TRADING PLACES

Reflecting on trade and investment in Southern Africa in 2016: The impact of Donald Trump’s presidential triumph, and the possibility of a ‘Hard Brexit’ in the first quarter of 2017

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Internal political drama and policies aside, international events of late, primarily the Brexit saga and Donald Trump’s presidential win, has shifted the focus (especially outside the US and UK) from reflecting on 2016 to looking deep into the 2017 crystal ball, as finance experts and economists continue to raise the red flags, highlighting the effects of these events on the global economy. And it’s not looking that good.

For South Africa, the past year has been challenging for its economy. The only real positive has been a slight clawing back in commodity prices (accounting for about 60% of our exports) and a bottoming out of emerging market currencies in the very early part of the year. Overall there has also been a lack of proactivity by policy makers to drive growth through carrying out deeper structural reforms and using fiscal policy to support growth.

According to Dr Martyn Davies, Deloitte’s Managing Director: Emerging Markets & Africa, the general negative perception toward investing in South Africa is of concern. The lack of policy certainty, standards of governance and political wranglings all feed into negativity from both local and global capital. Dr Davies says politics leads economics. South Africa possesses the ability to “turn on a dime” if only the political leadership was able to reform itself.

“The global macro has been buffeting emerging markets, including South Africa since 2013. I believe that for most Emerging Markets (EMs), with a few exceptions, growth bottomed out in early 2016. The global environment is now slightly more enabling with the headwinds lessening in strength. Ideally, South Africa needs to take advantage of this gradual shift by being more agile in terms of policy and most importantly, the state doing more with less rather than less with significantly more! Countries now have to work to grow and this is why the ‘political economy’ of growth is so important,” he told Opportunity magazine.

Emphasising the lessons learnt in 2016, Dr Davies is of the opinion that the strategy of business has been to externalise earnings, streamline costs and implement a strategy of fortitude at times. Companies have to work harder to drive growth. It is challenging to constantly grow one’s business in a flat line economy. “There is a heightened sense of risk but undoubtedly when the economy does turn—either from more enabling macro or domestic political factors—business will be in very good shape to aggressively expand; strong balance sheets and low cost models will support their competitiveness.” He firmly believes that the state can be the key role player in changing the current status quo.

Looking at improving intra-Africa trade and the progrees that South Africa has made in this regard in 2016, it has been a slow process, especially as the current global trend does not favour moves toward liberalised trade. However, he says South Africa has been progressive in the regional context. The policy is toward regional integration of SADC, EAC and COMESA. But, Dr Davies says on-the-ground challenges are pervasive and suggests that we need to be less grandiose in our ambitions and rather focus on blockages to freer trade—both tariff and non-tariff—in the immediate region. “But undoubtedly the EAC is the region which has been the most progressive toward liberalised trade across national boundaries in the Africa region.”

As for how instrumental BRICS has been to SA’s international trade relations, SA’s trade with a number of BRICS countries, especially China, has expanded significantly in recent years. But, he says, arguably this is a consequence of market forces, not political construct.

“For example, liberalised trade was not on the agenda at last month’s BRICS head of the state meeting in Goa, India. BRICS has morphed into a not-so-coherent geopolitical grouping of (mostly) large states with disparate economic interests.

How do we reconcile geopolitical interests with commercial competition between the BRICS members? This is the key challenge,” says Dr Davies.When assessing the future of international trade, experts are saying that the recent Brexit event, and the election of Donald Trump as the new American president, will have a strong impact on trade, investment and commerce in Africa and South Africa will also be affected.

According to the deVere Group’s Gavin Smith, many of the 300 000-plus British expats across South Africa are now urgently re-evaluating their medium and long-term financial plans due to an impending ‘Hard Brexit’. This observation comes following ongoing statements from British politicians about the negotiations for Britain’s exit from the EU and the subsequent financial fallout of these.

“UK Prime Minister, Theresa May, has recently announced that Article 50—the official starting pistol for Britain’s divorce proceedings from the EU—would come into play no later than March next year. The rhetoric coming from London suggests that the British government is heading for a Hard Brexit.

This means that the UK would slash ties from the single market for goods, services, people and capital, plus the free trade area.

“Following the UK government’s widely assumed Hard Brexit approach, the pound has fallen considerably against most major currencies. Indeed, immediately after Mrs May’s Brexit speech at the Conservative Party conference, the pound fell to a 30-year low of $1.27. The Brexit battering turbulence has continued since, with the pound losing 20.2% against the rand since the referendum result.”

Smith says this expected Hard Brexit, and the subsequent pounding of the pound, is having a major impact on British expats living here in South Africa. As a direct result, many are now urgently reviewing their medium- and long-term financial plans in three main areas.Firstly, the falling value of the pound has a serious negative effect for those who are in receipt of and/or live off a UK pension: they will have taken a 20% hit to their British pension since the Brexit vote. Therefore, the cost of living has become more expensive and their purchasing power has taken a bashing.

