For the past decade, Nomura’s Peter Attard Montalto has been the go-to guy for international investors looking for an independent insight into South Africa. And as the Zuma Administration has dragged on, Montalto has become progressively concerned – it was he who first used “tenderpreneurs” to describe the crony capitals who infest the ANC. In this insightful interview, Nomura’s Emerging Markets specialist shared with me how global investors read the South African political challenges. Sadly, corruption and the tenderpreneurs are now accepted as part of the SA reality. For investors, though, the attraction of the country’s stocks and bonds depends on how well Finance Minister Pravin Gordhan is able to reel in the corruption – or at the very least, stop it from getting out of hand. Pragmatic from an offshore perspective. But miles from the high moral ground the Rainbow Nation once enjoyed. – Alec Hogg
Well, it’s a lovely day in London. Peter Attard Montalto with Nomura (the city’s expert on South Africa) has invited me into this wonderful boardroom with a great view. Is this the way you guys live in the city?
Yes. We have some very nice offices here with views of the river but ultimately, what happens downstairs – talking to clients, and sales and trading – is what matters.
Peter, the South African situation is something that has interested you for a long time. Just by way of background, what got you involved in that part of the world?
Well, it was a total accident. When I was working at Lehman Brothers, the person who was covering South Africa before me left. I ended up taking over the responsibility and that was ten years ago (come this September, actually). I’ve been covering South Africa, travelling very regularly and interacting with locals and policymakers, and trying to figure out what’s going on.
An enormous network that you have both there and here, and the ability to see things from a distance must be an advantage.
There’s definitely a different perspective, sitting outside. The mortgage is obviously not as tied to local interest rates, which is quite important. You’re not worried about things like security in the same sorts of ways so you can take a slightly calmer, more data/model-driven view to the economy. There are more things to compare it to, sitting outside. Whether it’s Turkey or Latam (to make comparisons), or sitting in London and interacting with global investors definitely promotes that way of looking at it.
South Africans are getting very excited, one way or another, about the elections in August. The polls suggest there’s going to be a massive swing away from the ANC. What’s your feeling from the people that you’re engaging with?
I think the polls are quite unreliable. The sample is very, very small – mainly covering three cities. I don’t think we can put that much trust in the opinion polls. We’ve learned globally as well, how useful or useless opinion polls are, but I do think they show some rough trends. Tshwane and Nelson Mandela Bay are definitely in play and moving more towards the DA but Johannesburg might be a closer fight and it’s going to be a more complicated battle. I think that overall, a lot of investors are estimating that the ANC will drop in support terms. As loyal investors, you always think, “After the whole shock of Nkandla and everything, you have to have over 20 percent drop.” That’s not going to happen. They’re probably going to drop from 62 percent down to something like 56.5 or something like that – nationally – mainly lost in the urban areas with the rural holding up quite well for the ANC.
I don’t think it’s going to be that much of a national vote story. I don’t think it’s going to necessarily promote massive fears around where the ANC will be at in 2019 (nationally). It all depends what the ANC’s response to losing power is in key metro areas. As I said, particularly Tshwane and Nelson Mandela Bay, which could well fall from majority ANC-control but there’s usually uncertainty about what happens next. It’s far from obvious that you get the coalition between the EFF and the DA, for instance. There are coalition discussions going on in the background, despite their protestations that there aren’t. An uncontrollable force meeting a less politically dynamic force would be interesting to watch, and we may even end up with ANC minority governments. That might be the case, even in Johannesburg. Whilst it’s obvious that the ANC’s going to do very badly in the metro’s, it’s not obvious that the DA will be in charge.
We can well have quite an unstable situation where the ANC loses power, coalition agreements form, and then collapse in a couple of months’ time.
That’s not a good thing for investment.
No. Exactly. That’s probably the worst outcome – that very messy fine balance of coalitions going on. The EFF having policy control is probably less likely. If they are involved, it would probably be things like confidence supply and vote motions, etcetera. I think the DA certainly wouldn’t give major procuring ministries to the EFF. Investors would like to see either a very strong ANC victory in the metros or a very strong DA victory. Something in between is messier and more uncertain for investors.
The implications though, for Jacob Zuma…We’ve been following this ‘will he go/won’t he go’ saga for months now. Just when he seems to be on the verge of being booted out, somehow he regains his strength and his support. How are you reading that right now?
