Where is the SA economy heading? A view from 24 August 2016

Presentation to Society for Worldwide Interbank

Financial Telecommunication (SWIFT)

Ian Cruickshanks - Chief Economist

Centre for Risk Analysis

SA Institute of Race Relations

Economic outlook

What does current data mean to us?

Current period - greatest economic uncertainty since 1994.

No simple or even complex certain answers.

Understand current business climate, future risks.

Forced to proceed within our own “discomfort zone”, only certainty is

uncertainty.

Economics – dismal science – NO

Art appreciation in eye of beholder – Pierneef/Picasso.

Will not adopt classic economists’ traditional comments- “on the

one/ other hand” not a view but an escape route/ weather forecast.

Or- “all things being equal” –SA remains unbalanced, unfair and

unequal- still a long journey to equal opportunity for all – right

direction?

Understand challenges in Sub-Saharan African investment

infrastructure.

World economic outlook (IMF* July 2016) – interesting, worrying

Estimates % p.a.

*historically over-optimistic.

GDP/World Economy

US: 21% - Post financial crisis recovery slows

China: 12% - Industrial, consumer led consolidation

Africa: 3 % - Awaiting commodities cycle upturn

SA: < 1% - Awaiting commodities cycle/ African upturn

Global DM EM SA SSA

GDP 2015 +2.4 +3.1 +4.0 +1.3 +3.3

2016 +3.1 +3.1 +4.1 +0.1 +1.6

CPI 2015 +0.2 +6.0 +4.8

2016 +1.5 +4.7 +6.2

1996/2014 - SA GDP av. growth +3,2% p.a.

- Emerging Markets +5,6% p.a.

- World markets +3,6% p.a.

Electricity shortages, weak domestic demand, labour disruption, drought

Finance Minister Gordhan – 2016 growth subdued.

SARB Deputy Governor Daniel Mnele - I.C forecast possible

- Recession prospects increasing.

Government remains pre-occupied with redressing previous social

imbalances resulting in inefficient utilisation of resources.

SA overwhelmed by corruption, crime and inadequate service delivery --

- social unrest.

Finance Minister – “What has happened to honesty and integrity in

business?” Far too much corruption !

Municipal elections – Reality Check – Electorate crossing the floor.

Confirmation of change - started, continuity?

Urgent need for structural changes- President Zuma – R900billion

infrastructure developments, 5 million new jobs – fantasy ! !

Remains delayed as does robust growth.

Risk of stagflation – worst case outlook.

Commodities super-cycle follows oil – supply glut, protect market

share, low new development.

Limited SA export prospects.

Low domestic growth cycle.

Economic activity likely “weaker for longer”, lack of “robust

improvement” in advanced economies.

Following November 2001 (9/11) US terrorist attacks - 2002/2007 easy

credit party and subsequent bank credit crises.

Still grappling with extended global hangover from 2008/9 global

financial crisis – Lehman Brothers failed (not too big to fail).

Massive liquidity injections – “No quick fix.” – liquidity underutilised.

Global view

• SA – African Bank unsecured lending/Ellerines

• Investment priority – Return OF capital vs Return ON capital.

• “Too good to be true, probably is!”

Risk appetites slashed – skewed values – search for yield in bonds and

equities (safe havens – USD, CHF), negative interest rates.

SA foreign capital inflow risks reversal, JSE foreign capital flows – hot

money – 2016 – Equities: - R77bn

Bonds: + R64bn

Total outflow: - R13bn

Investor’s strategy primarily to avoid loss, rather than bold strategy to

maximise profit potential.

Global Central Banks

US Federal Open Market Committee (FOMC) asset purchase

programme – total QE $3tr. +/-, awaiting significant economic data

recovery (labour market, inflation, economic activity) - rate trend

reversal likely 2017 - moving goal posts – CPI targets.

European Central Bank President Draghi “do whatever it takes to

preserve the euro” – lower/negative interest rates for longer as low

economic activity persists.

Policies support record low interest rates and low volatility –

value being squeezed – credit spreads too tight- US 10 year

treasury yield 1,50%, Spain 10 year yield 1,0% - risk markets

could unravel when rate cycle turns.

Sub-Saharan Africa business environment

In Africa Global

Ease of doing business South Africa 2 35

Nigeria 19 133

Kenya 12 109

Global competitiveness South Africa 2 50

Nigeria 22 127

Kenya 11 102

Corruption perception South Africa * 8 64

Nigeria 37 143

Kenya 44 154

*Transparency International sees SA as condoning unethical practices.

• SA downgraded from Africa’s largest economy to no. 3

after Nigeria and Egypt.

