I consider South Africa “The Big Short”. I have been bearish on SA for a while, but things are really picking up pace now. This has nothing to do with how I feel about my country, it’s all about history (not necessarily local) repeating itself and the SA economic and governmental fundamentals (or lack thereof.) To position yourself financially (and this is all I will focus on) you should consider that the worsening situation will likely show up the most in South Africa’s share price – namely the Rand – as foreign investors voluntarily and involuntarily (as in the case of a Junk downgrade) pull their investments from SA, which will create huge selling pressure on the Rand as everyone tries to exchange local assets in Rands for their local foreign currency (US$, Euro etc.) as they pull out.
Let us consider the facts in order of importance/gravity
1. Bankrupt, corrupt and poorly managed State Owned Enterprises (SOE’s) will sink us
The SA government has approved a R59Bn taxpayer-funded bailout for Eskom, whose debt is now north of R500Bn. This is now a sovereign debt, it is no longer just ESKOM’s debt. This is R59Bn that had to be diverted from social and other infrastructure programs to keep the dysfunctional ESKOM afloat. To put this amount into perspective, this is the amount it cost SA for the free tertiary education program. Other dysfunctional SOE’s like SAA, SABC, Denel, PetroSA, SANRAL, Post Office and the Road Accident Fund, are also seeking billions to stay afloat. Bailouts themselves are not the problem, it’s the restructuring that is supposed to accompany them that are.
Most of the restructuring will require heavy staff layoffs and salary cuts due to bloated payrolls, appointment of professional non-cadre management, cutting off the spigots of corruption, sale of non-strategic assets and introduction of private-sector partnerships. The ANC as a collective, due to its structure of narrow self-interest groups, is having none of this. The labor unions have threatened to shut Eskom down if any staff restructuring takes place, senior ESKOM managers earning over R1.5m want wage increases and bonuses or they threaten to reintroduce load shedding, the corrupt elite will never agree to appointment of non-cadre deployees lest they lose control of the feeding trough of state funds, the communist, socialist and Unionist elements will never agree to the sale of non-strategic assets and private sector partnerships (being anti-capitalist and anti-job losses that will inevitably follow). So all we have are talk shops, promises and last minute desperate appointment of compromise CEO’s (as any with any integrity/intelligence to see the coming train wreck are leaving SOE’s in droves). Do not expect any changes any time soon – we are in a state of suspended SOE animation.
The lack of any lasting, meaningful restructuring among failing SOE’s will further burden the fiscus and most likely trigger a junk rating from Moody’s leading to SA falling out the World Government Bond Index and R100Bn forced (involuntary) disinvestment by funds. This is after those investors that will voluntarily offload around R100Bn in the lead-up to the junk rating as worsening fiscal conditions become more and more apparent. A R200Bn outflow is quite feasible, given that over R470Bn has already left SA in the wake of the Zuma 2nd term. This alone will drive the Rand straight north of R20/$, without question.
2. The Government doesn’t get the economy
SA’s economy has been a perennial underperformer for the last decade. It was the case that the powers that be could blame the global financial crisis but that ship has sailed long ago. The US is in its 10th year of economic expansion and most of the world has been expanding strongly since 2009. Not so South Africa which for the last 5 years has been among the slowest growing economies in the world. SA has only just managed to outgrow the economic basket-cases of Venezuela, Argentina and Turkey. Even the previous basket case of IMF-bailed out Greece is doing better than us. We have managed a 2% growth in the last 4 years versus our emerging market peers that have grown their GDP north of 11%. Even the large developed first world countries (G7) have mustered 7.5% growth. Given that our population has grown over 7% during this period, we are becoming poorer as a result on a GDP per capita basis.
The latest shock 29% official unemployment figures lead to the usual knee jerk “jobs is a crises” talk shops and narrative from the government talking heads, but this is a movie we have seen over and over again. Nothing meaningful ever changes. This is not the first time we have been forced to realize we have a national jobs crises. Incredulously, the unions’ most recent response is to spring into action and start pressing for stricter legislation to make it almost impossible or at least very costly to retrench anyone. This is the problem we have – the powers that be, or the narrow interest groups that wield a lot of power in the ANC think we can legislate and redistribute ourselves to prosperity whilst history shows us completely otherwise. Instead of fighting over the diminishing slices, nobody is focused on growing the pie!
Instead of fighting over the diminishing slices, nobody is focused on growing the pie!
Instead of focusing on improved economic outcomes, we’re passing legislation to make it impossible to maintain a flexible labor force in the face of changing economic conditions and we are hell bent on costly programs like NHI and Land Expropriation – more SOE that are going to be a feeding trough for the corrupt elite. It is really hard to read anything in the press today regarding the government or any of its initiatives and answer the question “how is this going to create more jobs?”
3. Its going to get worse before it gets better
In case you are tempted to think there is light at the end of the tunnel , think again. Just about every leading indicator for the stock market and local economy is pointed down. These are all indicators that over the decades have foretold of economic fortune or misfortune with an average 6-8 months lead time. Here is a set of these from RecessionALERT.com, where the only thing showing any positivity is the recent cut in local interest rates.
