands of pages. Do you think that that is the key to all of this, that that is going to change, the transparency might in fact become a dark place?

To a degree, I mean I think it is still very hard to look at the budget document, to look at the legislative documents that come with and to see contracts at a long item stage is still very difficult. But no in general there is a huge amount of transparency and so any call which the Minister has already made to prioritise the budget which echoes the call the NEC made, I think it was six months ago or so, will be very obvious on the surface. But you must remember how the Minister worked at the Department of Home Affairs. There was a big separation between the Ministry and the Department and all the advisers were in play as well there and I think that will be the interesting thing to watch on National Treasury. How leadership changes, how the structure of the organisation changes, because there has always been a close integration of the Department with the Ministry and National Treasury and it is one of the reasons why it has always worked so well.

Well we have seen that Lungisa Fuzile the six year-long Director General apparently has handed in his notice and he wants to leave at the end of the month. Is his replacement that key?

It is incredibly important for a number of reasons, I mean we should say that Lungisa was incredibly respected by investors and by markets. Liked as well, he is a very likable character and he has done a very good job there both for investors externally but also for the staff internally, I think. Ultimately that is the risk around flight of staff, I don’t think we are talking about, you know, half of the treasury staff leaving but are there key people in key places, not necessarily at senior levels, who leave is now a risk that investors are watching for very closely, particularly again related to SOEs and nuclear will be particularly important. But it is also important to have someone there, who understands stuff, who has come up through National Treasury and who is able to deal with a huge amount of complexity that does go on in National Treasury. As I say Lungisa has done very well and it is not obvious if you for instance get an external candidate as opposed to one of the current Deputy Generals. They won’t necessarily be able to have that skill even a Direct General from other departments. As indeed the Minister said in the press conference yesterday, wouldn’t necessarily have that ability to do that in the way that someone internally would. So I think that we are watching that replacement very very carefully.

There is a lot of resistance to this, we even hear in London they are going to have a protest outside of South Africa House on Saturday. There is a rolling mass action that has been called by civil society. From reading your reports you don’t… you think this is pretty much a lost cause.

Well I think that the resistance is largely irrelevant and I think that it is ultimately because the President doesn’t care. He has, as we have seen in the press conference, today on the National Working Committee, basically won that institution and has the majority within it and ultimately it is those internal structures in the ANC in the short term at least, until 2019, that matter and they are not flexed by civil society pressure at all. There is an internal factional cohesiveness which is immune to external pressure… .There are questions about 2019 which I am sure we will come onto later but I think for the interim we are basically stuck because the ANC ultimately holds control, ultimately is able to wrap itself up in unity and I think that is what the discussion has been with the anti-Zuma Camp over the last couple of months and have realised. Even the anti-Zuma Camp is still all wrapped up in the internal machinations of the ANC’s need for unity that they ultimately strap themselves down and prevent themselves from doing anything before you see any proper resistance coming through. So yes I discount to a very large degree the resistance that comes.

What about the economy, what is the impact going to be of what we have seen in the last week?

Well I took the decision to downgrade grey forecast very very quickly. I think there was no point in hanging around. I think there will be a big sentiment shock coming through to the economy. The economy is weaker now than it was going into ‘Nenegate’. And to ‘Nenegate’ the consumer was looking pretty strong, credit growth was pretty strong, we are seeing a pick in private investments as well. Now we have private sector investments still contracting and that will go lower. The consumer is much weaker, credit growth is lower, banks are under a lot more stress and also your labour costs are much lower. So I think basically we will now see minimal growth this year, we have revised down from 1.1 to 0.2 for this year. I say it is very early to do that, we will probably change the numbers, but I think that gives the indication of the shock to come.

Image courtesy of Currency Partners

Slow down a little. 1.1% down to 0.2%. That is off a cliff.

Well yes, that is not a recession, that is not a Brazil style shock that we saw in Brazil two years ago and I think there is still, because of relatively rapid population growth in the economy because Net Trade is doing okay because the Global Economy is doing okay. That is not a fall of a cliff moment but is clearly vastly inadequate for development and unemployment. And it is still way below population growth hence you know the capital income growth. I think that is what is frustrating me about the market narrative, even excluding the reshuffle in the recent months. People got too excited about turnaround and the economy when actually we were still going to have negative capital income growth, unemployment was still going to be high anyway and now with an additional shock on top.

What about 2018 and 2019?

So we have revised growth estimates for them as well basically getting back towards 2% much much more slowly. Now saying 0.7 most likely for next year. I think originally we were saying 1.7 for next year. So I think the problem here, and this again what we will have to see coming through in the data is, when you open Pandora’s Box like this twice you are going to see some stickiness in people’s reactions, risk aversion of people investing locally, people looking to invest more offshore. Remember that was one of the key flows after negate was more money flowing offshore from corporates. I think that reinforces this sort of lower grade narrative domestically. We should remember the less investment now means less capacity in the future and less opportunity for growth in the future as well. It reinforces itself through lower employment growth etc. So yes I think we are basically stuck at a lower level now for longer and getting back to what are still very low long term potential growth sort of estimates at 2% now way beyond 2020.

It’s virtually one percentage point difference in this year and next year’s growth. If you take that as a round number, what has Gordhan’s firing cost the South African economy?

It is hard to put that in number terms I think but I think it will mean several percentage points higher in unemployment. It’s going to mean a few hundred thousand people more unemployed which is probably the best way of looking at it.

But if you were to take 1% of GDP, $35 billion.


Sorry, $3.5 billion.

Exactly, it is levels like that which we will be talking about. People get hung up on those numbers though. In a sense they are sort of meaningless but yes, I think the unemployment way is a better way of looking at it.

If you go forward the market’s reaction has been pretty muted. About half, I worked the numbers out on the interested rate stocks. They lost about half in market cap to what they lost in the two days Nenegate. So relatively speaking not such a disaster.

Well this is the problem we have, I think, around what pressure is being felt by the President. About the way maybe the ANC could have reacted differently to this if the market had sold off more. Maybe it would have been more likely to have a repeat of Nenegate. I think it is really reflective of the global environment that people, funds and foreign investors are seeing inflows at the moment, having a lot of spare money to put to work. And so even if you are massively negative on South Africa you are underway to your benchmark, you are still going to have to put some money in, if you are getting new money in put it down in South Africa. And that is why we are seeing buying going on in the last couple of days since the reshuffle. And this means the Dollar Rand is remarkably well behaved and I think, things could have been different potentially, we would have seen a much larger sell off in Dollar Rand and if we basically stick around current levels or even just move a little bit higher up to 14 or 50 or so I think that reinforces the President in his position actually and markets and particularly local South Africans should probably actually dwell on that and think on that.

RW Johnson’s ‘How long will South Africa survive’ predicted junk status in two years, it’s coming 23 months. He also predicts a physical cliff and the country being forced to go to the International Monetary Fund to be bailed out. First of all do you agree with that narrative and secondly is it coming closer?

Well I think the physical cliff is still very far away. There are still a lot of changes that can be done on the revenue side. They are very politically difficult of course, VAT being the main one and also raising corporation tax or wealth tax which is being discussed as also possible. So there are still a lot of options I think but this old cupboard is looking pretty bare but not totally empty quite yet. But as I said expenditure I am not really expecting massive changes on the surface but it is beneath the expenditure ceiling that is important but interest expenditures are going to keep gridding up as we see more downgrades coming through this year. So there is definitely a lot of stress on the physical side, Deputy is going to be on a continual upward path now towards 60% probably in two or three four years time. But a true physical cliff is a very specific event and is about a sort of sudden stop of funding coming through and I think in this global environment it is very hard to see.

Explain a little more if you would the downgrades and the impact thereof.

So we saw [S&P] react very fast. They made the decision on Friday, communicated on Monday. That was as expected. They were hanging on by their fingernails after the December update they had on investment growth, so now their external rating is on junk – low currency is still just an investment grade. I think they will close that gap and downgrade the local rating to junk later in the year in response to actual policy changes and to the low growth coming through and that will be an important event. Fitch we are waiting for as expected in the next week or so, I think they will downgrade again, sort of hanging on by their fingernails after December. And I think both those agencies are downgrading initially on the removal of Pravin Gordhan. This is ultimately about removing someone who is anti-corruption is the hint and single to rating agencies. It was very telling that S&P kept their rating on negative watch on Monday again that shows the risks to come on growth especially for physical. [This] is different, I think there is a lot of frustration in the investment community around…I think [Moody’s are] behind the curb. They will probably downgrade one notch because they are higher than the other agencies in May, June or July which is the window they sort of identified after this review they have announced. But they still seem to be on a slightly different planet than the other two rating agencies.

