London-based economic research firm Capital Economics said investors are underestimating the possibility of SA’s public finances deteriorating further after 2024’s elections, causing increased risk premiums of the country’s equity market, with weakness in the Chinese economy another headwind.
Thomas Mathews, senior markets economist at Capital Economics, said growing concerns about the direction of SA’s public finances have caused the bond yield curve to steepen as risk premiums have risen, a trend that may continue as the elections approach.
“We suspect investors are also underestimating the prospects for SA’s fiscal position to deteriorate after next year’s election,” Mathews said.
“We also think investors are underestimating fiscal and banking risks in some major emerging markets, including India, Brazil and SA, and expect that to push premiums up a bit further. One key exception to this is China’s stock market, where a lot of bad news already looks priced in.”
There was some reprieve for China’s economy on Friday when data showed industrial output and retail sales grew year on year in August. However, weakness in the property market remains.
Signs that China’s economy regained momentum in August, and minor cuts to bank reserve requirements boosted industrial metals prices, with the price of iron ore rising nearly 6% last week.
This caused shares in SA’s biggest iron ore producer, Kumba, to rise more than 16% last week. However, Mathews said the rally in iron ore prices is on borrowed time.
“Steel production should continue to fall back in the final months of the year due to a combination of emissions-related curbs and fading steel demand,” Mathews said.
“Policymakers’ efforts to prop up the renminbi and the yen are not enough to generate a lasting turnaround. But they will probably do enough to buy time until US interest rate expectations and Treasury yields fall back and the dollar depreciates of its own accord.”
China’s economic fortunes are intractably linked to that of SA. The world’s second-largest economy is a big buyer of SA commodities.
The Asian giant is also the world’s largest commodity consumer, and this demand is key for prices, another important factor for SA, with the rand largely a commodities currency.
“With China’s economy floundering, the picture for industrial metal demand doesn’t look great to us either, even if economic growth in developed market economies may help prices hold up,” Mathews said.
The effect of the slowdown in the Chinese economy on SA’s equities was highlighted in the JSE’s performance in August.
Mining stocks were the biggest drag, shedding more than 10% as weak Chinese demand hit metal prices.
Platinum miners on the local bourse took the biggest hit, shedding 20%, according to Anchor Capital. The domestic market is expected to remain on edge in the lead up to the medium-term budget policy statement, slated for November 1. Finance minister Enoch Godongwana is said to be trying to convince his cabinet colleagues that deep cuts in spending are needed to avoid a public debt crisis.
Balancing act
Nolan Wapenaar, co-chief investment officer at Anchor Capital, said Godongwana has a difficult balancing act, and the market will react extremely negatively to any budget based on wishful thinking and promises of economic growth.
“The government will need to rein in spending close to an election year, which will be highly unpopular with politicians, in an attempt to keep the ship afloat. Increasing taxation in an already highly taxed country with poor government service delivery will be difficult, but we should expect the government to try,” said Wapenaar.
David Omojomolo, Africa economist at Capital Economics, said as the elections come into view, the focus on SA’s public finances will only intensify.
“Not only is there likely to be a further tilt away from austerity as the ANC looks to bolster support, but there is the real possibility that the party loses its majority and ends up in coalition with the left-wing EFF.
“In that scenario, radical and costly proposals such as a basic income grant could come under more serious consideration,” he said.
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