Ramaphosa’s GNU Dawn

GNU spurs market optimism

A South African Government of National Unity (GNU) received little serious mention in pre-election musings on the likely political outcomes and government formations. However, the sharp decline in electoral support for the African National Congress brought an abrupt end to the age of national single party dominance. The new realities presented by the hasty formation of a GNU are now setting in. Positively, the GNU represents a first step by policy makers to answer the longstanding call by citizens, financial markets, and other economic agents to transcend partisan politics and prioritise economic reform and inclusive growth. Rooted in its advocacy for constitutionalism and the reform agenda driven by Operation Vulindlela, financial markets have rightfully been buoyed by the promise the GNU presents – but we remain alive to the risk that ideological differences may continue to cause policy and implementation gridlocks.

While political uncertainty lingers both domestically and abroad, with more than 2 billion people eligible to vote in national elections worldwide in 2024, the path for interest rates became clearer in the past quarter. The Swiss National Bank led the charge on the interest rate cutting cycle in the developed world, cutting its main policy rate by a cumulative 50 basis points in recent months. The Bank of Canada, Sweden’s Riksbank and the European Central Bank (ECB) followed suit, commencing their respective interest rate cutting cycles in the past quarter. However, with lingering uncertainty on the sustainability of the recent cooling in inflation, Christine Lagarde and her Governing Council colleagues have clearly cautioned the market against expectations of sequential interest rate cuts. Monetary policy calibration will remain highly data dependent, with a further cooling of inflation expectations necessary to drive a faster and deeper interest rate cutting cycle.

Figure 1: Global Headline Consumer Price Inflation (year-on-year)

Source: Bloomberg, Futuregrowth

The US Federal Reserve Bank (Fed) will rightfully remain a laggard in this interest rate cycle, given the relative stickiness of US headline consumer prices and still robust labour market. The Fed faces a wider inflation gap, with year-on-year consumer price inflation stuck well above its 2% target level. However, inflation expectations remain reasonably contained, and provide room for policy cuts once the Federal Open Market Committee finds comfort with the sustainability of the disinflation trend. Outsized household savings have coincided with the stickiness in consumer prices in recent years – but indications that these savings have now been depleted lays the grounds for moderating consumer spending, and an eventual slow and shallow interest rate cutting cycle.

Rates have peaked, shallow cuts to follow

Domestic headline consumer price (CPI) Inflation flatlined at 5.2% year on year in May. While consumer inflation remains elevated and sticky, recent months have provided downside inflation surprises relative to median market expectations. These downside surprises have been aided by colling energy prices and muted food price pressures, against our expectations of upside risk stemming primarily from the El Niño weather pattern and consequent drop in domestic white maize harvests. Furthermore, contained global food inflation, when lagged by 7-9 months, is highly correlated to domestic food inflation and will continue to stem domestic price pressures in the medium term.

We retain our view that the nominal repo rate has peaked at 8.25% in the current interest rate cycle. However, despite the already elevated real rate environment, the South African Reserve Bank (SARB) will rightfully remain hawkish until convinced that domestic consumer price inflation has moved sustainably towards the 4.5% year-on-year midpoint of the inflation target band. We expect this comfort to be reached in the third or fourth quarter of 2024, allowing a shallow and gradual interest rate cutting cycle to follow.

Figure 2: South Africa Forward Rate Agreement (FRA) Rates

Source: Bloomberg, Futuregrowth

Electricity shortfall eases

The macroeconomic highlight of the second quarter of 2024 was undoubtedly the complete absence of loadshedding by Eskom. The energy availability factor (EAF) across the large coal-fired power plants, including beleaguered Medupi and Kusile, has hovered towards 70% in recent months - a drastic turn from the near 50% EAF at the start of the year. This marks the highest EAF by Eskom since August 2021, and bodes well for improved investor confidence, a necessary precondition to stimulating macroeconomic growth in South Africa. The reform agenda driven by Operation Vulindlela has been instrumental in stabilising South Africa’s electricity production constraints. We now look forward to improved port and rail logistics in the coming months and years – sparing us from the ignominy of having some of the poorest performing ports in the world.