• SA recovers no. 1 African position as currency recovers. Nigeria naira collapses, economy shrinks.

• SA remains Africa’s financial services centre. Gateway to development in Africa.

South African Domestic challenges

Unstable labour force- demand for higher wages for “decent work” not linked to

productivity, employment should be a privilege not a right – Asian work ethic.

Likely further economic isolation, rand depreciation, rising unit production costs,

less globally price competitive, lower production volumes, risk of less

investment, lower profitability, job losses, capital flight (vicious cycle).

Should be rate for the job based on value creation- no minimum- lower unit

costs- raise revenue, profitability, attract new capital investment and job

creation- benefit consumer spending, financial services, promote growth

economy (virtuous cycle) – unlikely short term.

Fixed Capital Investment Strategies

Government leads in job creation but with less operating efficiency- job

seekers’ preference.

Private sector likely to increase automation – fewer, skilled/ better paid

jobs.

Unskilled sector facing widespread retrenchments.

Lose basic operators- petrol jockeys, shopping packers-

Is SA ready?

Likely further government business regulation

(participation/interference) – less efficiency.

Inevitable higher unemployment .

• Increased demand for social unemployment grants- divert funds away

from infrastructural development towards focus on “fair wage and

decent work” ? inefficient capital utilisation.

Result – slower growth.

Higher budget deficit as government revenue moves ex growth.

Higher production cost base, lower exports, higher trade and current

account deficits.

Weaker ZAR – SARB Governor Gill Marcus’s quote on CPI / Monetary

policy

Temporary higher export ZAR earnings, but higher CAPEX costs

Rising producer/ consumer inflation - Higher interest rates.

Slower economic activity- stagflation- possible 2016 H2.

Sovereign investment downgrade.

Alternative

Develop public/private partnerships.

Education- reintroduce trade schools and apprenticeship system-

create employment - brick-layers, carpenters, electricians, plumbers.

Broad base bottom up system vs Dep. Pres. Cyril Ramaphosa top -

down – 20 PHD’s

New economic base for consumer spending upturn.

Restore self-sufficiency and dignity.

Stimulate new growth era.

Short-term - Unlikely!

Political Preference • ANC preference - socialism, centralised control ( +SACP, trade

unions), marginalise private sector.

• ANC National Executive Committee (NEC) post-election strategy (August 15 – 18).

• ANC leadership above criticism – President “not part of the problem”. Not on agenda. SA has good story to tell – NO!!

• “Reprioritise budget towards job creation, poverty reduction.”

SA services achievements • Formal housing – 2014 - 12.4m (1996 - 5.8m)

Electricity 2014 - 91% (1996 – 58%) Water 2014 - 90% (1996 – 83%) Sanitation 2014 - 80% (2002 – 62%)

• Long-term positive economic impact.

Political change

1985/1990- shift from political right to centre, saved SA from complete

isolation.

2015/2019- shift from political left towards centre – possible positive

move – DE/EFF co-operation.

Alternative - shift further left towards socialism, communism, central

planning – failed model, economic disaster e.g. USSR & Zimbabwe (failed

state).

Government

Must include more business leaders.

Realise destructive reality of recent policies.

Adopt commercial possibilities of National Development Plan,

avoid National Democratic Revolution.

Prepare for leadership change –

When? Economy must endure further squeezing, live in discomfort zone

until 2019.

Alternative - SA condemned to marginal economic change, social desperation on rising unemployment. (Not 25% should be 35%+). Youth 15-25 years unemployment over 60% – potential for unrest. To ignore this would be naïve.

Investment outlook – financial markets

JSE reflects global liquidity, SA corporate forex earnings.

Beware value risk – ALSI P/E 21x, L/T av P/E 14.5x.

Rising interest rates – estimate +25bp in 2017 Q1 – Likely negative

corporate/consumer impact.

Outlook – positive factors

SA - African management record.

Sandton infrastructure (cranes/ development),Cape Town foreshore

developments, financial services, communication, football stadiums,

national roads,

Captains of industry,

Climate,

Golf courses.

Foreign capital flows ? May take time to follow.

Gateway to Africa- exploit resources of African continent, utilise SA

expertise.

Await commodities cycle recovery.

Summary

Outlook short to medium-term remains – be prepared further tough

times

(1 -3 years).

Longer-term – sense should prevail?

Alternative Zimbabwe (failed state) – Absolute control over bankrupt

economy preferred to shared democracy – chaos ! !

Thank you for your attention.

Questions?

Ian Cruickshanks

Chief Economist, South African Institute of Race Relations

ian@sairr.org.za

011 482 7221 ext. 2008

083 326 0026