So if politics does matter how do you, sitting in London, perceive South Africa today?

Well ultimately I think what is going on here is to use Pravin Gordhan’s phrase is a joining of the dots is starting to happen. As you know I have been exceptionally [bearish] with South Africa for a long time, I think I was joining the dots up a long time ago and the market is now catching up and doing that and I think in a sense the underlying story is new. I don’t think anything new here is going on in the sense of a playing out of Zuma’s strategy. It is the existing patches that are in place that is again feeding into this. But what really happens I think going forward is we require a step level change regarding pricing in South Africa risk. So we need probably another 50/75 basis points in ten year local debt. Dollar Rand probably should up around 15/50 or so even in this global environment and that risk basically is about the erosion of institutions. The involvement of politics in independent institutions. Stuff like that. I don’t think we are in a crisis here in a true sense… we don’t have a sudden stop balance of payments crisis on the horizon. That is because of South Africa’s cap controls because there is a lack of external debt. Say that a country like Turkey has. But we are talking about a step level re pricing that is needed to take into account these risks.

What about the business sector, you haven’t seen them coming out even in the Apartheid era with strong language and significant threats. Now they hold the first strings to VAT, to PAYE, to all the money that goes into Government month after month. Would you put that as a possible risk that they might decide revolt tax wise?

I don’t think a tax revolt is going to happen. I just don’t see people having the ability to form a narrative around this that makes sense for a President who ultimately has done nothing wrong, in a sense. He has acted within the constitution, he has even acted probably within the ANC’s requirements. He has informed the top six about what is going on even though they disagree with it. So the reshuffle, even though it is completely irrational, doesn’t break any laws for a democratically elected government and president. If you add in the fact that Parliament will be given an opportunity on the no confidence vote will vote against. I think it is hard for business than to justify a tax revolt in that situation and it will ultimately come down to 2019.

The no confidence debate. You say Parliament will vote against it.

ANC logo stencilled on a wall in Soweto, Johannesburg

Well I think the strong signal that has come now from the ANC today is that the caucus cannot vote with the opposition that the … conference said very specifically that the ANC president is the country’s president and that hasn’t changed. I think there is a large number of extensions probably from the ANC benches but we won’t get the 60 odd required transfer of votes from the ANC across the opposition to actually allow it to pass. It will be interesting if we see a majority vote for the vote of no confidence but I think we have to remember it has to reach the 201 threshold of actual votes required from all members. The interesting thing is if we see a repeat of November, the last one where we saw the influence of security services in Parliament around the ANC caucus. And I think if you combine that with maybe some of the events around the protests on Friday and maybe some counter clashes with MK veterans and ANC Youth League. I think the market maybe then start to get a slightly better understanding of the larger context of what is going on here.

You have mentioned 2019 a couple of times. The election that is coming now, if some of the cynics are saying Zuma is the best thing that could happen to the opposition parties, is he really that good for him? Will he galvanise their vote?

To a degree, I think this definitely increases the chances that the ANC will drop 50% in 2019. But what I regret really is this notion that it is obvious that the ANC loses power in 2019. I think there are several key factors. Firstly the marginal vote in South Africa is ANC don’t vote. It’s not ANC/DA or ANC either. And as long as that happens it is a very big sort of uphill struggle for opposition parties to get enough votes for the ANC to drop below 50%. On top of that I think opposition parties are capped on the upside, that is ultimately and urban protest movement and is probably capped at 10 or 11%. DA is capped I think by the fact that they still have issues on policy, they still shoot themselves in the foot with Tweets from Helen Zille and stuff like that. Maybe they capped at 30 odd percent. So if you look at it from both sides I think it is quite… it is not obvious that the ANC falls below 50%. If you map forward the collection results you come up with something like 53 odd or maybe take a percent or so off from that from these current events and yes you probably get the ANC in 2019 getting just below 50%. Again it is not obvious.

And that is on the strength of them being led into that election by another Zuma, Zuma’s wife.

Exactly and so the forecast here is not that quite complicated to communicate. I think Zuma is not going until after elected conference but I think he does go and he goes early, maybe in May next year to allow his ex-wife then a year to campaign for the election on a platform but also a fresh face and a woman. I think that there is no point in upside in votes but I think it caps the downside maybe for them and does help in the election.

Former African Union Chair Nkosazana Dlamini-Zuma

But it still keeps the network of patronage alive and well.

