Brilliant analysis: #GordhanGate – The Good, the Bad and the Ugly

The scenario planners are out, as the knives circle finance minister Pravin Gordhan. And unfortunately this is not the first time, and if he survives this current onslaught, one can be forgiven for being pessimistic in saying it won’t be the last. But what does this all mean for a South African economy that is on the crescendo of junk, with a weakening rand fuelled by this uncertainty, and more so global factors. Azar Jammine sinks his economic mind into this unfolding saga. He says the economy is on a fascinating knife-edge, and much good can come out of the current turmoil with an outside chance of disaster. A must read. – Stuart Lowman

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By Azar Jammine*

Crescendo Of Criticism Of Perceived State Capture By Zuma Acolytes

The past week has been fascinating in terms of the crescendo of opposition to and anxiety caused by perceived attempts at “state capture” by president Zuma and his acolytes. In the face of attempts by the Hawks to threaten the rest of the Minister of Finance, there has been an explosion of concern that such moves represent thinly-veiled attempts by President Zuma and some of those close to him to rationalise a Cabinet reshuffle which sees Pravin Gordhan being replaced by someone more pliable and less opposed to their attempts to gain control of state finances and the procurement processes of SOEs.

Such concerns escalated dramatically on Tuesday with the story that President Zuma had organised for himself to take charge of a newly formed Coordinating Council for SOE strategy. This was seen as a direct attempt by Zuma to be able to lay his hands on lucrative deals surrounding such organisations. Already there have been several areas where such suspicions have arisen.

There are suggestions that Eskom has agreed to deals with coal mining companies whereby the utility is set to pay far above market prices to procure its coal in order to benefit politically connected owners of the coal mines, led by the Gupta family. Then there are the suspicions that Eskom is trying to arrange trillion Rand deal with Russia to build nuclear power stations with Zuma and those close to him standing to benefit from such a deal.

Thirdly, there are stories surrounding the armaments SOE Denel trying to arrange deals which will benefit Gupta-related companies. Fourthly, there appear to have been attempts, subsequently denied by the Minister of Transport, to halt an investigation by the board of passenger rail agency Prasa to investigate questionable procurement deals undertaken by its former CEO Lucky Montana. Fifth, there is concern that the attempt by Gordhan to link the granting of a R5bn guarantee to South African Airways predicated on the airline reconstituting its board to exclude Zuma’s close confidante and current SAA Chairperson, Dudu Myeni, is one of the very reasons the president might be trying to get rid of Gordhan.

These are seen as being but the tip of the iceberg of attempts by the President and those close to him to gain access to funds and deals which might enrich them at the expense of the efficient running of these organisations.

The Fear Of Total Economic Meltdown If Gordhan Removed

It is difficult to find articles in the media justifying the move by the Hawks to gun for Gordhan. There is an overwhelming outcry based on the fear of the economic implications of the mooted potential arrest of the Minister of Finance. One by one, various members of the ANC or Communist Party, business leaders and academic economists (whose efforts we have publicly supported) have been coming out in support of Gordhan in an unprecedented outpouring of fear regarding what his removal might bring about.

The underlying concern is that such a move could threaten a vicious circle of declining currency and economic growth. The principal concern of credit rating agencies is of an inability of the South African government to limit the rising trend of its public debt, with a particular risk being the call-up of R500bn worth of guarantees provided by the state to SOEs in the event that they cannot meet their liabilities. Accordingly, there can be no doubt that a replacement of the current fiscally- disciplined Gordhan in the midst of concomitant “capture” of SOEs, would be seen to raise the risk of populist spending, leading to credit ratings downgrades to junk status. The trouble is that the spiral of downgrades need not end with a mere one notch downgrade.

Read also: Gordhan: “I don’t know whether I did the right thing taking this job?”

The threat of such downgrades could set in motion huge withdrawals of capital which would see the currency plunging to levels that would compel the Reserve Bank to raise interest rates in such a way as to drive economic growth downwards sharply, threatening still further credit rating downgrades. This is because sharply higher interest rates and sharply reduced tax revenues due to lower growth would be associated with an acceleration of government borrowing.

The latter could get out of hand if populist policies were pursued with abandon. Ironically, there is a precedent just to the north of South Africa for such a spiralling degeneration of economic growth and rising debt in the guise of Zimbabwe. We all know how that ended up with the government printing money to pay its way. It is fascinating to note that President Mugabe faces a renewed threat of revolt from amongst his own police force and defence force on account of the government’s inability to pay salaries to the teams given responsibility to maintain security. Under such circumstances, there is no telling how far the Rand could depreciate.

Fortunately, Enough People With Common Sense

With a smidgen of precedent for the above situation materialising in the form of market reaction following the replacement of former Finance Minister Nhlanhla Nene in December, one would like to think that there are sufficient forces within the ANC itself to recognise the dangers of the current situation and to prevent it coming to pass. On the contrary, in the midst of such growth in opposition to corruption and state capture, one can contemplate a countervailing positive energy which might bring about such a concerted effort to prevent further economic degeneration, with the concomitant huge savings to be made in avoidance of irregular, unauthorised and wasteful expenditure by the government.

