Can the GNU fix inflation, interest rates and the rand?
The big question South Africa-based asset managers and investment advisers want answered halfway through 2024 is whether the country’s recently established government of national unity (GNU) will deliver on its promised economic and political reforms or fizzle out like so many of the country’s previous false starts. To find answers, your writer attended the economic overview component of the Sanlam Investments H1 Fund Update webinar series.
Backing economic reforms
“The most important factor to note is that we now have a government that has chosen a reform path,” said the fund manager’s Chief Economist, Arthur Kamp, as he delved into South Africa’s prospects. He added that over two-thirds of GNU participants were centrist in their thinking and supported the Constitution. This loose alliance of parties holding extremely disparate views will face a number of tests in the coming years, not least of which the next local elections in 2026, and the 2027 African National Congress (ANC) party elections.
These potential hiccups aside, South Africans are desperate for the economic growth and jobs windfall that should accompany sensible policymaking and a narrower focus on delivering on the programmes shortlisted under government’s Operation Vulindlela. Kamp held some hope that the GNU might bump the domestic economy out of its decades-long ‘negative doom loop’. You can think of the doom loop as a list of cause-and-effect macro measures causing a whirlpool, with the good ship South Africa Inc gradually being drawn into its centre. Or you could go with Kamp’s detailed explainer.
The economist commented that the country’s negative doom loop had started with a sustained decline in foreign capital inflows coupled with serious maintenance-related infrastructure problems. These factors combined to limit the country’s potential economic growth, weighing on the all-important unemployment statistics, and bringing significant pressure to bear on government finances. “[This doom loop] increased unemployment rates [and the number of] people dependent on the state; lowered economic growth and state revenue; and resulted in larger budget deficits and a rising debt ratio,” Kamp said. But it does not end there.
The negative doom loop conundrum
The negative doom loop continues with ratings agency downgrades; upward pressure on interest rates; and a much weaker local currency. “Higher interest rates make the private sector invest less; the private sector is crowded out of the economy, and you get further declines in economic growth and lower foreign capital inflows,” he said. In this context, the biggest risk to the economy is that populist policies take centre stage, and that government attempts to correct its economic woes through increased social spending which in turn contributes to fiscal issues.
“The GNU gives us the opportunity to shift away from [this path] with reforms [taking the country] onto a higher growth path,” Kamp said, before using unemployment estimates to illustrate high- and low-road GDP growth outcomes. He argued that South Africa could reduce its current mid-30% unemployment ratio to just 20% by growing the economy by 5% per annum over the next decade. If, however, the growth stumbles along at 1% for that period, unemployment will bubble higher, to 40% or worse. To temper expectations, the economist suggested that South Africa could start moving in a positive direction by aiming for an achievable 3% annual GDP growth over the short-term.
Discussions on GDP growth and unemployment are kind of ‘big picture’ in the financial advice realm. After all, your clients are more impacted by the day-to-day tangibles such as interest rates, inflation, and foreign currency crosses. Kamp kicked off coverage of these ‘basic’ measures by putting the rand under the microscope. He offered various factors including higher interest rates in the United States; lacklustre domestic growth on the back of infrastructure-related logistics constraints; and poor commodity prices to declare the rand was “trading more or less where it should be”. PS, the dreaded Financial Action Task Force (FATF) grey listing has not helped.
Some purchasing price parity promise
There is some upside over the longer term. “We are a small, open economy and over time you would expect the currency to move in line with the inflation differentials with its larger trading partners,” Kamp said. Pointing the audience to a chart of rand-dollar purchasing price parity, the economist hinted that the rand was two standard deviations off its fair value. He said the FATF grey listing; BRICS-aligned international policy; and global economic uncertainty had prevented the rand’s usual recovery following domestic interest rate hiking cycles. “When the South African Reserve Bank (SARB) responds and starts hiking interest rates you normally see the currency stabilising; it has not quite come back as firmly and as soon as it has on previous occasions,” he said.
One hope for South Africa Inc is that the global obsession with transitioning away from fossil fuels could rekindle demand, and prices, for certain metals and minerals. Another is that the US Federal Reserve will finally start cutting interest rates, triggering a round of rate-cutting action by central banks worldwide. “The current Federal Funds rate is at around 5.25%, a long way above the desired 3.5%, which indicates that the Fed has a significant amount of room to cut interest rates,” Kamp said. He added that although the SARB did not follow the Fed, US rates were part of its decision-making toolset. US rate cuts will relieve some of the pressure on the rand.
The domestic inflation outlook seems benign too, and Sanlam Investments says the core inflation of 4.6% is not too far off the 4.5%. Headline inflation is a bit stickier, at 5.2%, but still safely within the SARB 3-6% target range. The SARB decided to keep interest rates unchanged at its July 2024 meeting, but Kamp reckons if inflation anchors at around 4.5% over the medium term, they will have space to start cutting interest rates, soon. The food price component of the inflation basket could also get a boost from lower food prices on the back of better crops as the country moves away from the drier El Nino towards a wetter La Nina weather cycle.
Rate respite still a year away?
The economist was not as enthusiastic about interest rate cuts as your writer expected him to be. And it looks like you might have to wait deep into 2025 for a mere 75 basis point total cut, taking the Repo rate from its current 8.25% to 7.5%. “These cuts will give local households a little bit of relief [and coupled] with lower inflation, perhaps offer some improvements in real income growth to help get the cycle going; but the medium-term outlook depends very much on government implementing Operation Vulindlela effectively,” Kamp concluded.
This programme, if properly effected, could get GDP growth back in the 2-3% channel, taking pressure off the fiscus, and setting the country back on the straight and narrow.
Writer’s thoughts:
Interest rates and inflation have immediate and long-term impacts on your clients. In the short-term, interest rates deplete household incomes, while inflation erodes the future value of each rand saved for retirement. Do you think your clients can survive another year at the current 8.25% Repo rate? Please comment below, interact with us on X at @fanews_online or email us your thoughts editor@fanews.co.za.