I don’t think there’s been a particular move within the NEC since the start of the year. He roughly has 60 percent support on the NEC but the key thing there is he has to maintain the rent extraction machine and that’s been gummed up at the moment by Pravin Gordhan and National Treasury refusing to sign off on a whole host of deals. The prison deal that came up recently and some of the issues around the Central Energy Fund as well, played into that. That’s why ultimately, from the smooth running of the tenderpreneur machine, Pravin Gordhan will probably have to bide by Jacob Zuma to get these deals through, to have a reshuffle, and to put someone in place who will sign off on deals like that. Of course, the ultimate one is nuclear, which he has to do whilst he’s still in office. That sort of math on that side of the equation for Jacob Zuma and his faction, makes it quite worrying for investors, I would say.
On the flipside, I think people around Jacob Zuma do know (and are aware of) market reactions more and totally take them into account. There is still underestimation of the impact of sudden investment grade on the economy (or on this tenderpreneur class, even). It’s very finely balanced. Pravin Gordhan’s been successful in the first half of the year, batting back the pushes made against him. Ultimately, Jacob Zuma only has to win one battle in terms of getting rid of (or not) the Finance Minister. It’s going to be a very difficult period after the election when these fights come back into the open again.
You say it so casually, so calmly and yet, the implications of having a tenderpreneur class, which you’ve written about often who are grabbing parts of the public purse are horrific for taxpayers and surely, for economic growth in not just the long term but even in the short and medium term.
Exactly. I think the problem is really that this has certainly arrived in the last ten years or so in a big way, but has always been there beneath the surface. If you think about the South African narrative, it was largely ignored until maybe around two years ago, when the tenderpreneur class idea really came into the open much more strongly. Not even at the start of the Nkandla saga, did people fully realise what was going on. Eskom, SAA, etc…things have just come together very solidly in the last two years. I suppose the problem overall is that this isn’t a big enough destabilising factor on fiscal policies directly, and National Treasury does still have a lot of control. It’s the tail risk in the medium run, if you start taking up a larger share of the budget in terms of inefficient expenditure if you have more risk around guarantees and around the functioning of state-owned enterprises.
For instance, South African Airways not functioning correctly and being a state-owned entity doesn’t particularly matter on a gross scale, overall. It has a small impact but when you’re talking about Eskom paying over the odds for black coal contracts and the optimum coal deal etcetera, then you’ll talk about more impact on growth in the long run and suppressing medium run potential growth.
Isn’t it a cancer though, as we see in many other countries – that when you get this kind of corruption, it eventually only has one conclusion, tears?
I think the interesting thing about South Africa is that the tenderpreneur class is a small band that sits on top of the growth pie. It’s not like Nigeria where you see corruption at every single level and you can’t leave a hotel without someone asking for some payoff or something. There are more reports of traffic cops and things like that in South Africa. It doesn’t feel as widespread of a problem. It doesn’t come up in everyday life in quite the same way that it does in some other African countries. As long as that’s the case (and has been the case over time), I think people downplay it to a certain degree. Ultimately, I think it does feed into the expression of ‘potential growth being suboptimal and below the levels required to lower unemployment’.
Well, today we saw the International Monetary Fund again downgrading its growth forecast for South Africa, to just point-one percent for this year. That’s a long way from what was anticipated before Nenegate. Is this now a reflection of the kind of growth path that can be expected?
Let me think back to this time last year. I think I was assuming maybe one-and-a-half percent. We factored in a big negative shock on investment from Nenegate and then slower global growth. All of these factors have come together and now it’s at zero-point-four percent, showing just a little bit above where the IMF is. The more concerning thing is the continual revision down the medium-run growth. Now, for 2018, we’re only at one-and-a-half percent whereas originally, we were thinking (maybe a year or so ago) of approaching two-and-a-half or above percent. You’re going into a very different situation in terms of the implications for job creation. Of course, that’s what ultimately matters. In the medium run, we’re going from a situation creating 300/400-thousand jobs per quarter back to basically, zero over the medium term horizon.
That’s a very dangerous situation to be in. When you accumulate over time, quarter after quarter of a lack of job creation and a lack of absorption of people coming into the labour force. That’s what worries me in the medium run.
And the population growth rate continues at well above one percent.
Exactly. Per capita income stagnates and that was the point that the IMF was making today – that growth is not catching up with that. For their perspective, that leads to a lot of problems around dead dynamics in the medium run around what happens to the fiscus and that’s why, when you delve into some of these IMF reports, you actually see some worrying/shocking scenarios around where debt GDP would go in the medium run.
Peter, to be brutally honest on this one: we have had a lot of promises coming from Pravin Gordhan. Just last week, he was in London and he told the Financial Times that he doesn’t expect the downgrading to occur (as most other people do) at the end of this year – or definitely, into next year. What’s your reading of all of this?
