IMF highlights SA's need for structural reform

FX

The IMF has published its annual Article IV country report on South Africa. The agency has lowered its 2015 economic growth forecast from 2.5% to 2.1%, citing depressed consumption expenditure amid tight financial conditions. This is largely in line with our expectation for growth next year. The agency expects growth could rise to 2.75% over 2016-19, as infrastructure constraints ease and global growth tailwinds strengthen; however, they report that this will not be enough to lower unemployment considerably – “structural reforms are essential to generate more growth and jobs”. While “welcomed” the planned fiscal consolidation measures outline in 2014 Medium-Term Budget Policy Statement, they pointed out that “further adjustments may be necessary to stabilize debt over the medium-term”, again highlighting the importance of “growth-friendly measures” in this regard. In terms of financial stability, the agency reports that while financial sector risks are “elevated” they remain “manageable”.

Commodity prices in general remain under pressure, with crude oil still declining. Brent crude oil is now below USD65/bbl, despite the dollar weakening marginally over the past two days. We pointed out yesterday that inflationary pressures in China are very low following the publication of their November CPI data. This is also the case in the US, where bond yields are pricing substantially lower inflationary expectations over the next 2 years than 6 months ago when oil was still close to a USD100/bbl. Although South Africa’s CPI for November was unchanged in November at 5.8% y/y, it is worth mentioning that BER indicated that inflation expectations for both labour and business have reduced for 2015. The BER indicated that labour inflation expectations declined by -30bps to 5.9% for 2015 and business expectations fell to 6.2% from 6.4% for 2015. Should the rand not depreciate too much, and oil prices remain low we could see further easing of inflation expectations in 2015.

On the local data front, Stats SA released the November CPI print yesterday, which moderated in line with expectations. CPI came in at 5.8% y/y in November from 5.9% y/y in October, with the drop largely driven by a 45c/l fall in the petrol price. Petrol price inflation slowed from 2.7% y/y to 1.4% y/y and shaved 0.07 pps off October’s 5.9% y/y CPI inflation rate. Petrol fell a further 69c/l in December, and will shave 0.38 pps off November’s 5.8% y/y inflation rate. Petrol fell a further 69c/l in December, and will shave 0.38 pps off November’s 5.8% y/y inflation rate. All things equal, this would result in CPI of 5.4% y/y in December. Food inflation also moderated, albeit slightly, in November, to 7.7% y/y, from 8.0% y/y in October. This was despite bread and cereals inflation rising, from 5.2% y/y to 5.5% y/y. Meat, dairy and sugar price inflation remains elevated, but meat and sugar slowed in November, from 9.3% y/y to 9.1% y/y, and 8.9% y/y to 8.2% y/y respectively, while dairy accelerated from 12.4% y/y to 12.9% y/y. SBGS economist Kim Silberman suggests that due to the transmission from higher wheat and maize prices in the first quarter of this year, there is a chance of renewed pressure on food prices, particularly bread and cereals in Q4:14 , which is already evident. Kim expects food to trend lower and average between 4.5% and 5.0% in 2015. Core inflation (ex food & NAB, petrol & energy), rose to 5.8% y/y in November, up from 5.3% at the end of 2013, indicating that second round effects of the weaker currency are gradually passing through to core inflation, unlike in mid-2013. She also believes that as headline CPI falls, the SARB will refer more to core inflation as a risk. This will allow the SARB to continue to engage in hawkish rhetoric, which can reduce the extent to which they actually have to raise rates.

Stats SA releases the Q3:14 non-farm payrolls report today. Looking back employment in Q2:14 in the formal non-agricultural economy rose by 155,000 people, or 1.8%, compared with Q1:14, and by 229,000 people, or 2.7%, compared with Q2:13. This was the largest increase recorded in a single quarter since the 1980s. 143,000 or 92% of these were employed by government, while only 12,000 were employed by the private sector. Over the last 18 months, persistent job shedding in mining, manufacturing, transport and construction have been compensated for by persistent increases in public sector employment and to a lesser extent employment in trade and finance. According to the Q2:14 QES data release, the increase of 9.2% y/y and 5.8% q/q in employment by the public sector was due mainly to “increases in employment in other central government activities (IEC’s national elections); universities and universities of technology; provincial departments; national departments; and health and social work.” While the elections may have accounted for some of the exceptional increase in public sector employment in Q2:14, in April 2009 (previous elections), public sector employment increased by only 3.8% y/y or 80,000 (0.8% q/q or 17,000). It is unlikely that we will see a significant increase in government employment in Q3:14. Employment gains in Q2:14 were impacted by industrial action in the mining and manufacturing sectors. While strike activity in the mining sector ended in June and in July in the manufacturing sector, we could see Q3:14 employment growth numbers still impacted by the spillover effects of the strikes. Bloomberg consensus has pencilled in a 0.9% y/y increase in non-farm payrolls in Q3:14, from 2.7% y/y in Q2:14.

The rand weakened on Wednesday, following some strength on Tuesday. The rand closed at USDZAR11.42 yesterday, compared with Tuesday’s close of USDZAR11.39. Rand depreciation against the dollar occurred despite dollar weakness against all of the major crosses. The rand weakened against all of the major crosses, with the biggest decrease seen against the euro (-1.3%) and the pound (1.0%). The rand put in the worst performance amongst the commodity currencies we monitor and was the second-worst performer in the EM currency space, only ahead of the RUB. The rand traded between a low of USDZAR11.4224 and a high of USDZAR11.6023 intraday – this marks a six-year weak point for the rand against the dollar.

Commodities were down on the day. Copper was down by 1.0% while platinum and gold fell 0.5% and 0.4% respectively. Brent declined further on Wednesday, falling by 3.9% to a five-year low. Both the developed market MSCI and the MSCI EM were down on the day, by 1.4% and 0.7% respectively. The ALSI was up by 0.4% on the day. The EMBI spread widened by 17 bps, while SA’s 5yr CDS spread widened by 13 bps. The CBOE VIX index, a volatility-based proxy for global risk appetite/aversion, increased by 24.5%.

Non-residents were net sellers of local equities (-ZAR1 4952 million). Non-residents were also aggressive net sellers of local bonds (-ZAR1 864 million). Selling of bonds was in the 12+ (-ZAR906 million), 1-3 (-ZAR8881 million) and 3-7 (-ZAR181 million) year segments. Buying was noted in the 7-12 (ZAR110 million) year segment. Bond yields increased by between 12 bps (R203, R186) and 16 bps (R214). The 3x6 FRA increased by 1 bp, the 6X9 FRA by 2 bps and the 12x15 FRA by 6 bps.

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