ECONOMIC AND MARKET OVERVIEW
Global
Macroeconomic indicators published during July confirmed what investment markets pointed to in the middle of March – a significant reduction in global economic output.
The next question is, of course, how quickly economies will recover after the global lockdown in the second quarter, as this will have a significant impact on the profitability of companies around the world. The sustainability of the recovery in equity markets will be tested as more information about economic activity is published in the coming weeks and months.
With every significant economy hit by the Covid-19 pandemic and the associated limitations on the movement of people and goods, it was no real surprise that Gross Domestic Output in the United States (as only one example) declined by 33% quarter on quarter. This was the biggest contraction since the US government began tracking such data in 1947. What’s important to remember, however, is that if it’s in the press, it’s in the price. In addition, it’s key to remember that the terrifying 33 percent figure is the economic contraction as presented at an annualised rate. i.e., how much the economy would shrink if conditions observed during Q2 carried on for a year (which is an unlikely outcome). If it’s not annualised, GDP “only” declined by a somewhat less jaw-dropping 9.5 percent between the end of March and the end of June.
Tantalum Capital has previously reported that they expect a divergence in economic recovery paths. Well resourced, strongly developed and properly financed countries are likely to have an easier road to recovery than those with weak economic fundamentals, poorer medical resources and reliance on foreign direct investment. This divergence is becoming more apparent, as well as the difference between industry sectors and companies. The ongoing trade disputes between China and the United States is an example of how political differences add to ongoing tensions and will continue to weigh on market sentiment.
The silver lining is that governments around the world are keeping their feet on the fiscal and monetary pedals as central banks continue to keep interest rates low and expand their asset purchasing programs. According to RMB Global Markets’ base case scenario, leading indicators point to a global economic recovery taking hold in the second half of 2020. This may, however, marterialise at a slower rate than anticipated by financial markets as capacity in several industries (such as tourism and hospitality) has been permanently destroyed. They further expect precarious growth for 2021, but express concern for increased inflation due to a higher oil price and a reversal in globalisation.
So what’s not priced in? A delay in the development of a vaccine or cure for Covid-19 beyond 2021, hyper-inflation and coordinated fiscal tightening by central banks around the world. Add to that the unknown political outcomes within countries (the upcoming US election, for instance) and between countries (US-China trade tensions), and investment outcomes for the rest of the year are far from certain. That will, however, not come as a surprise to investors, who will do well to remember that fortune favours the brave, and this too shall pass.
South Africa
The South African Reserve Bank’s Monetary Policy Committee (MPC) announced a further reduction of 0.25% in the repurchase rate, taking it to 3.5% and the prime lending rate to 7%.
Two of the MPC members voted to keep the rate unchanged, with three members favouring a reduction of 0.25%. It’s likely that this will be the last change in rates this year as the governor reiterated that monetary policy alone cannot improve the potential growth rate of the economy or reduce fiscal risks. He added that these risk should be addressed by implementing prudent macroeconomic policies and structural reforms that lower costs generally, and increase investment opportunities, potential growth and job creation. Such steps will enhance the effectiveness of monetary policy and its transmission to the broader economy.
South Africa’s application for a USD 4.3 billion loan (around R75 billion at the time of writing) from the International Monetary Fund’s Rapid Financing Instrument program was approved in July. Together with other foreign loans and government debt issued in foreign currencies so far this year, it just about covers the South African government’s planned foreign debt borrowings for the year. In its announcement of the loan the IMF highlighted fiscal consolidation, improving governance and operations of state-owned enterprises, preserving the SARB’s inflation mandate, and the implementation of specific reform efforts at the time of the Medium Term Budget Policy Statement (MTBPS) in October.
To put the R75 billion into perspective it’s useful to know that the SA government currently raises R8.6 billion every week in the nominal and inflation linked bond markets. R75 billion therefore equates to about two months of current fund raising and, at an interest rate of 1.1% and a repayment term of five years, it has a beneficial effect on the country’s debt servicing costs. It’s only the fifth time that SA has borrowed money from the IMF, with the previous instance as far back as 1983 when foreign disinvestment was at its peak. As the chart below shows, South Africa is certainly not alone in knocking on the IMF’s vault, but we would do well to find better company soon:
