Investors must understandably be concerned that news headlines once again portend doom and gloom. These negative sentiments seem to have been validated by the sharp decline in global equity markets over the past three months, a sharp decline in the dollar, a fall in the US 10 year bond yield to just above 1.5% and the continued decline in commodity prices – especially oil. Headlines that advise investors to “sell everything” are rather evocative. Apart from gaining a great deal of traction through social media they do little else as the analysis is often superficial at best. In a similar vein, many comments and opinions exist regarding the state of the nation in SA and what needs to be done to elevate growth back to 3% – 5%.
While we would love to know the answers to all these issues we remain focused on analysing the key questions that inform a more cogent perspective of the macro-economic environment going forward. Central banks, at this juncture, seem almost alone in trying to get growth going again. In the US the prognosis seems better than for Europe or Japan. Growth for the first quarter of 2016 in the US could well be around 2.5% compared to estimates of around 1% less than a month ago by the Atlanta Fed. Real wages are rising, jobs continue to be created, capacity is not in oversupply and a weak oil price is promoting some degree of consumer spending. The problem that the Fed has, in leaning into the headwind of slow growth, is that the political discourse has taken a nasty turn to the right. Regionalism, protectionism and exclusionism form the basis of electioneering by Republican candidates. The question that thus needs to be asked is not whether the Fed can do anything more to stimulate growth but rather whether the necessary environment exists within the political environment to support the Fed through appropriate fiscal policy reform. Whilst the strong dollar has translated into cheaper imports for US consumers, it has unquestionably increased cost pressure in the manufacturing sector.
The second question that occupies our minds is whether the impact of deflation exported by the East to the West will moderate? China has surplus capacity in nearly all its industrial base. As it seeks to avoid an unemployment problem it will actively seek to export this surplus to the West through lower prices and a weaker currency. As western developed nations are desperately trying to reflate their economies this added pressure is not welcomed, particularly at a time when the only major policy responses by the ECB, BOJ and potentially the Fed are low nominal interest rates and ultimately currency devaluation. Let’s hope it doesn’t come to that.
The third question that needs to be asked is how the broader grouping of emerging markets that are linked to the commodity cycle and which have run current account deficits for a number of years will meet their debt obligations in the event that global financial markets experience another liquidity squeeze. Here the answer is less clear as any policy response designed to weaken a particular EM currency sets in motion a round of competitive devaluations. We remain concerned that China could topple the EM currency cart in the year ahead as it struggles to manage a difficult transition away from investment-led growth. We don’t fully subscribe to the western styled economic theory that a switch to a consumption driven model will either sustain growth or be the correct approach for China to adopt. China is at the so-called “Lewis tipping point”, named after economist W. Arthur Lewis to describe a point at which surplus rural labour is simply no longer in abundance, resulting in labour no longer subsidizing the cost of capital. Higher wage costs, lower profit margins and slower growth are the inevitable result.
The problems of structural unemployment levels being too high in far too many countries, inequality in earnings, loss on institutional credibility, regionalism and political dysfunction all amplify the risks associated with the three key dynamics set out above.
South Africa finds itself challenged by many of these factors. In addressing the question of how the country could return to a more sustainable growth rate, a distinction needs to be made between those responses that are internal and the external forces over which key decision makers have no control but where risk still needs to be managed. Let’s start with the obvious: SA needs to recognize that it lacks productivity, capacity and cost competitiveness in key segments of its economy. Capital is not appropriately allocated to beneficiation nor is it allocated to technology. Broadly speaking the incentivisation programs needed to attract job-creating capital are sorely lacking. At a more nuanced level, government inefficiency and the management of many SOEs retards growth as it consumes capital that could be productively used elsewhere. While programs such as social grants are important in narrowing the equality gap and alleviating poverty, such programs need to be supported by growth oriented policies that are sustainable. SA, over the past ten years, has moved away from a sustainable growth model. This needs to be changed through bold moves by treasury and government. It is indeed sad that it takes the threat of a rating agency downgrade to crystallize the minds of policy makers.
Looking at the external factors, we see SA as being overly vulnerable to liquidity and currency shocks. In a similar vein to Turkey and Brazil, SA is dependent on foreign capital to balance its current account deficit. Greater attention is needed to place the country on a sound footing in relation to these external risks. The National Development Plan unquestionably provides such a framework. Sadly many of the key tenets of the NDP have either been overlooked or ignored. But time has run out. The global tide has shifted markedly. SA needs to respond appropriately.
Source: Tony Bell – KI, MiPlan; Fund Manager & CIO, Vunani Fund Managers