FINANCE

Take a hike

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When the South African Reserve Bank increased the repo rate by 50 basis points in January, it was clear, for the man in the street, and businesses alike, our landscape would change forever. It would severely impact the cash strapped South African consumers, who will have to endure a prime lending rate increase to 10.25%---the figure charged by banks to customers? Further to this, an increase in food prices is expected again as the hike delivers another blow to farmers already struggling amid the drought season.

Businesses, especially small and medium enterprises, were at the time also predicted to suffer under the pressure added to the already challenging times.

A recent study by the Bureau of Market Research (BMR) at the University of South Africa (Unisa) shows that the bulk of personal income in South Africa accrue to people in Gauteng, the Western Cape and KwaZulu-Natal. More specifically, personal incomes are concentrated in the major metropolitan areas inclusive of the City of Tshwane, Johannesburg, Ekurhuleni, eThekwini and Cape Town. Whereas Gauteng contributes most to South Africa’s personal income, the Northern Cape Province has the least income. Interestingly, the BMR study reveals that income is most likely to increase when people are better educated.  In fact, the study indicates that the incomes of the affluent and educated are growing much faster than the less educated poor.

The study reveals that income inequality in South Africa poses a risk to political and socio-economic stability and that no substantial higher income growth rates are anticipated for the short- to medium-term.

Other concerns are that the interest rate hike will put more pressure on South Africa’s economy, thus contributing to “the perfect storm” facing the country’s economy.

Reasearch conductors, Prof CJ van Aard and Marietjie Coetzee, say the hike in the repo will affect consumers in different ways, namely those consumers with debt (such as in the form of mortgages, personal loans, credit card debt and overdrafts) will be negatively affected because of the higher interest rates of banks, while consumers living of interest that they receive from financial institutions will be positively impacted. Unfortunately South Africans save very little and are generally very indebted with the consequence that the hike in the repo rate will have more negative than positive impacts on consumer finances.

Prof Van Aard says this is being exacerbated by the fact that the hike in the repo will also give rise to lower economic growth which in terms gives rise to lower levels of job creation as well as lower levels of personal income growth. It must, however, be said on the other hand that if the Reserve Bank did not hike the repo rate and we get very high price inflation as a result it will become increasingly impossible for consumers to afford the necessities they require to survive.

Lower economic growth

“The most important short-term result will be that South Africa is being put on both lower inflation (positive) and lower economic growth (negative) trajectories. It is of vital importance to hike the repo in the presence of many threats to lower inflation (such as the decreasing value of rand against major currencies, high growth in administered prices, rapid rise in food prices due to the droughts, etc.). However, given the precarious situation of the economy, a 50 basis point hike was probably not wise.”

Talking about how this move will affect business in SA, Prof Van Aard says more than 60% of the gross value added produced by businesses can be explained by household spending. If household spending is being negatively impacted upon by hikes in the repo rate, businesses also suffer.

Asked how the move will affect trade and investment, Prof Van Aard told Opportunity magazine that Hikes in the repo rate affect trade and investment in a variety of positive and negative ways. Positive ways including the fact that such hikes demonstrate to investors and potential investors that a country is serious with respect to its macroprudential framework, financial and price stability, protecting the value of its currency and taking unpopular decisions to stabilise the economic ship. On the negative side repo hikes give rise to lower economic growth by suppressing demand which is negative for traders and investors.

The BMR study reveals that income is most likely to increase when people are better educated. In fact, the study indicates that the incomes of the affluent and educated are growing much faster than the less educated poor. But the question of how this will increase the risk of political and socio-economic instability, has stimulated a lot of debate among economists.

“The higher paying jobs in South Africa is for the highly skilled. Research has shown that the higher your skills level the greater your chance of getting a job or a formal sector business opportunity, which in turn result in higher incomes. Research has also shown that the chance of a person with matric as highest qualification to obtain a formal sector job opportunity is on the decrease,” says Prof Van Aard.

However, he says it is highly unlikely that we can expect an economy with substantial higher income growth rates any time soon.