I think Pravin Gordhan has done a great job of providing a floor under sentiment, particularly for the local business community with his interactions with the President. Arguably, Key 1 GDP growth might have been even worse if he hadn’t been doing that. I think that has definitely been his aim and what he’s been trying to achieve. Really, the test is going to come in the second half of the year. Investors are going to be there on the anniversary of Nenegate, looking back and thinking, “What has actually happened?” We know that things like the MRPDMM and labour reforms are all ‘kind of’ there, waiting to be implemented. The usual political forces outside National Treasury in the Presidency, DTI, and the DMR are still there. They’re still frustrating these reforms really coming through. The most important one I think, is the labour market reforms.
Pravin Gordhan mentioned it in the FT article. The article came out the next day and said that NEDLAC was nowhere near any sort of agreement on labour reforms. I think the issue there is that the minimum wage has been portrayed as a positive reform, which in my eyes, it definitely isn’t – depending of course, on what level you put it at. The COSATU level that’s been talked about (R5,500 per month) is probably going to have a very detrimental impact on the economy in the medium run. It’s not necessarily going to mean mass job layoffs or anything like that but it will mean a more capital-intensive cycle. On the next upswing, we’ll finally get to that for South Africa and it will mean that a large number of unskilled people – currently unemployed or entering the labour market – will be locked out. It’s nice to do comparisons while sitting in London over what a cup of coffee costs here.
The simple fact is that employment is arguably much more important than people’s income level in terms of providing security, being able to get a mortgage or some form of borrowing. We’re still seeing the triumph in South Africa of wage levels over employment and all focus really, should be on employment.
So the downgrade (or potential thereof) …
I still think it can happen in December for S&P, Fitch as well. On this minimum wage point, Fitch has been a lot more negative about highlighting the downside risks from minimum wage. Maybe I’m wavering very slightly, but the problem with S&P is that National Treasury gives a very good spiel on what’s going on, on fiscal policy on reforms. There’s a niggle at the back of my mind. Will S&P give the benefit of the doubt yet again, in December? Arguably, they shouldn’t, given that there’ll potentially be enough other reasons to downgrade. Lowering their GDP forecasts, maybe pencil in a tiny bit of fiscal slippage, or a little bit higher debt-to-GDP. I think that overall, we’re still on the inevitable path towards sub-investment grade if we don’t see the structural reforms coming forward that can boost people’s expectations around medium run growth.
Something that worries South Africans and observers of the situation there is that when Pravin Gordhan came in he was forced upon the Zuma administration (the tenderpreneur faction, as you call it), and he drew some lines in the sand. The first one was with the South African Revenue Services. Well, nothing has happened there. He hasn’t resigned and the guy he wants out, hasn’t resigned either. Now we have all these disclosures that are coming out about South African Airways and how the chairman (who’s very close to Jacob Zuma) was extracting rent. There’s even a number on it – R256m. Yet again, this is something that Pravin Gordhan did promise he was going to address – that he was going to change the board. Nothing’s happened. Don’t people sitting this side of the water at some point in time, start losing patience?
Well, I think people will definitely be testing South Africa on what promises it does deliver. The calculation that must be going on in National Treasury’s head is that keeping the status quo going for now, is not as bad as pressing nuclear buttons or doing anything particularly dramatic. That calculus may well change, depending on what the tenderpreneur faction does in the second half of the year. That’s why the post-local election time is going to be so important as this war that has been surpressed into the local elections between the tenderpreneur camp and the anti-tenderpreneur camp finally bubbles back to a surface. I think we are definitely getting to a crunch point where investors will look for actual deliveries on these various factors, as you mentioned.
We’ve had the bombshell disclosures by the Deputy Finance Minister Mcebisi Jonas, about being offered a job by the Guptas, the Guptas departing…We haven’t had a chance to discuss all of those issues since it happened. Is that relevant in the whole scenario in South Africa or were the Guptas perhaps just a bit part?
I think people overly concentrate on the Guptas. They’re the most obvious example on the surface of alleged tenderpreneurship but I think we have to remember there are many more people’s whose names we probably don’t know, whether it’s at central government, municipal, or local government level involved in contracts. The story in Business Day this morning came out with a new outfit and an unknown in terms of contracts with SAA. I think that’s what makes the story very hard. It’s actually like an iceberg. We see a tiny bit sticking out above the surface. Most of it, we know, is there but we can’t really pinpoint and point at specific people. I think investors for the moment, are obviously supported by global loose monetary policy. In particular, it means focusing on some of these micro details and South Africa is not quite as important. I think that if the Fed is hiking rates at the end of the year…if we get a swash back in the loose monetary policy environment then people will be focusing back a lot more on these domestic idiosyncratic issues such as tenderpreneurship in South Africa.