Well that is broadly the long term forecast here as status quo basically. Both on potential growth, on reform and on politics.

But at some point in time then you hit the physical cliff and at that point in time what happens?

Well this is the problem around the long run forecast. As I said the physical cupboard is getting more bare, we would have to assume that in the long run that the VAT hikes, taxes etc., land taxes maybe, are undertaken. And then it comes down to a very difficult decision. Do you cut the main feature in the budget which is wages, which will be very hard at that point. Or do you have a sudden stop and an inability to fund yourself. You have to remember there is a key stage before that, and again this is partly why I see the physical cliff quite far off – the key step first would be prescribed assets and that is a key issue we are watching in the [inaudible: 00:>21:50] in the middle of the year. I am not against prescribed assets ideologically in themselves for development purposes there may be a better way of going about it. But actually I think further down the line if you saw a requirement on funds by Government bonds as opposed to infrastructure bonds or anything like that, that would be a very worrying signal and would start to indicate that we are approaching that point.

That is a very rational outlook that you post there but it is also very depressing. How high would you put the chance then of South Africa following the Zimbabwe route which appears now to be emerging increasingly in the policy documentation.

Well I still reject the Zimbabwe outcome as a likely scenario for South Africa in the sense of militarization, of land grab and stuff like that. I think we will see fast land reform, I think there is space in the constitution already, it has always been a slight surprise that they haven’t done more within the existing constitution. I think there is populism as you say now coming out from the campaign into the policy conference but it is interesting. I think Zuma doesn’t necessarily believe in all the populism that he is currently campaigning on. I think some of the best times that he has spoken with investors without note has been against populism in land reform. But I think he is using this as a political wedge and to define splits within the party into the elective conference. So I think on the Zimbabwe scenario. Ultimately if we come out of this people still have comfortable lives in South Africa who are fortunate enough. If we see people going about their every day business if you can keep patronage network going, things kind of bumble along without necessarily going down the Zimbabwe route. So I think that is ultimately why I reject it, I just see the economy and the society in a kind of sweet spot and that is why this Friday will be so important – the level of protest action that does turn out. If it is like after Nenegate when there were promises of million people turning up and it ended up being well below hundred thousand then I think that shows you again that there isn’t really this mass rising up.

And if there were a million?

Then I think that would be interesting. Then I think you are confronting a force that has nowhere really to go in a sense. Do they want, they don’t want to vote for ANC, they wouldn’t necessarily vote for the DA. Where do they go in the political spectrum in 2019, is may be a hard question if that starts to happen. And maybe he is still impervious to that kind of pressure and then maybe we will have to start thinking about other scenarios.

You have spoken about patronage. You know the inside story in South Africa but there is a lot of plundering of the national purse. You are looking at it very rationally but I am sure a lot of other people are looking at it much more emotionally. Isn’t there an emotional reaction possible here given the low economic growth or economic growth is now going to, for an extended period of time, going to be below the population growth rate, which just escalates the pressure on social unrest.

Well I think we have to define where that emotional reaction would come from. Are we talking about housewives living in Sandton and Rosebank or people wearing black shirts to the office on a Monday or are we talking about your average person in a township on the street. And there it is not clear at all I think that you see that kind of reaction necessarily and I think there is still a very strong pull around the 94, around the ANC for that kind of part of the electorate. People have seen their lives improved, they do now have access to better housing. To services and to grants of course as well. And maybe that keeps people just on the right side of support for the status quo and why we haven’t see any kind of mass rise up on these issues quite yet. So yes I think it would be interesting if we saw that kind of emotional reaction, it is hard really to see necessarily where it comes from, around stuff that you can’t really see, if you think about it. These patronage issues, individual contracts, are all kind of below the service and have to be dug up by investigative journalists etc.

What if you were living in South Africa and were a South African, what would you be doing right now?

I don’t think I would be joining marches necessarily, I certainly wouldn’t be joining some things that are very ANC aligned like Save SA. I think I would probably be even maybe rebelling at some of these issues like wearing a black shirt on Monday I think, those sort of things don’t necessarily go to mean very much unless you are doing more on the ground. I think the interesting thing would be to think about what real options there are for a change in South Africa and in particular people are doing a very good job like Corruption Watch for instance… These sorts of people who have been very effective in exposing what is going on and establishing the narrative much more openly. I think these are the interesting people to be tracking here.

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