“To help mitigate the adverse impact of currency fluctuations, there’s been a significant increase in people seeking to transfer their UK pensions out of Britain into an HMRC- recognised overseas pension scheme,” Smith says.

Secondly, for expats earning rands and sending money ‘back home’, the scenario is quite different. A weaker pound helps to repatriate a higher amount straight away.

Those who are working in South Africa and have liabilities in the UK, such as a mortgage, school fees, or a child’s wedding, for example, have got richer with sterling’s fall.

“These people will be seeking advice on how to capitalise on this because whilst a cheaper currency will lead to inflation, the negative effects of inflation will take time to come into play, whilst the currency exchange advantages happen immediately.”

And thirdly, until negotiations start—and beyond—there remain question marks over the UK’s relationship with Europe and the rest of the world. Naturally, this creates ongoing and growing uncertainty.

“Against this backdrop of uncertainty, many expats will be looking to reassess their investment portfolios, reducing their exposure to UK assets, and increasing exposure to international ones. The fallout of Brexit is likely to impact British expats across South Africa in one way or another. Therefore, it is shrewd and proactive that many are seeking advice on how to sidestep the negatives of this referendum, and how to use the opportunities it presents to their financial benefit,” according to Smith.Looking ahead at 2017, Shannon Butler, Credit Analyst at the International Trade Credit Insurance Company, says the effect the recent rise in populist sentiment globally will have on the African market remains to be seen. In the run-up to the US presidential election, newly elected American Republican president, Donald Trump, offered economic proposals that would have a possible long-term impact on African trade with the United States. Then there is the prospect of a ‘Hard Brexit’ and its possible implications on trade with Sub-Saharan Africa.

A continual theme throughout the Republican’s campaign has been that the United States had entered into numerous trade agreements, which he feels are unfavourable.

“Whether the newly elected president sticks to his promise remains to be seen. However, it is likely that African countries will face further out-of-cycle reviews of the Africa Growth and Opportunity Act (AGOA). Over 40 eligible Sub-Sahara African countries has been a boon to the region,” says Butler. According to the report titled Beyond AGOA from the Office of the US Trade Representative, non-oil total goods trade has grown from $13 billion a year to nearly $30 billion since AGOA was enacted.“That increased out-of-cycle reviews will be likely and has been further evidenced by the July 2015 out-of-cycle review regarding South Africa’s eligibility and Burundi’s ejection due to crackdowns in the country on political opposition.

The threat of an out-of-cycle review with Sub-Saharan Africa’s leading country, South Africa, as again resurfaced with the South African Poultry Association (SAPA) and South African Pork Producers Organisation (SAPPO) looking to obtain a court injunction to block US chicken imports,” says Butler.

Lesotho’s inclusion is likely to face scrutiny as a result of the on-going political crises facing the country. Lesotho has to an extent been one of the largest beneficiaries of AGOA with around 80% of its textile and garment exports going to the US.

Butler also mentions Brexit, saying that the prospect of a ‘Hard Brexit’ by the UK could cause considerable uncertainty for a number of Sub-Saharan countries. “It’s unclear what the full effect this [a ‘Hard Brexit’] will have on Sub-Saharan Africa, however the effect is likely to be largely negative with trade agreements such as EU-SADC Economic Partnership Agreement (EPA) becoming void.”

She says renegotiating terms for an agreement could take years. However this is likely to be fast-tracked should this scenario come to fruition, given the significant exposure African export markets have to the UK with the largest exposure lying in South Africa. Countries will be inclined to negotiate new trade deals with the UK within the framework of the various regional blocs, increasing their leverage in negotiations and speeding up the process.

“The increased populist sentiment is expected to have longer-term effects on Sub-Saharan Africa’s relationship with the world. Nevertheless, in the short-term these moves are expected to reduce capital flows into the higher risk Sub-Sahara African region with jittery investors looking to safer markets for generating returns. There is however a silver lining to the rise of populist sentiment in the form of increased opposition to austerity. Of late, there have been numerous pronouncements regarding the reintroduction of fiscal stimulus measures,” says Butler.

She highlights the fact that in the run-up to the election, the newly elected US president has pledged to make use of various infrastructure spend initiatives. Japan has announced a 28.1 trillion yen stimulus programme, Canada has also announced a further increase of 60 billion Canadian dollars in new infrastructure spend and China has also released their 1.6 trillion yuan Northeast Revitalisation Plan 2.0. “These will optimistically have the effect of boosting demand for Sub-Saharan African commodity exports, increasing commodity prices and leading to increased levels of growth in Sub-Saharan Africa.”

