Macroeconomic update 2016Q1: Weak rand has placed the economy in danger of recession
Wednesday, February 10th, 2016
By Russell Lamberti, Chief Strategist: ETM Analytics
Graph of the quarter
The extent of the rand’s depreciation in December and January has superseded even the most bearish short-term expectations of market analysts. The move is strongly reminiscent of previous blowouts and the top in the rand/dollar exchange rate is a now largely a guessing game. Putting the rand in a long-term context (chart below) suggests the current move is yet to match up to the early 80s and late 90s rand sell-offs. This should be cause for concern that perhaps worse is still to come. Also, such sharp rand depreciation is bad news for the SA economy and raises substantially the odds of a recession in 2016.
Key macroeconomic developments: Q4 2015
Without a doubt Q4 2015 will be remembered for President Zuma’s ill-advised sacking of finance minister Nhlanhla Nene in December only to backtrack on his decision three days later and appoint Nene’s predecessor Pravin Gordhan. The political blunder did huge damage to investor, business and consumer confidence as the rand plummeted in value. This followed on the heels of a credit ratings downgrade, leaving South Africa facing near-certain ‘junk’ grade status unless a dramatic fiscal turnaround takes place. The overwhelming focus in Q4 and early 2016 is the rand exchange rate. Such volatility in the currency is not good news for investment and hiring activity as companies turn conservative to protect cash flows.
- Electricity output increased 2,8% in the three months to November, but was still 2,9% below its levels at the start of 2015.
- Barclays PMI ended the year at 45,5, well down from 49,9 at the end of Q3 2015. The Standard Bank PMI ended Q4 at 49,1, up from 47,9 three months earlier. Official manufacturing output fell 0,8% in the three months to November and remains stagnant since 2012.
- Mining output was exactly flat on the quarter and remains roughly stagnant since 2009.
- Building plans completed according to Stats SA fell 6,3% y/y in October and have stagnated since 2012.
- Total vehicle sales volumes fell 4,3% y/y in Q4 2015. Seasonally adjusted passenger car sales climbed 5,9% q/q, but were still down 7,6% y/y.
- CPI inflation edged higher to 4,8% y/y in November from 4,6% three months earlier.
- Retail sales increased by an annualised rate of 1,6% in the three months to October.
- Road and rail freight tonnage was down 6,2% y/y in October.
- The official unemployment rate increased from 25,0% in Q2 2015 to 25,5% in Q3.
Standard & Poor’s downgraded SA’s credit rating outlook to negative in December, which means that its next ratings action will most likely be to classify SA as sub-investment grade. Economic growth is the major gripe for the agencies and in this regard the outlook remains bleak with limited budgetary space for government to provide support. Increasingly attention turns towards the need for policy reform, which government has been loath to implement.
Business cycle and growth
The present rate of rand depreciation is consistent with business cycle downturns as determined by the SARB. A sharply weakening and volatile currency wreaks havoc with business and financial conditions. Import costs escalate dramatically, which encumbers a small open economy. Manufacturing rarely benefits on the whole since the imported component in manufacturing is so large. Interest rate risk escalates as the SARB is forced to contain rand depreciation and inflation risks by hiking interest rates.
Inflation and currency
Although nothing dictates that the present rand bear market has to conform to previous bear markets, it is nonetheless instructive that the current bear cycle is now becoming quite mature by historical standards in terms of both duration and the extent of depreciation. This does not, however, preclude another 25% depreciation and the bear cycle extending through 2016. A 70% fall from the late 2010 highs implies a USD-ZAR at ~R22/$. The rand is facing similar problems as it did in the previous bear cycles, and in large measure: A global dollar bull cycle, rising political risk perceptions, elevated fiscal risk perceptions, low/falling commodity prices, and capital expatriation. The SA economy has rarely, if ever, been more fragile, or commitment among capital allocators more brittle.
Slowing car sales foreshadow more difficult conditions in the broader retail sector. In the chart below, car sales growth leads overall retail sales growth by around six months (reflected in the lagged retail sales line). The implication is that retail sales volumes are going to level off and then possibly contract as 2016 unfolds.
Meanwhile, the present rate of rand depreciation is also consistent with retail slumps. Import costs escalate dramatically, business and credit conditions worsen and prices of imported goods inflate faster. Retail volumes inevitably tend to suffer. In the chart below retail sales also lag six months behind year-on-year changes in the trade-weighted rand exchange rate.
Corporate and productive health
Manufacturing, on the whole, seldom benefits from rand depreciation. Local export competitiveness brought about by a weaker exchange rate is offset by numerous factors, including more expensive imported inputs, higher domestic goods and wage inflation, higher interest rates, weaker global demand growth and investment uncertainty due to higher currency volatility. We find that, if anything, manufacturing output responds positively to rand strength, and negatively to rand weakness, on a 6–12 month lag. In short, rand weakness is very unlikely to pull manufacturing out of its prolonged slump and is more likely to drag manufacturing weaker by the end of 2016.