South Africa - Solidarity and the Post-Covid Opportunity

It is almost two months into what is perhaps the most severe crisis facing South Africa since Apartheid. Market participants are trying to imagine what the future holds, but we can all agree that whatever version we hold, some level of a dystopian existence is expected. Globally, economies are expected to start reopening, even without a full understanding of the Covid-19 virus. One can only argue that governments’ have had to face up to the cruel trade-off between the spread of Covid-19 and the detrimental long term economic impact of prolonged lockdowns. South Africa was already on the economic skids, COVID is the iceberg. The economic hit we were expecting has arrived, and as much as the government nobly responds, the lost years of policy reform will certainly come to the fore as we enter what is likely to be a multi-year economic decline. 

Domestically, both the SARB and Treasury have responded with policy measures that should provide some relief, but will it be enough? Beyond that the stock-specific news is broadly negative with dividends being put on hold, and forward-looking guidance being trashed by management teams. It means they know as much as you do, which is not a lot right now. The quantum of slow to no commercial activity is difficult to calculate, especially in the future. Investors have reacted by chasing predictability, as has been the case globally. JSE Technology Index is up 24.57% year to date, the Consumer Goods index is close to flat, Basic Materials have staged a sort of recovery, and leading the pack is the Gold Index up 74.7% year to date. This might have a lot to do with the rand and a global flight to safety, the former suffering a severe sell-off after Moody’s finally downgraded the SA sovereign to junk.

For many sophisticated investors and policymakers, the downgrade was seen as a stab in the back, but perhaps there is another narrative to consider, especially if one accepts that the downgrade in itself was inevitable. Just contemplate for a moment if the downgrade had occurred under normalised conditions (ex-COVID) – the solidarity the President has spent the last 6 weeks edifying, would be non-existent. Ramaphosa protagonists within the ruling party and the opposition would have politicised the downgrade and made South Africa’s politics more precarious and noisier. Thus, the receipt of junk status amid COVID has in some way saved the country from an all-mighty political squabble and so COVID should be credited for present political unity, which the administration should aggressively exploit as a window of opportunity needed to make the tough decisions as a way of preparing a stronger developmental narrative post-Covid. That said, the downgrade remains an indication of the almost incurable character of the South African Economy. 

The fall of the oil price has been another saving grace, as it has offset whatever damage was going to be done by the potential inflation pass through. Pump prices were at the higher end of R15/ltr before the COVID lockdown, now their trading in the middle of R13/ltr and could come lower. It might not seem like a lot but an R2 saving per litre for households could be material, and as that feeds into the SARB’s inflation model, we could perhaps see additional interest rates cuts beyond the 225bps already gifted to South African households. Inflation in South Africa was already heading toward the lower band (3% - 6%) at 4.1% for March and with the repo rate at 4.5% real rates are not far from ZERO. Despite the positives, there are serious structural issues that face the economy, and the monetary and fiscal responses also exacerbate some of the negatives. 

There is limited evidence in the developing world of lower rates being converted into higher economic activity, and one also needs to consider the shifts in socio-economic behaviour that will occur in the context of a COVID threatened world. While lower interest rates are welcomed as a form stimulus, pervasive inequality in South Africa is likely to increase. The majority of South African households are living hand-to-mouth (household debt to income 80% Dec-19), lower rates make it harder for those who might be able to save a little to get a decent return. These households have no hope of wealth accumulation. More importantly, lower rates are supposed to spur growth and real wage increases, but entering into COVID, SA real wage growth had already stalled. The risk is that poor wages outcomes are here to stay, the young who dominate the unemployed demographic cannot find jobs, and post-COVID new jobs will likely be low paying. Without a robust middle class with a propensity to borrow more under present monetary conditions the expected boost in demand is not likely to materialise. Within the context of inequality, it is suggested by experts that a weak transmission mechanism serves as one of the major causes of monetary policy ineffectiveness. Not much needs to be said about the upper-middle class and the one percenter’s, except that the inequality gap will probably widen in the medium to long-term. 

The fiscal response of R500bln has been engineered in such a way as to avoid material debt outcomes. Funding is being allocated toward propping up business, creating jobs, and subsidizing wages. Some calculations suggest that the daily national lockdown cost is around R14bln per day. Beyond questions around the efficient allocation of funds, is the R500bln (10% of GDP) enough, and does it consider longer-term structural challenges. Some of the funding will go toward propping up Social Security payments for a period of six months. What happens when the additional payments cease, in an environment of lower economic activity? One should expect that some of these short-term measures will very difficult to unwind at expiry; how do you ask 18 million unemployed recipients of social grants to take a pay-cut. No doubt the macro-fiscal metrics will deteriorate with lower tax revenues, lower exports, and lower consumer activity, leading to a greater need to borrow down the road. To answer the question R500bln is not going to be enough. 

The question we should be asking ourselves, over and above a return to economic normality is whether negative trend growth in unemployment and productivity can be reversed. Within the backdrop of COVID, the state should be making considerations which go further than just survival of the economy, but the next wave of economic growth. It requires gross acknowledgment that there exists a misallocation of physical and human capital, a lack of competition in many sectors, a widening informal economy, this over and above still high levels of corruption. In response, South Africa requires trade openness, more and better-quality infrastructure, economic institutions that promote competitiveness across sectors, and encouragement of innovation and entrepreneurship. 

COVID has fostered unity, in the form of ‘solidarity’, it’s a small window of opportunity where this consensus can be used to initiate the right policy measures which secure positive future economic outcomes. The alternative is to stay as we are and continue to deteriorate, disease, or not.