Coalition governments in leading cities of the country could expedite the fight against corruption. Gordhan himself last week was quoted as suggesting that if even a quarter of state capture were prevented, this would save the government R40bn, or 1% of GDP. The intimation is that state capture amounts to 4% of GDP. Imagine if such savings were redirected to other more worthy causes.

The R2bn needed to finance higher education in the event of a no further increase in fees could easily be afforded. Gordhan seems to have committed himself to not resigning and to leading the crusade against corruption and state capture. One might suggest that President Zuma’s power to get his way on SOEs might prove to be fairly limited with such a groundswell of opposition to his methods. In other words, the economy might be at just such a breaking point that might unleash forces of economic growth even without tackling many of the other structural impediments to improvement in performance.

Economy And The Rand On A Knife-Edge

In conclusion, there is no question that the economy is currently situated on a knife-edge. If one is pessimistic and believes as some do that there is nothing that can prevent the President and his acolytes from achieving their goals and getting rid of Gordhan and other leading members of Treasury, then there can be no telling how far the exchange rate might fall in the economy might slide.

On the other hand, the economy might be on an unexpected verge of turning around from its five-year-long slide precisely because of the wake-up call provided to combat corruption and state capture. In the midst of the very short-term uncertainty surrounding the political vicissitudes surrounding the role of Treasury, it is likely that there will be some further losses on the currency market. However, if one believes as we do that the worst-case scenario is unlikely to materialise, one should not expect the Rand to depreciate much further than, say, R15 to the Dollar any time soon. Conversely, it is unlikely that events will unfold in such a way as to improve prospects for the currency to restore the R13.20 high seen a fortnight ago.

External Events Also Continue Influencing The Currency

The final point to make about the Rand is one we have reiterated on several occasions in recent months and that is that by no means is all the weakness in the currency attributable to domestic political factors. Even the latest weakness in the Rand on Friday was in part attributable to escalating fears of US interest rates rising. Fed Chairperson Janet Yellen, in a speech addressing the annual meeting of central bankers from around the world at the Wyoming mountain resort of Jackson Hole, gave the impression that the US economy is doing well enough to countenance interest rate increases sooner rather than later.

The probability of a hike in the Fed Funds rate already in September has been seen to rise to 50% or so from no more than 20% to 30% a few weeks ago. This has brought about renewed risk aversion towards emerging markets, with money flowing back towards the safe haven status of the Dollar and to a lesser extent other advanced economy currencies. As has been the case on several occasions in the past three years, the Rand is the exaggerated barometer of emerging market risk aversion.

The fact that political turmoil surrounding the Ministry of Finance happened to coincide with this recent change in sentiment for the worst towards emerging markets, meant that there was an added reason to send the Rand tumbling by even more than other emerging market currencies. But it was not alone in terms of the downward direction of its movement, just that the latter was greater in the case of most of the other currencies. The corollary to draw is that as much as events surrounding the incumbency of Pravin Gordhan might be depressing the currency, an even bigger potential depressant would be a further escalation of interest rate hike expectations in the US.

For example, if August US payrolls data due out on Friday turn out to be considerably stronger than the 180,000 addition to the job market in the US currently expected, this could have as negative an impact on the Rand as an escalation of fears of Gordhan being replaced.

Key Points 

  • One is greatly encouraged by the crescendo of criticism of perceived attempts by those hoping to benefit from state capture to undermine the position of Finance Minister Pravin Gordhan. Many see these attempts as a thinly veiled attempt to prepare the way for getting rid of forces working against those trying to exploit state-owned enterprises for their own benefit.
  • The overwhelming opposition to state capture from so many quarters may heighten the country’s resolve to stamp out corruption in a manner that could begin to save tens of millions of Rands in irregular, wasteful and unauthorised expenditure. Issues such as no fee increases at universities could suddenly become affordable.
  • There are concerns that President Zuma’s appointment of himself as head of a Coordinating Council for state-owned enterprises (SOEs) has raised alarm amongst many that this represents the most blatant attempt at state capture. However, one is beginning to wonder whether the President has much power left, even within his own party, to get away with such a ruse in the midst of so much opposition.
  • The economy’s future to some extent sits on a knife edge. In the unlikely event that Pravin Gordhan is replaced as Finance Minister, there is a real risk that the country might see a huge degeneration of economic activity, starting with massive currency devaluation and credit ratings downgrades that ultimately lead to a large escalation of interest rates and lower economic growth. On the other hand, even taking into account the many daunting structural impediments to economic growth, the latter can be greatly enhanced by a concerted national effort supported by most to get rid of corruption and state capture.
  • It is also important to emphasise yet again that a fair amount of Rand weakness currently is being caused, not exclusively by the domestic political turmoil surrounding the Finance Minister, but by renewed expectations of US interest rate hikes which are leading to an increase in risk aversion towards all emerging markets.

*Azar Jammine is the chief economist of Econometrix.

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