GDP

“Our probabilistic macroeconomic forecasting model expects and economic growth rate of 0.63% for 2016. Given the hike in the repo that we’ve had and one later this year, GDP won’t reach real growth of 0.63% this year. We will most probably experience negative economic growth rates during the second and third quarters of this year which means that we will technically be in a recession then. I’m not expecting 2017 to be much better GDP growth-wise because quite a lot of the existing downside risks will still be with us in 2017.”

Although he is reluctant to make long-term forecasts “because they usually turn out to be wrong”, the professor’s gut feel is, however, that we will in all likelihood only pick up pace with respect to economic growth, business and consumer confidence, employment, etc. after 2017.

Looking at the South African economy and how it will put further pressure on South Africa’s economy, Marc Joffe, CEO of Global Credit Ratings, says in the short-term, the interest rate hike is a viable solution to containing both the depreciation of the rand and inflation. However, in the medium- to long-term, and with an expectation of further interest rate increases, it will further raise the cost of borrowing for both companies and consumers, putting additional strain on an economy with slowing levels of growth and a high possibility of entering a recession. Both businesses and consumers who are caught in the debt trap will find it increasingly difficult to service their debt.

Regarding the borrowing costs of South African companies, Joffe says a further downgrade could be the difference in whether the country will still be regarded as an attractive investment opportunity for stakeholders such as investors and fund managers, among others. Should sovereign ratings follow suit with the IMF’s forecast, it will raise the cost of borrowing for both South Africa and state-owned entities, which will further trickle down to local companies, and, by association, the consumer.

Negative ramifications

“The hardest hit industries will typically be the consumer discretionary market, such as retailers, mobile operators, luxury goods, high end vehicle manufacturers, construction and property developers. The mining and energy industries will also experience negative ramifications, in particular those with geared balance sheets, as they are already faced with declining global commodity prices and demand, as well as protracted labour disputes.

“Financial services companies such as banks and insurers should benefit at current interest rates due to the additional interest margin they will generate. However, persistent interest rate increases will likely offset this benefit through increasing bad debts by virtue of consumers or companies’ inability to service their loans. Middle to lower income retailers will likely also benefit as consumers trade down from higher end to more affordable goods. Exporters, meanwhile, will likely have benefited from the depreciating Rand, which has increased the purchasing potential of foreign buyers while simultaneously weakening the potential for imports,” Joffe told Opportunity in an exclusive interview.

When asked whether he thinks that the forecast will influence perceptions of South Africa as an investment destination, Joffe says amid the IMF’s subdued growth forecast, another major concern for emerging markets is any potential flight by investors from riskier asset classes. “In this regard, by virtue of the low growth prospects in South Africa, investors are finding better opportunities elsewhere. This trend is likely to continue in the absence of a sustainable improvement. South Africa needs to instil confidence in local and foreign investors, through the implementation of policy measures that will revive the relatively stagnant economy and achieve meaningful job creation.” The pace of their implementation is also crucial in terms of boosting investor confidence and reviving GDP growth.

“South Africa cannot afford to spend more on interest costs if we want to maintain current levels of social spending and fund the vast infrastructure investment initiatives. This is particularly crucial given that the revenue base is not expected to advance at a sufficient rate over the medium term. Unless interventions are implemented and followed through over the long term, there is a high possibility for another growth forecast cut.

“Credit rating agencies play a critical role in facilitating information about, and access to, capital markets. Their assessments also assist in the development of more efficient markets. In particular, credit ratings improve the transparency and marketability of companies being assessed. They provide a mechanism for investors to quantify and price for risk, across both individual companies as well as industry sectors.

With emerging markets presenting increased regulation, transparency and substantial growing debt in their capital markets, there is a continuously rising global interest in their credit ratings. This is because of the acknowledgement that credit ratings provide a means to better understand the credit risks associated with these markets, as well as their future prospects, in order to make informed investment decisions.

Thami Mthembu & Palesa Ntshalintshali

 

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