SA's deeply entrenched socio-economic problems need urgent attention

Domestic economic growth will remain under strain as a result of negative fallout from industrial action, and weak demand from the country’s main trading partners.

The European sovereign debt crisis will limit manufactured exports, and slower growth in China will temper demand for locally extracted minerals. Risks that South Africa’s credit rating will come under pressure in the near term have increased with deeply entrenched socio-economic problems requiring urgent attention,” said Francois van der Merwe, Head of Macro Research at Novare Investments.

The government’s ability to respond to subdued growth is constrained by budget deficit forecasts that have increased in line with the intention to use public sector spending to keep economic activity afloat. South Africa, which already has one of the highest debt levels amongst its emerging market peers, will have to reign in the budget deficit sooner rather than later.

Van der Merwe added: “The Reserve Bank will have less scope to offer more accommodative monetary policy due to upside inflationary pressures, the recent weakness in the currency and a widening current account deficit.

“The pick-up in inflation due to higher food and fuel prices and the depreciation in the currency is expected to remain, while the current account deficit is likely to persist due to export growth lagging import demand. In terms of financing the current account deficit, the rand will be under pressure to depreciate should portfolio inflows not continue.”

Another problem is that consumers are under pressure from weaker growth in real disposable income and, as a result, are not expected to be one of the main drivers of domestic GDP growth, which the IMF has forecast at 2.6% for this year and 3% for 2013.

Although the equity market remains attractive compared to money market investments from a dividend yield perspective, the sharp recent run in the local market means prices are looking fairly valued.

“Company earnings outside of the resources sector are expected to remain resilient, but given the economic backdrop, that might prove to be somewhat optimistic,” commented van der Merwe.

“We remain concerned over the valuation levels of domestic bonds and waning support received from inclusion in the international bond index. The probability of another interest rate cut, despite the poor growth conditions, has diminished and upside inflation pressures pose further risks to the bond market outlook.

“On top of that, we have concerns that the government will struggle to keep the fiscal deficit in check. The listed property market will take its lead from the bond market, but investors in international assets could benefit from potential rand weakness.”