Speaker 0:
Hello and welcome to Absa S quarterly update today. I'm joined again by Peter Worthington, senior economist at Absa Corporate Investment Bank. Welcome back, Peter.

Speaker 1:
Thanks Chloe.

Speaker 0:
So Peter, considering the macro global macro environment that we're currently finding ourselves in has the fed's hiking cycle peaked. And what has the effect of the higher interest rates been on South Africa?

Speaker 1:
Well, markets certainly believe that the fed's hiking cycle has peaked. Uh fed is trying to be a little bit more equivocal about it. I mean, they have signaled now after this last move uh that they would be looking probably to a pause but also keeping their options open uh for the future if conditions shift

Speaker 1:
because of course, they have these super robust labor markets and they do uh want to bring inflation down. We did, we did have a good inflation print in the US uh today, which I think would have left um the Fed happy when the US hikes uh to some degree the rest of the world has to follow. Uh and that's um

Speaker 1:
certainly been true for us in South Africa where the S A B has been paying a lot more attention to what the fed and other advanced economies, central banks are doing. So in some sense, you can say that when the fed begins to tighten, when the global cycling, when the global cycle is tightening, South Africa has to follow a little bit. Um I also think that we're near the peak of our rate hiking cycle as well, but we can chat about that in a bit.

Speaker 0:
So when we last spoke, we touched on what may be expected in the National Budget speech, were there any surprises

Speaker 1:
for me? What was a surprise was the announcement of an Eskom uh debt deal? I was of the view that Treasury wouldn't be able to announce it because no conditionality had been agreed at that stage with Eskom. Uh but they took a different route and they announced sort of a timing and quantum

Speaker 1:
uh of debt relief and some broad conditions for Eskom to observe. Um but the detailed conditionality has yet to be uh decided it's under negotiation between uh Treasury and Eskom and other stakeholders. Um We'll see what that looks like. I I I think ultimately, we had to do something for Eskom um whether uh

Speaker 1:
the debt relief deal is going to sort of extract changes from Eskom in terms of its uh uh the way it's functioning, the way it's operating uh beneficial changes. I I think that remains to be seen. So the debt deal was something that I hadn't uh kind of fully expected. I think in general, with the budget, we have the Finance Minister and National Treasury doing a really good job

Speaker 1:
in really difficult circumstances. Um We have a big fiscal problem unfortunately, though in that the only kind of super convincing answer to our fiscal challenges is much stronger growth and the sorts of policies that we would need to implement to get that much stronger growth are outside of control of treasury. So,

Speaker 1:
um I think we're going to be facing some tough fiscal years, particularly in an environment where we're much more heavily indebted than we were uh prior to the pandemic.

Speaker 0:
The recently hiked rates by a little bit more than what the market expected is this expected to last? And what effects are the higher rates head on consumers' disposable income and as well as business confidence?

Speaker 1:
Sure. Yeah, that last uh rate hike was a surprise. I I don't ever remember going into an N PC meeting where the economists were so unanimous in what they were expecting.

Speaker 1:
Uh let alone one where the N PC then went and did something completely different with this 50 basis point hike when nearly everyone had been expecting 25.

Speaker 0:
So Peter, we've seen our inflation peaking ahead of most other emerging markets and developed markets. How is our inflation outlook different then from the rest of the world?

Speaker 1:
So uh as you correctly point out, we've peaked at about 7.8% in the middle of last year and we are down to 7.1% as of March. And our forecast for April which will be published uh next week by stats S A is 6.8. So clearly headline C P I is on a downward trend. But the reason it's on a downward trend is really because of one thing which is fuel prices. We are getting

Speaker 1:
cuts in fuel prices now because the oil price is low. It's been offset a little bit by the weakness of the rand, but the oil price has fallen and that's showing up um in fuel prices right now. But we also have strong base effects. So fuel prices were very elevated in uh the middle of last year. So it's the decline in fuel inflation which is dragging headlines C P I lower.

Speaker 1:
But behind that, what we've had is rising core C P I inflation

Speaker 1:
and also rising food price inflation. We actually believe that both are peaking right now. We think the core C P I will kind of uh print again at 5.2% in April for April and then will grind very slowly lower to the midpoint of the target range 4.5 by the middle of next year.

Speaker 1:
Food inflation has been a particular upside surprise. I mean, we had to print the 14% year on year food inflation uh for the month of March. Uh We think it's going to print at 14.2% for the month of uh uh April. But

Speaker 1:
when you look at South Africa and you look at things like crop prices, maize prices have come off a lot. Global food prices have come off a lot. One of the reasons why we have seen elevated food inflation we believe is because of load shedding. So food producers and distributors are lucky in a way uh that they have faced fairly what economists would term

Speaker 1:
uh price in elastic demand for the thing that they are supplying. In other words, um what it means is food is kind of essential. You know, you may have a bit of an opportunity not to consume um some good or service, that's discretionary, that's optional. You can decide not to go to the movies. If they're expensive, you can decide not to buy a pair of shoes if they're too expensive, but you kind of have to buy food. Um And so it really

Speaker 1:
to some degree doesn't matter what price you charge. Uh people are going to have to buy it. And what we've been seeing is uh that food distributors, um and producers, particularly those who are spending a lot on diesel to secure a cold storage chain uh for produce and other um

Speaker 1:
uh groceries that need cold storage that they've been passing on price increases uh to their uh customers. Uh But we think that that's largely coming to a close now um globally uh the Food and Agricultural Organization Food Price Index um has been coming off. And so I think um we're looking at some down trend showing up uh on food price inflation, quite a significant one. After the next print,

Speaker 1:
there is a bit of an upside risk though as we go into 2024. And that's that we have some early indications of an el nino climatic event which uh could push up crop prices if, if it proves pretty severe. But we'll just have to see how all of that uh kind of plays out the way it all aggregates in our forecast uh for headline C P I. Uh As I say, we're forecasting 6.8 for the month of April, it will be published next week.

Speaker 1:
We think we will dip below 6% dip below the upper end of the target band in the print for June

Speaker 1:
and then a slow grind lower so that we get down to the mid point of the target range, which is where the S A R wants to see inflation at around 4.5. We think we'll get there uh towards uh the end of uh in some time in the second half of 2024.

Speaker 0:
So Peter, given this inflation trajectory and seeing inflation dip down to 4.4 point five or the mid points by the mid middle of 2024. When are we expected to start seeing rate cuts.

Speaker 1:
So the S A B M PC tries to be a bit forward looking. I don't think we need to see inflation all the way down to the midpoint in order for the Sarb to cut. But we do want to see inflation clearly on a trajectory towards the midpoint, a sustainable trajectory towards the midpoint. Um Our view is that we will probably see the Sarb start to implement some modest easing in March next year.

Speaker 1:
It could come a little earlier. But I think in order for it to come earlier, we would need a few things to fall into place. Number one, we would need the Federal Reserve to be signaling very clearly that it had reached the peak of its hiking cycle.

Speaker 1:
We would need the rand to be quite stable at that time. We would need core C P I also to be grinding towards the mid point of the target range clearly heading down there. Uh And we would need as well inflation expectations uh to be uh dropping also. Um If we had all of those things arrive earlier than we were anticipating,

Speaker 1:
um We could perhaps have the Sarb cut earlier than March, but our base case forecast uh is that it will only uh begin to ease in March. And the easing that we get will be pretty modest 75 basis points in all taking the repo rate down to seven. Uh That's what the Sarb uh judge's neutral Reaper rate to be that would leave the prime interest rate at 10.5.

Speaker 1:
Um So we're not looking at a big cutting cycle, to be honest, I often get asked. Well, you know, is that, why wouldn't we see growth uh respond? And my answer to that is that really

Speaker 1:
uh interest rates

Speaker 1:
are not a particularly effective uh tool for stimulating growth or controlling inflation. Their impact is quite small.

Speaker 1:
Um And the constraints on our growth rate really have very little to do with interest rates. Uh over the long run, it's all the other structural issues um that we've talked about 75 basis points of easing will not provide a huge amount of relief uh to household uh disposable income. Uh you know, out of

Speaker 1:
a little bit of spending power back, but bear in mind that we have seen sort of the fastest uh rate increases in a long, long time. Uh The repo rate is now back at the level that we have not seen since the global financial crisis. We're uh 75 basis points higher than we were prior to the COVID pandemic. So, um

Speaker 1:
there's been quite AAA crush on consumers disposable income up to now. I think all things considered the consumer has been surprisingly resilient, although not totally immune. We're starting to see signs of consumer distress. Uh Lots of anecdotal media reports about struggling consumers curbing expenditure, relying more on distressed borrowing and the like. Um,

Speaker 1:
so we, we'll, we'll get a little bit of relief from the cuts when they, when they arrive, but certainly we won't have the full hiking cycle reversed. Um And I think, uh you know, the structural reasons are why growth will remain low uh over the medium term, not, not because of the level of interest rates.

Speaker 0:
So Peter, you mentioned that inflation has been reacting to the higher interest rates. What components of inflation are still keeping interest rates higher? And are we expected to see interest rates moderating? Um when we start seeing certain parts of inflation reacting?

Speaker 1:
I think so and to be honest, I'm not sure that inflation, the decline that we're getting in headline inflation is uh a result of the interest rate increases that have been pushed through to date. The main reason why headline inflation is coming down now is

Speaker 1:
because we're getting pretty, pretty strong base effects in fuel prices as well as lower fuel prices right now. So price cuts showing up right now and then the year on year rate of inflation for fuel prices has fallen a lot and that's pulled down headline C P I. Um working against that, we've had increases coming through in core C P I and much higher than expected food price inflation uh for different reasons.

Speaker 1:
Um I think the S A R is going to want to see core C P I inflation

Speaker 1:
clearly peaked and on a downward trend towards the mid point of the target range. So at the moment, it's 5.2, we think it's gonna flat line here uh for a little bit and then grind very slowly down to 4.5.

Speaker 1:
The A R is also going to want to see uh food price inflation which is very elevated right now come down a lot because food prices are very noticeable to consumers and everybody they affect uh inflation expectations. Um They're going to want to see that food price inflation clearly coming down that most of these sort of push through of these high

Speaker 1:
higher uh diesel cost for from food producers and distributors that that is kind of done. It's in the system, there aren't more price increases coming through as a consequence of load shedding. And I think they're going to want to see inflation expectations themselves also uh coming down in the last quarterly survey, those inflation expectations ticked up a bit. And um I think that was a bit alarming to the Monetary Policy Committee. They'll want them back on a downward trend.

Speaker 1:
And I think they'll want to see the rand trading quite stably as well before contemplating cuts. So quite a few things uh that need to fall into place before we're going to see any easing uh of the policy rate from the reserve bank.

Speaker 0:
So Peter, you've mentioned now that the South African Rand is trading, it's slightly below fair value. What drives the current valuation of the rand? And are we going to start seeing a little bit of a strengthening in our currency?

Speaker 1:
Uh fair valuation for the currency? Well, it, you know, estimates of where fair value are, are challenging. It depends what models uh you are using. Uh the S A P for example, at the last N PC uh said that the RAND was uh 10% undervalued or would be 10% undervalued in, in 2023. But currencies can diverge from fair value for long periods of time.

Speaker 1:
Um We're of the view that with the current account that is going to be getting weaker um with the global economy not looking particularly strong with our own domestic uh idiosyncratic economic weaknesses load shedding, political risk, et cetera, et cetera that uh the rand is going to remain weak for, for some time.

Speaker 1:
And we're not really looking at a big uh appreciation of the rand versus the dollar over our forecast horizon.

Speaker 0:
So the South African Investment conference was recently held. What were some of the highlights particularly surrounding renewable energy spending and um green hydrogen.

Speaker 1:
Yeah, that was a very notable investment. We have a view in absa research that what we are seeing right now on the investment front in South Africa is a sort of investment in maintenance by businesses and some investment in kind of renewable energy, you know, uh businesses putting in solar. Um you know,

Speaker 1:
that kind of a thing. That's where a lot of the investment seems to be happening more broadly than that, though, mostly businesses are really only investing in essential maintenance. Um And so the investment conference was quite striking because we had this 105 billion rand pledge by hive hydrogen to do something completely new,

Speaker 1:
which is a green ammonia plant uh in the eastern cape. That's a very big uh investment project. It's kind of an area which we're sort of thinking is maybe a, a nascent uh industry for South Africa, something that we might have pretty good comparative advantage in going forward. And so I think that that's actually quite exciting.