If the tide goes out (as Warren Buffett says), then we will really see who has been swimming without their trunks.
Peter, what about the knock-on effect of Nenegate? The Rand is still not where it was pre-Nenegate, but bonds have actually recovered now to the level that they were around this time last year. This is being interpreted by certain people as showing that nothing really happened on the 9th of December 2015. Is that your view?
Well, nothing in particular happened on the fiscal policy. We’re roughly where we were before the Nenegate incident. If anything, we have a National Treasury that’s a little bit more focused on tight fiscal policy and trying to achieve that in a very low growth environment. In terms of credit views and for the curve, that has some importance. I think the real problem for the markets though, is in this very loose global monetary policy environment. It’s very hard to play the blow-up stories and to wait, bleeding and rolled down on the bond curve – being short and round, waiting for these events to happen. Even if we assume that everything’s going to blow up at the end of the year with a downgrade; actually, it doesn’t make any sense in terms of risk/reward to be short-run now. That’s what we’ve seen in this very loose monetary policy environment.
There is money flowing into EM funds. People don’t want to see particularly underweight countries like South Africa and so in the last month, you’ve seen all-time record inflows in South Africa for bonds and equities. $4.2bn of inflow into the South African market, just for equities since the 1st of June and that’s just the global environment that we’re in. This is not a South African love story. People are not buying South Africa because they believe in their reform story or in the growth story. This is just South Africa, sitting in a global portfolio management context. As I often say to people, in the rates market there’s the lazy receive, which is when you always want to receive rates thinking they’ll go low in the front end.
They’ll grind two percent lower and then you’ll have a ten percent blow-up when things finally hit the wall. The lesson – very much – for asset managers is there’s no point in trading those events too far in advance, particularly not before the local elections.
If Jacob Zuma were to look at this and say ‘I told you Nenegate was not an issue. I told you I didn’t need Pravin Gordhan and I’ll get rid of him because he has been putting a spanner in my works’, what would the global community’s reaction then be?
I think people do still say that. I think Jacob Zuma does still say that in public about the Rand not particularly reacting and downplaying the impact of downgrades. I think investors would worry a lot that lessons haven’t been learned, that whoever is coming in would have to be viewed very sceptically, and one would assume that whoever is coming in to be the next Finance Minister or Deputy (there might be a reshuffle there first) would have to be there with some particular political agenda. This has been the assumption around Des van Rooyen and his advisors. I think that would be the fear going forward. As we said, in Nenegate in that peak period between Nene and Gordhan, you have to assume that nothing is sacrosanct. You’ve opened Pandora’s box and I think that’s what you will see once again, in the very negative market reaction with long-end yields back to 10:50. With the Dollar/Rand, the Rand will be significantly weaker. I think you will see a very sharp, knee-jerk reaction with less willingness to forgive.
What’s the upside in all of this?
The upside is that the slow, decent, and hard-fought fight that Pravin Gordhan is undertaking is actually successful in every single attempt to intimidate that camp. To try and discredit them is not successful. Politically, the NEC and the ANC understands the winds of change are happening from local election results and becomes more policy-orientated as opposed to non-ideological/non-policy driven, given the dominance of the tenderpreneur camp. You can then shift onto a reform path. You oust Zuma. The person who is put in his place then becomes much more policy-orientated, actually willing to take difficult decisions, understanding the risks around the 2019 election, and the job creation. That’s the upside scenario, which is quite difficult, to be honest. One of the reasons I am negative is because I have mapped various paths through different successors to Jacob Zuma.
I think you don’t particularly, in the long run, end up in that different a place. You need a very fundamental shift in the way the ANC works and the way political capital is deployed from the ANC, to make very difficult decisions happen. For me, that is too fundamental a change.
So the likely scenario…?
It’s that you end up in sub-investment grade eventually anyway, no matter which route you take. Maybe you go via short-term asset market rallies. Say Zuma is fired and Ramaphosa takes over, but then you realise in the medium run that he’s sold out to the unions for instance, and has the backing of too many on the left and policy actually shifts slightly towards the left. Under that scenario, he can’t be his own man and put his own policy in place. The other scenario is the Zuma scenario. You bumble along with the status quo (as with the Mbeki scenario as well). The most interesting and uncertain one of course, is the Mkhize scenario in the middle where potentially, you do have someone who is incredibly politically astute, who maybe can balance forces and allow some structural form to happen. Maybe that’s just trying to find some little optimistic outlet.