Sasfin : Forex Daily Market – SA’s fiscus is still not on a sustainable path

Today’s Talking Point

Budget balance: Dec

Expected: R40bn

Prior: R-21.8bn

Analysis: While the budget deficit in South Africa narrowed in November, the cumulative budget deficit for the current fiscal year widened further. This suggests that SA’s fiscus is still not on a sustainable path, especially with the improvement resting largely on the windfall revenue from high commodity prices and a revision to GDP calculations. Although the rhetoric used in the MTBPS was encouraging, there is little concrete evidence that the government is committed to pushing through much-needed structural reforms aimed at boosting growth while at the same time steering the country towards a more sustainable debt path. Some of the key areas that need to be addressed are the inflated public sector wage bill and the privatisation of SOEs, which for the most part, are a significant burden on the government and will continue to drive the budget deficits wider if left unaddressed.

Rand Update

The past week has been a kind one for the USD. It has surged impressively following the FOMC decision and statement, which confirmed that the Fed would complete its taper by March and could start lifting rates around the same time. Add to that the strong data and earnings results, and there are no downside risks to growth or employment that the Fed has to worry about, implying that the USD could still rally further. Technically, it has smashed through the prior highs achieved in Nov and Dec or 2021 and is now trading at the highs last seen in July 2021. It appears to be an important technical break that opens the door for more such gains in the future.

Concerning the ZAR, yesterday’s MPC decision and statement could be described as a more dovish hike. Although it met market expectations of a 25bp hike, year-end repo estimates for the year were revised lower in the QPM despite near-term inflation being revised higher, while growth estimates were also lowered. SARB Gov Kganyago indicated that the SARB would look through the temporary price shock and made it clear that while headline inflation was high and rising, core inflation was still low and comfortably below the midpoint of the inflation target range. If anything, investors would be forgiven for believing that the SARB might be able to keep monetary policy more accommodative than what is reflected in the QPM. On the forecasts of the QPM, Kganyago added that it was but just one input into the MPC meeting and did not dictate what decisions the committee should make.

The result was a ZAR that came under pressure, although that is more likely a function of a surging USD than it is anything that the SARB said or did. Emerging markets more broadly have been under pressure, and the rise in the volatility of equity markets has been a catalyst for rotation away from EMs and back towards safe-haven assets. In other words, this is not a ZAR specific development rather than a broader USD and emerging market one.

Bond Update

The South African Reserve Bank (SARB) raised interest rates by another 25bp at yesterday’s monetary policy meeting, bringing the benchmark repurchase rate to 4.0% and the prime lending rate to 7.5%. This was generally in line with guidance as rates remained highly stimulatory from the central bank’s perspective. An outlook for further tightening was communicated, although the bank also highlighted that growth risks persist when looking ahead.

There are several reasons to think that SA’s structurally fragile economy could underperform its potential in coming years, with business investment levels exceptionally weak, the labour market under pressure and the government’s balance sheet bloated. Inflation risks were nevertheless assessed as being to the upside, mainly owing to the costs administered by government institutions such as Eskom. A 14.5% increase in electricity prices has been pencilled in. The bank’s forecast nevertheless suggests that inflation will have peaked in Q1, moderating in 2022 from an average of 5.6% in Q1 to 4.3% in Q4.

Note that despite weak growth and moderating inflation, a higher rate outlook persists due to real interest rates being deeply in negative territory. The quarterly projection model (QPM) assumes a “neutral real rate” of 2.3% for the next two years and a CPI assumption of 4.3% in Q4 (4.6% for 2022 as a whole), suggesting that rates could rise to 6.6% (2.3% + 4.3%) by the end of 2022 while still being assessed as accommodative. Despite an effective target of 6.6%, the QPM’s cognition of growth risks was represented in its repo rate forecast, which was downwardly revised to 4.91% by the end of 2022. This also suggests that rates will remain in accommodative territory by nearly 1.7 percentage points.

The Q4 2023 average inflation assumption of 4.6% y/y suggests that the bank considers 6.9% to be the “neutral rate” target for 2023. Therefore, its repo rate forecast of 5.84% by the end of 2023 also remains reflective of sub-optimal growth conditions. Kganyago again highlighted that the QPM forecast was but one input into the SARB’s decision process, suggesting that policymakers remain ready to manoeuvre in accordance with a range of factors not necessarily reflected in the model. By definition, a model is a simplified version of reality, after all. The need for structural reform was also mentioned, with government debt levels and administered price increases referenced.

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