Speaker 1:
I will say though that even if you got all of that 105 billion rand in kind of one year and it doesn't ever flow all in one year even though it's very big in and of itself. Uh It would still only lift our in gross fixed investment rate by around 1.5% points of GDP. So it would take us up, let's say from 14.5, currently up to 16,

Speaker 1:
even 16 is too low. We need our fixed investment rate uh up above 20. And ideally according to the National Development plan, closer to 30 in order to meet our growth objectives, we're extremely far away from that. Um

Speaker 1:
And all of the investment conferences that we have had, they've produced some notable investments. They've also sort of some things which would have happened anyway, have been dressed up kind of and produces an investment commitment, but some of it is just maintenance investment. But so there have been some new things come through.

Speaker 1:
But all of that is still shy of what, what we require in order to grow more strongly. And I think uh we have a problem really with the progress of our structural reform program until we can show that we're on track to provide reliable, affordable electricity, uh functional transport, logistics. So exporters can get goods out of the country um

Speaker 1:
until we can sort of make sure that we have water distribution networks that will uh not lead to water outages in key economic hubs like joburg um until we can do a lot more on the structural reform front, I think business confidence is going to remain uh sort of fairly subdued and their investment spend will consequently remain subdued as well.

Speaker 0:
So, on the point of the electricity security um position of South Africa, what has been the developments um with regards to addressing load shedding and how has the South African economic growth outlook been adjusted to take into consideration the effects of load shedding?

Speaker 1:
Yeah, listen, load shedding is a huge problem for growth. Um There's no growth without power. So in our last forecast round, we had a a view about how load shedding would evolve uh one quarter ago and it's turned out that it's actually a lot worse than what we had anticipated that Eskom has made very little headway in stabilizing the performance of its existing generating plant and that has negative consequences for growth. So

Speaker 1:
um we have revised down our forecast of GDP growth this year to 0.3%.

Speaker 1:
Our econometric estimates suggest that if we had no load shedding at all this year, we would be growing at around 2.32 point 5% in the absence of load shedding, but we do have load shedding. Um I also think that kind of load shedding doesn't just hurt growth right now in terms of its negative impact on production.

Speaker 1:
But it's this deterrent to investment, a business isn't going to invest in an economy that can't produce power and that has negative consequences for growth into the future. We've also trimmed our medium term growth forecasts uh one quarter ago, we were forecasting trend growth of around 2%. Now we're down at around 1.5%. Um

Speaker 1:
It's not enough. Um And unfortunately, I don't think our load shedding performance is going to sort of alleviate hugely in the near term. We have a lot of private generation projects

Speaker 1:
sort of waiting in the wings, 10,000 megawatts uh apparently of distributed generation projects waiting to go, but we have only just started to see registration of utility scale projects with the regulator as of really March

Speaker 1:
and after registration it takes time to uh contract construct and connect to the grid. And so all of those private power projects, they're really only gonna come into play as a major relief for us on the energy front really in 2025. And it doesn't seem as though Eskom is going to be able to make big headway in improving its own energy availability factor. Um

Speaker 1:
Not for the old uh coal fired power stations. Um And it's only really in late 2024 into 2025 that we are likely to sort of have uh Coburg fully back online and the three units of kil that were taken out when that chip

Speaker 1:
collapsed. Um We'll only have them online. So I think the load shedding is with us really for all of 2023 into at least the first half of 2024 probably towards the end of it. Um And that means that our growth performance over the next couple of years is going to be pretty poor,

Speaker 1:
unfortunately.

Speaker 0:
Yeah.

Speaker 0:
So Peter then, why has South Africa's net exports slumped as well? And what effect is this expected to have then on the current account deficits and effectively our currency?

