It’s almost a month since President Jacob Zuma missed out on a trifecta of disposing with “unco-operative” cabinet ministers. There was barely a whisper when he replaced Energy Minister Ben Martins with the more compliant Tina Joemat-Pettersson ahead of pushing through his $100bn nuclear deal. Ditto last September’s replacement of Mining Minister Ngoako Ramathlodi by the junior Free State MEC – and Gupta associate – Mosebenzi Zwane. But Zuma’s firing of respected Finance Minister Nhlanhla Nene with yet another pliable junior, David van Rooyen, backfired spectacularly when the value of SA assets went into freefall. There was an immediate recovery when Pravin Gordhan took over from Zuma’s “Weekend Special” appointment. But as this excellent analysis by former UCT professor and Investec economic advisor Brian Kantor illustrates, investors are now pricing in a permanent “Zuma” cost for SA assets. They simply don’t trust Zuma anymore. And want insurance against him trying another crazy, costly maneuver. For taxpayers, compared with Zuma’s blunder on Nene, Nkandla’s R246m was a snip. – Alec Hogg Â
By Brian Kantor*
The Zuma shock wave of Wednesday 9 December 2015, when Nhlanhla Nene was replaced by the little-known David van Rooyen, only to be replaced that weekend by Pravin Gordhan, has had time to be absorbed by the markets.
As we show below, some recovery from the events of that day have been registered on the share, bond and currency markets. As may be seen below, the JSE All Share Index has recovered best: at one point in late December it was almost back to its month end November levels. The RSA bond market, represented by the All Bond Index, with a duration of about six years, was the most deeply affected at the time, but then recovered and is now trading at about 94% of its 1 December value. The trade weighted rand is worth about 8% less than it was on 1 December.
Figure 1: Equity, bond and currency markets to 4 January 2016 (1 December 2015 = 100)
Source: I-Net Bridge, Investec Wealth & Investment
That the Zuma intervention in our fiscal affairs is not regarded by the market as a temporary aberration but more as a permanent danger, is fully reflected in the extra costs of insuring against a RSA default of its obligations on its foreign currency denominated debt. The five year Credit Default Swap (CDS) spreads on RSA debt widened sharply on 9 December and have remained at a highly elevated level of over 350bps. This spread has also increased sharply when compared to the spread on the Emerging Market Bond Index (EMBI – indicated by a narrower difference between the EMBI and RSA spreads) and also when compared to Russian spreads. SA is now regarded as more likely to default than Russia and Brazil. Our credit rating in the market place is thus of junk status. It appears to be only a matter of time before the credit rating agencies catch up with the market place.
Unless the SA government can convince the market place very soon that SA’s fiscal intentions have not changed permanently for the worse, the Zuma shock will prove very expensive for SA’s taxpayers who have to service significantly more expensive debts to come as current debts are matured. Nkandla is very small change compared to this potential bill. The market place will need assurance that SA’s tax base can withstand the higher interest expenses incurred. Evidence that the growth in government expenditure, especially the growth in spending on government sector employment benefits, is slowing down sharply, would be helpful to this end. More important still is any indication and that the growth outlook for SA is improving to help generate more tax revenue to ease the pain of higher taxes rates. The chances of more fiscal discipline seem better than a meaningful pick up in GDP growth. Though the dramatically more competitive rand could and should be helpful to this end, strikes and unhelpful policy interventions permitting. The Barmy Cricket Army are an advance tourist guard doing their best to improve export earnings.
Figure 2: Credit Default Spreads (five year), 1 December 2015 to 5 January 2016
Source: Bloomberg, Investec Wealth & Investment
Figure 3: Credit Spreads (five year), RSA vs Russia, 1 December 2015 to 5 January 2016
Source: Bloomberg, Investec Wealth & Investment
Figure 4: Credit Spreads (five year), RSA vs Brazil, 1 December 2015 to 5 January 2016
Source: Bloomberg, Investec Wealth & Investment
The spread between the RSA 10 year bond yield and the yield on a 10 year US Treasury also widened sharply, to over 8% on the fateful day and has since narrowed to about 7.2% as may be seen in figure 5. This spread indicates that the rand is expected to depreciate by about 7.2% a year, on average, over the next 10 years.
Figure 5: 10 year bond yield spreads, RSA minus USA, 1 December 2015 to 4 January 2016
Source: Bloomberg, Investec Wealth & Investment
The reactions in the market place to date indicate that the rand continues to respond to the usual daily forces, but off a significantly weaker base. The weaker emerging equity and bond markets are, the weaker the USD/ZAR exchange rate will be and vice versa. Commodity price trends will also be an influence on exchange rates. But these forces are acting off a weaker base, as we show below. The rand is now much weaker than would have been predicted before December 2015 using the Aussie / US dollar exchange rate and the EMBI spread as predictors. A value closer to R13 than R16 might have seemed more reasonable before 9 December. The question then arises: can we confidently expect the base value of the USD/ZAR to improve any time soon?
Figure 6: The Zuma shock for the rand / US dollar exchange rate, actual and predicted values, daily data to 4 January 2016
Source: I-Net Bridge, Investec Wealth & Investment
The answer appears to be an unfortunately negative one, absent an equally dramatic development on the political and economic policy fronts. It does not take much to imagine what that would have to be. The government however will be under few illusions that SA’s dependence on foreign capital remains as heavy as ever. Given the currently low base and highly depressed expectations of SA, the benefits of surprising the markets with good news could have an unusual upside. Good, credible news about fiscal sustainability and more market respecting (business friendly) dispositions- maybe even some privatisation of publicly owned assets to reduce public debt and improve economic efficiency, could much improve the mood. Call them public private partnerships if you have to. But actions and better intentions towards market forces, both inside and outside the country, are urgently called for.
- Brian Kantor is the Chief Strategist and Economist at Investec Wealth and Investment in South Africa.
