Holborn Assets believes that the slowdown in the global economy will remain soft and the implication will be felt on South Africa’s ability to recover from an anemic third-quarter growth of only 0.7%, which makes us expect a slightly weaker outcome in 2016, we now expect a GDP growth of only 1.2% in 2016.
Emerging markets and especially South Africa is going to soon become another reminder of just how fragile the global financial system is, if it’s not already showing these signs in various outlets.
Interest rates and Inflation
During the last week of January, the South African Reserve Bank raised the benchmark rate by 0.50% to 6.75%. While this hike was within the consensus view, Holborn Assets thinks that this is just the beginning of a longer and more pronounced hiking cycle. We also believe that in terms of magnitude, a lot will be dictated by inflation expectations.
The South African Rand has lost more than 14% since the last MPC meeting and while this wasn’t a major factor in the MPC decision-making process it did play a part, this was coupled with a worsening inflation rate with food inflation surprising to the upside.
Holborn Assets thinks that given the change in expectations in terms of inflation, the stance taken by the Central Bank is definitely the correct one. Holborn also thinks that the hawkish statement delivered recently by the RBNZ, does serve as an indication that you know there is more to come. If one looks at the revisions the Central Bank is now expecting, it shows that inflation is to be outside the target band for a longer time. than previously expected.
We’re quite pessimistic on food prices as the RBNZ has revised the food forecast upward quite significantly, so we think that the stance taken by the RBNZ is definitely the correct one. Our forecast is for inflation to pick up to 6% by the end of 2016, driven mainly by a weaker Rand and drought-induced rise in food prices.
We also have to take into consideration that South Africa is under the watchful eye of rating agencies and they want to see policies moving in the right direction and to see restrictive fiscal policies. Holborn Assets thinks that the next couple of years is going to be very difficult and despite the weak growth outlook, the government is likely to stay on their path and lower expenditures.
China and Lower Commodity Prices
The Chinese economic slowdown alongside the lower commodity prices has been the two most prominent drivers of market instability and a subdued outlook for the South Africa economy. China is, without doubt, the most prominent of the threats in this big picture assessment and when we look at China, we know how important its economy is because it’s number two in the world and it’s South Africa’s biggest trading partner.
China is obviously the source of all these conversations about whether they are going to have a soft or a hard landing and Holborn Assets believes that due to the enormous amount of unsustainable debt and persistent capital outflow, the Chinese economy is in for a hard landing in 2016, which will export deflation not just to the South African Markets, but to the entire world as well. In 2015, an estimated $930 billion has left China.
South Africa AGOA Trade Benefits
South Africa has a deadline until 15th March to comply with the USA’s demands otherwise the duty-free access of South Africa agricultural exports can be removed. Holborn Assets thinks that South Africa will be able to pass over the AGOA (The African Growth and Opportunity Act) dispute and will continue to benefit its exports. We believe that under the AGOA act, South Africa will be able to maintain the current trade balance surplus. Under the AGOA act, South Africa was able to export more than 7000 products, with the vegetable products being the fastest-growing industry, which is currently up 550% since 2010. The agricultural good under the AGOA act accounted for more than 14% of total South African exports or about $154 million.
The South African Rand was the third worst performing major currency in 2015, after depreciating more than 26% in 2015, and continued to hit new historical lows in the first week of trading in 2016. With the Chinese economic slowdown and lower commodity prices, we believe that even though the Rand has dropped aggressively, this trend will continue to persist in 2016 as well. We still expect the global risk-off environment coupled with the Fed tightening cycle to put downside pressure on the Rand.
With the broad based US Dollar strength and the direct exposure South Africa is having through its big chunk of US Dollar denominated debt, Holborn Assets believes South Africa will be forced to seek help from the IMF in 2016, which is going to be a market driver of higher volatility and unpredictable currency exchange rates. In our forecast, we see the USD to ZAR exchange rate potentially hitting 19.0000.