Speaker 1:
Right. So, you know, listen, we had an unusual situation in, in 2020 and 2021. Um And to some extent in 2022 where we were running current account surpluses, that's not kind of normal for an emerging market uh in general that needs to import capital and is short on savings. So, um it was kind of unusual uh part of it was due to sort of super robust

Speaker 1:
commodity export prices, those have been coming off. That's one of the reasons why the current account is going to weaken slightly. Um We also have logistics constraints particularly in terms of our rail and port facilities, our ability to export bulk mineral commodities, um coal, iron ore. Um and the like

Speaker 1:
um the Minerals Council have said that the, you know, the opportunity cost, the lost exports runs into uh tens of billions of rand, 50 billion rand I think is the figure that they put on it for 2022 alone. That's the reason why we're seeing a a hit to net exports. Um And then we've got some things coming through on the import side as well. I mean, if you compare with 2020 crude oil prices are higher that shows up on the import side of the bill, we're not really important

Speaker 1:
as much crude oil anymore because the refineries are shut locally. So we're importing refined product uh which is more expensive and actually has the premium above crude has risen. So that's showing up on the import bill. And we're also seeing big surges come through in imports of renewable energy related uh machinery and equipment that's also showing up on the import bill. So for those reasons um the current account has gone back into deficit, but I don't think it's sort of,

Speaker 1:
we, we're not looking at alarming levels of, uh for the current account deficit. Our forecast for this year is about, I believe 2.3% of GDP that's kind of within the norm, uh where you, you might expect sustainability for an emerging economy. The problem is, is that while sentiment on South Africa is so negative, uh it'll be hard to attract the capital inflows to finance that. And that's kind of why we're seeing the rand uh weakening right now.

Speaker 1:
Uh Risk aversion is sort of, well, let's say there's not super strong risk, appetite and not uh a sort of appetite for South African risk and particularly not right now.

Speaker 0:
Thank you, Peter. So then is it all doom and gloom or are these structural reforms that you spoke about earlier? Painting a brighter picture for South Africa

Speaker 1:
eventually. Um But I think the structural reform program is sort of progressing slowly and it's partial in many ways. Um I think we have a state that is not particularly capable on the implementation front

Speaker 1:
and we have had political tensions within the A N C stymie. Some of the more um difficult reforms that would involve a degree of upfront pain. You need a really strong focused um political leadership to drive structural reform. And I would say that the political leadership uh over the last uh couple of years has not been uh extremely focused or uh strong.

Speaker 1:
And then we have the problem that the the state itself, that the bureaucracy, um you know, the that kind of interface uh to the economy, uh the government's interface to the economy through the bureaucracy has not been uh super capable in a large number of areas. I mean, just look at the the municipal dysfunction, for example, where they are unable to provide basic services. Um

Speaker 1:
and what business can really operate uh in, in a, in a municipal jurisdiction like that.

Speaker 1:
So we do have structural reforms. You've obviously got the energy sector. There are some reforms uh envisaged in the transport sector. We have seen uh the sort of um auction of spectrum. Uh last year, we have some ideas for reform in the water sector. Uh but we're kind of far away from the end goal which is to have kind of functioning network industries. Uh

Speaker 1:
um And then in other areas, even ones that are not necessarily ideologically contested, you know, something simple like uh a functional uh mining rights administration system, we've been promised a replacement for Sam Rad for probably over a decade now. And it's really only now after multiple delays for reasons that are hard to understand that uh D M R E is going out with, with a tender. Um

Speaker 1:
There are other areas where we probably need a fair bit of reform if we want to grow. But where we're unlikely to see it because of ideological contestation and an area there that I'm really thinking of is labor markets. There are some things that need to be changed about our labor market regulations if we want to have strong employment intensive growth. Um But I don't think it's likely to happen because it will be opposed by uh cosatu and large parts of the um

Speaker 1:
A N C and I, I just don't see it being pushed through right now when there's uh so much flus within the governing alliance. So I, I think in general, our reform program is moving forward. Um Ultimately, it's headed in the right direction,

Speaker 1:
maybe not all parts moving at the, the speed we want though. I think in order for it to start to show results in terms of our macroeconomic performance, though, we're going to need a sort of a, a bigger quantum of reform sort of actually done, done and dusted um and kind of commencement of reforms in, in some of the other areas which are are not really on the to do list

Speaker 0:
yet.

Speaker 0:
Peter. Thank you for sharing your insights into the latest quarterly update. We appreciate your time.

Speaker 1:
It's my pleasure. Always good to talk to you Chloe.