TalkingEconomics: Déjà vu in South Africa

Trouble at home…and abroad

The domestic reaction to Pravin Gordhan’s sacking has been negative, with opposition parties requesting a motion of no confidence in the president.

The external reaction has also been bad news for President Zuma. Both S&P and Fitch downgraded South Africa’s foreign currency credit rating to sub-investment grade, forcing its exclusion from benchmark debt indices.

Local currency debt retains an investment grade rating for now with S&P and Moody’s, needed for inclusion in the World Government Bond Index (WGBI).

Economic implications

We would expect some negative economic fallout from the ongoing political turmoil, even assuming little change in policy.

First round effects might arise from the weakening of the currency, the credit downgrade, and the heightened uncertainty. The latter in particular will drag down private sector growth, while the radical economic transformation promised by the new finance minister is likely to ring a few alarm bells for corporates. And it may reduce their willingness to invest.

Both consumers and corporates also potentially face further drags in the form of higher interest rates.

So far, the reaction to recent events seems muted; markets had been pricing South Africa’s foreign currency debt as junk quality for some time, following the sacking of Finance Minister Nhlanhla Nene in late 2015. The next risk then potentially arises from a downgrade of local currency debt, still safely ensconced in investment grade territory, for now.

Fiscal outlook poses the biggest risk

Overall, there is likely to be a modest macroeconomic impact. But this is primarily because some of the damage has already been done. There has been a gradual lowering of expectations over the last year and a half.

That said, interest rate cuts need not be entirely off the table. The recent depreciation in the rand should have limited inflationary consequences as it follows a prolonged period of strength versus the dollar.

We would note also that the central bank is assuming a benign global backdrop persists. Should global growth struggle in the second half of the year, a more dovish policy stance could evolve.

Beyond that, the biggest risk is the fiscal outlook, much of which will depend on how the new finance minister proceeds. However, revenues will presumably take a hit if growth slows from here, and exclusion from the WGBI would be a painful blow.