Other high frequency macroeconomic indicators didn’t suggest any significant improvement in aggregate growth in the second quarter of 2024. These included modest and volatile mining and manufacturing statistics. Consumer readings also continued to paint a mixed picture in the second quarter. While private sector credit extension growth showed resilience in May (rebounding to 4.3% year on year from a downtrodden 3.9% in April) this drive was spurred by supportive base effects, and the headline reading belies some on the underlying weakness in domestic credit lending conditions. The weakness is apparent in household credit lending growth, which slowed to 3.4% year on year in May from 3.5% in April. This marks a sharp ascent from the near 4.5% growth rate in household credit lending at the start of the year. In real terms, credit extension has stalled, and will continue to be a headwind to aggregate economic growth with monetary policy anchored in restrictive territory. Credit lending standards have not been important determinants of monetary policy in the current hiking cycle, but they nonetheless highlight the weakness of aggregated demand (particularly for households) and will lend support to the arguments for monetary policy easing in the second half of 2024.

Further signs of fiscal consolidation

Fiscal year-to-date data suggests a continued trend of resilience in public finances. This follows the confirmation of a 4.6% budget deficit/GDP for the 2023/24 fiscal year relative to the 4.7% tabled by National Treasury in the February budget. The buoyancy in fiscal revenue receipts has been broad based, and is encouraging both in terms of its readthrough to the resilience of the underlying economy, as well as the efficiency gains at the South African Revenue Service. While too soon to call a trend, an extrapolation of year-to-date fiscal revenue is broadly consistent with National Treasury’s estimates. On the expenditure front, amidst significant expenditure pressure, we are encouraged by the perpetuation of the fiscal restraint evidenced by government departments in recent months.

However, fiscal flexibility remains a constraint for government finances in the medium term. The hasty pre-election signing of the National Health Insurance (NHI) bill has potential to further constrain government finances – although implementation was always due to be phased in over time and might yet be hindered by litigation and wrangling within the GNU. In our estimation, based on the current fiscal framework, debt sustainability will only be achieved with real GDP growth on approach of 3% per annum – a low water mark in an emerging market context yet meaningfully removed from South Africa’s growth rate of 1% - 2% over the past decade. The liberalisation of electricity production is a first important step to stimulating growth, with the now prolonged absence of loadshedding lending hope to an improved growth outlook in the medium-term. The other policy initiatives driven by Operation Vulindlela (particularly the stabilisation and eventual improvement of port and rail logistics) also remain key to stimulating aggregate growth. This remains a key watchpoint for us in the seventh administration of the Republic of South Africa.

Figure 3: Main budget balance

Source: National Treasury, Futuregrowth

GNU slashes the sovereign risk premium

The domestic nominal yield curve shifted lower in the second quarter, driven by improved risk appetite in local and foreign market participants. ALBI +12 years was the best performing segment of the nominal bond curve, rendering a total return of 9.91% for the quarter relative to the ALBI total return of 7.49%. Cash, proxied by the SteFI Call Deposit Index, rendered a return of 1.98% for the month, with the IGOV Index, comprised of sovereign issued local currency inflation-linked bonds (ILBs), rendering a return of 2.43%.

Figure 4: Bond market index returns (periods ending June 2024)

Source: IRESS, Futuregrowth

/// THE TAKEOUT: The age of single party dominance in South African politics is over. Bond markets have been buoyed by the promise of a Government of National Unity and the advocacy for constitutionalism and reforms. While political uncertainty lingers both domestically and abroad, the path for interest rates became clearer with the ECB confirming the peak in its interest rate cycle. We expect the Fed to follow suit in the second half of 2024, once it has found comfort with the sustainability of the disinflation trend. Domestically, we maintain our view that the nominal repo rate has peaked at 8.25% in the current interest rate cycle and continue to expect a modest interest rate cutting cycle to start in the second half of 2024. While fiscal metrics have recently met or exceeded market expectations, the signing of the NHI bill into law muddies the fiscal outlook and risks further constraining fiscal flexibility.