Also referring to the current US situation, Dave Mohr, Old Mutual Multi-Managers’s Chief Investment Strategist, says monetary policy in the US, as in South Africa, is run independently of the executive and legislative branches of Government, and unlikely to be influenced by the outcome of the election. The Federal Reserve’s recent monetary policy meeting set the stage for an interest rate hike in December. The Fed said that it was waiting for ‘some’ further evidence of continued progress toward its goals of 2% inflation and full employment. Inflation has been creeping up in the past few months, and the Fed expects it to be on target by 2018. Unemployment remains low.

“Other economic data—on retail sales, manufacturing and housing—have been mixed but generally point to continued moderate growth. So barring an extremely negative data point or severe market meltdown, a hike next month is likely. Futures markets are pricing in an 80% probability, while US long-bond yields have risen to the highest level since March (though at 1.8%, the yield on the 10-year is still well below the 2.25% starting level for the year).

Pressure on the rand

What does this mean for us in South Africa? Mohr is of the opinion that a stronger dollar will put pressure on the rand. “The key issue is not whether there is a hike now, but rather how many hikes there will be after December. If the Fed overreacts, the dollar could surge, placing the rand under tremendous pressure. However, a dollar that is too strong works against the Fed’s objectives and it is therefore unlikely that they will increase rates by too much.”

As it is, the rand has done very well over the past three weeks, supported by domestic political developments (the dropping of charges against Finance Minister Pravin Gordhan and the release of the Public Protector’s report on state capture), and firmer prices for our main commodity exports. The gold price is around $1300/oz again, while platinum is close to $1000/oz. Iron ore prices lifted from $56 per tonne to around $66 per tonne. For iron ore, platinum and gold, the prevailing dollar price is still below the 2016 high point. But at $67 per tonne, the price of export thermal coal is at the highest level this year, up from $50 per tonne in January.

Taking a closer look at our currency and inflation outlook, Mohr says at current levels around R13.50 per US dollar, the rand is more or less where it was last year. This level is probably weak enough to support exports and tourism, but it creates a bit of a problem for investors. Global equity markets moved sideways in US dollars over the past two years, but local investors benefited from persistent depreciation in the rand to boost offshore returns. No more. Similarly, the large rand-hedge component of the JSE benefited from a weaker rand.

“The rand tends to overshoot on the upside and downside, but at the moment the rand-dollar exchange rate is well below the average of R14.50 for the second half of 2015 and the first half of 2016. This is positive for the inflation and interest rate outlook. The rand has gained 15% against the Chinese yuan this year, which is notable given how many consumer goods are imported from China. Government’s Crop Estimates Committee recently projected that farmers would plant 2.4 million hectares of maize for the next growing season, a 26% year-on-year increase. This points to a rebound in agricultural production and downward pressure on food inflation. The oil price has also given back some of its recent gains as it appears less and less likely that oil producers will stick to agreed production cuts.

“Lower inflation is positive for consumers, who are currently clearly under pressure. For instance, new passenger car sales were down 9.5% year-on-year in October,” according to Naamsa.

However, there are signs that the worst is over. From a low of 26 014 units in April, sales have rebounded somewhat to 32 739 in October. Exports of new vehicles remain strong at 32 800 units.According to Old Mutual Multi-Managers other recent local economic data continues to be mixed, but still points to a gradual improvement. The Barclays/BER manufacturing purchasing managers’ index (PMI) fell back in October, bucking the global trend. However, the broader Standard Bank/Markit PMI remained above 50 in October, pointing to positive growth. Although based on slightly older data, the Reserve Bank’s leading economic indicator echoed this, by showing an improvement on a year-on-year basis for the first time in three years.

Trade balance

South Africa recorded a trade surplus of R6 billion in September. On a cumulative basis (for the first nine months of the year) the trade balance was in deficit, but at R9.9 billion this is an enormous improvement from R37 billion over the same period last year.

“Credit growth picked up somewhat in September. Total loans and advances grew by 6.7% year-on-year, up from 6.2% in August. Corporate credit growth accelerated to 12.6% from 11.4% but household borrowing (adjusted for African Bank) slowed to 3.5% from 3.7%. Instalment credit growth (mainly vehicle loans) is anaemic at 1.4% while mortgage credit growth remains below inflation at 5.3%.”

The weakness in household credit supports the notion that there will not be further interest rate increases. Higher rates are supposed to suppress borrowing, but there is almost nothing to suppress on the household side. Even if rates aren’t cut soon, the outlook for monetary policy is more favourable.

“The outlook for fiscal policy unfortunately is less so.

The planned fiscal consolidation—closing the budget deficit—is a headwind for the local economy. However, Treasury has been careful not to close the deficit too quickly to avoid tipping the economy into recession.

Either way, the continued commitment to fiscal discipline is important for the longer-term health of the economy,” Mohr concludes.

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