4. Costly side-projects will sink our finances
There is an enormous amount of focus being given to programs such as National Health Insurance (NHI), nationalizing the Reserve Bank and Land Expropriation. If the government had a great track record with SOE’s we probably wouldn’t give it much thought but who honestly thinks that the establishment of more SOE’s responsible for hundreds of billions or even trillions of Rands is going to manage outcomes any differently to the existing failing SOE’s? What is concerning is the statements from government that “XYZ is coming whether we like it or not” and yet the NHI government pilot programs have failed dismally and the government has done an appalling job with existing land distribution to date. Its as if the voice of reason and warnings coming from respected quarters about the many ways these programs are going to fail just fall on deaf ears. The odds of any of these programs being executed properly whilst trying to fix the existing mess at the SOE’s are just not making any sense. It reminds me of how the industry warned the government on the travel restrictions legislation and it took a nosedive in our tourist arrivals for the government to backtrack the legislation. Nobody seems to care about the voice of reason anymore.
5. The Global Economy is headed for a period of slow growth or outright recession
Growth is slowing around the world and we are in the endgame for the current expansion. All the countries have been able to build up reserves and tools to provide countercyclical economic support, but the SA cupboard is bare – we have used up all our resources and will enter the next global recession with an empty toolbox to provide any support to the economy. We failed to capitalize on the current growth cycle and will be paying for it dearly in the next global recession or financial crises. SA is not an island and if the rest of the world sneezes we truly will catch a bad cold, with no medication in the medicine cabinet.
6. Government is out of borrowing options
Our debt to GDP ratios is climbing beyond 60% but even if we wanted it to go to 70%, we are out of options for people to loan us any money to dig us out a hole. It is estimated that SA would need north of US50Bn to fix the current mess we are in. The African Development bank in its entire history since 1984 has loaned $47Bn and they only loan for infrastructure projects (we use our loans mostly to pay salaries) so they aren’t going to be an option. The Brics Bank only has a $3.4Bn budget per year and its unlikely we would get all of that. It also only makes loans for infrastructure spending. The World Bank only lends for infrastructure finance. That leaves the IMF which is the only bank which has sufficient funds and which lends not for infrastructure projects but to bail out countries which have got into a mess. The IMF however, would attach restrictions to the loans that make our currently unpalatable options look like a school picnic. One only needs to look at the experience of Greece and the riots that followed as the restrictions were put into play to understand how much the government would lose their sovereignty under this option.
What about cozying up to our friends the Chinese? They may have deep pockets but frankly, were probably better off with the IMF given the conditions the Chinese would attach to their loans. African countries having to relinquish control and ownership of Airports and national ports to the Chinese in lieu of failing to be able to pay their debts comes to mind. But besides that, the recent interview of the Chinese ambassador by Reuters regarding possibility of making further loans to SA must have dropped some jaws. In a nutshell they see Eskom as a debt trap and refuse to loan any further money to them and were also quite clear that SA loan initiatives are short on infrastructure projects, light on feasibility studies and lacking in investment protection laws (another piece of legislation we repealed recently to chase investment away.) Incredibly, the Ambassador suggested SA look to the IMF and then they might support SA – presumably because the Chinese know what strenuous conditions would accompany IMF loans.
With no budging on structural reform of SOE’s and no external loan options to finance inefficiency, corruption and largess, that leaves a diminishing pool of taxpayers forced to pay higher taxes and employee pension funds being targeted with prescribed assets. Watch this space closely.
7. The Rand is primed for a blowout
The chart below from RMB Global Markets shows how the Rand reacted to the last 4 first US Fed cuts, depreciating an average of 45% within 12 months:
A 45% Rand blowout will take us from R14/$ to R20/$. This is just global forces of supply and demand reacting to interest rate policy (Emerging Market Risk-off sentiment) so any further deterioration of SA’s fundamentals regarding fiscal position, debt-to-GDP, SOEs, the economy, junk status, expropriation and so forth could potentially make R20/$ a best-case scenario.
In our article two weeks ago “10 CRUCIAL LESSONS FOR JSE INVESTORS IN THE ZAR/USD” we showed how local investors should ignore seasonal Rand depreciation in the month of August at their peril. It appears this depreciation has commenced already with the Rand falling over 3% in the first 2 days of August, but the coinciding of the first fed rate cut makes the seasonal pattern even more ominous.
The risks for the Rand are very high – seasonally, from a global interest rate policy perspective (first Fed cut) and poor fundamentals (perilous state of SA finances.) Below are a range of potential options available to counter this risk, with which options and combinations being suitable being different for every investors’ situation. It’s probably best to consult a professional Wealth Advisor or licensed broker or Financial Planner on the options best suited for your personal circumstances.
1. Move Rands offshore to invest in offshore shares
2. Stick to strong Rand hedge JSE shares
3. Invest in gold through a locally available ETF
4. Try a small taste of Bitcoin, a perfect rand hedge
5. Invest in local ETFs exposed to offshore assets
6. Invest in a Rand/$ tracker ETN
7. Unit trusts with maximum offshore exposure