Our winners and losers keep changing

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By Cees Bruggemans, Chief Economist of FNB.

The Americans and Chinese remain equally adamant about their domestic priorities. In the process the rest of the world gets flooded by yield-seeking liquidity, yet further boosted by Japanese countermeasures.

South Africa, like so many other emerging and commodity producers, keeps encountering large capital inflows.

This global spiff and the deep uncertainties and anxieties it fosters also boosts our precious metal prices and our terms of trade (export minus import prices), and thus our national income and balance of payments surplus.

The corporate scene adds yet more fuel to the fire with mega corporate deals, foreign financed.

Thus the Rand is strong, indeed at 6.80:$ already 20% overvalued, with more to come, as this global condition has many more months to run, and on some reckoning even a few years before finally turning.

There are apparently only five options for a country like ours how to react to this development: acquiesce to the inevitable as the Rand gets firmer, verbal intervention, intervene by buying foreign exchange, cut interest rates, and/or impose transaction taxes.


Singapore is an example of acquiesce, tightening rates (as its economy is already performing above potential and accepting the discipline of an appreciating exchange rate forcing structural change in its economy).

Others like Aussie and Israel have stopped tightening rates for the time being but are essentially riding this global reality as it firms their currencies.

Europe is the one major region so far not having responded, though steadily moving towards an exit strategy, implying effectively the start of policy tightening despite the firming Euro.

This, though, is partly helpful in putting more pressure on politicians to do more domestic reform, precisely what the ECB is seeking at this juncture. So the firming Euro, besides becalming market concerns about Europe’s institutional outlook, is not entirely unwelcome.

Brazil, Chile and Thailand have imposed transaction taxes, with nobody claiming victory, indeed quite the opposite as markets incorporate these taxes into their calculations and, on finding the speculative investment profits outweigh these puny gestures, continue to flood these countries with capital.

China, Japan, Korea and Switzerland are the big interveners, selling local currency and buying Dollars while mostly sterilizing such external transactions with bond issuance, trying to prevent appreciation or even achieve depreciation of their currencies.

Few are cutting rates (not counting Japan’s 0.1% gesture two weeks ago), as nearly everyone (bar one or two global laggards) have already fully exhausted that option.

And all are applying verbal intervention and succeed in not getting listened to, except the Americans as main player, with the Fed as liquidity pusher of global last resort (for the Americans) taken very seriously indeed (and any US political claims of wishing for a strong Dollar widely recognized as cynical window dressing).


Where does this leave South Africa?

Recent weeks have seen a steady drip of official views, last week turning into a roaring flood.

The Minister of Finance, as financial commander in chief, has repeatedly commented that a weaker, stable Rand is much to be preferred. That at least sets the scene for what comes next.

Our Planning Minister, Trevor Manuel, has opinioned a number of times.

Memorably, he indicated that not even the strongest local political language seemed to frighten off foreign boarders, never mind more sober official pronouncements.

So open-mouth policy, once so beloved of a former SARB Governor, isn’t apparently much of an option, at least for now, for if there are no means to back up suggestions, markets will look through these and only sense weakness rather than policy determination, and act accordingly.

Also, Mr Manuel has usefully indicated that it would be crazy to fix the currency or to expensively intervene, thus neutralizing competitive noises elsewhere in the political firmament.

This has often been commented on before, for if such interventions are to be neutralized and prevented from increasing local liquidity, the Rands created to buy Dollars need to be drained out again through the state selling bonds into the market.

If the Dollars so invested overseas earn 0.2% and our government issues bonds at 8.2%, the running tap is 8% annually. If over two years you would want to buy $20bn of excess dollars for the foreign reserves and keeping the Rand at 7.50:$ (say), that would eventually give an interest cost of R10bn annually.

That’s 1% on VAT, or the equivalent of what the Health Ministry likes extra from next year or enough to pay for an Eskom power station while it is getting build.

Any appetite for such forex buying? No, okay let’s pass.

The Treasury Director-General has also let it be known there is no appetite for foreign transaction taxes despite other countries trying them out.

Of course, South Africa has already for many years also shown no appetite for fully lifting exchange control, fearing its disruptive influences, instead preferring to stick with prudential limits and firm controls.

That leaves very few options. In terms of the original short-list of five there remain only two, acquiesce and cutting interest rates.

In South Africa’s case, to acquiesce WITHOUT cutting interest rates any further would mean acceptance that the Rand will firm further under the influence of the forces already described, for as long as these may be evident.

And as the SARB chief economist Mnyande indicated again last week, this could go on still for a (very) long time.

In the process, our inflation and growth trajectories could be pushed lower (assuming everything else staying the same, which is pretty much the assumption).

And though we would love to have a lower inflation rate (at least some of us, especially the 75% of South Africans who are desperately poor and don’t belong to a labour union), we can overdo it if achieving such a structural change too wrenchingly.

Official policy is 3%-6% inflation and this for now remains a good target range, seeing what global excesses and their inflation consequences are capable of pushing towards us (ranging from 2% to 10%).

Also, more importantly, a Rand firming without any form of countervailing compensation when the country already suffers a sizeable output gap suggests continuation, if not the widening, of such a gap as unemployment worsens, private capacity utilization starts stagnating (rather than recovering) and private fixed investment decisions are getting more and more postponed.

In short, we aren’t Singapore, India, Aussie or Brazil, even if in our dreams we think we are.

We are we.

In a way perverse, but having kept its powder dry so far (which is one way of looking at the situation), the SARB still has cuttable interest rates at this critical juncture.

And substantially so, in real terms and especially in nominal terms (repo still 6% above Fedfunds, UK and Japanese intervention rates and 5% above Europe’s).

Way to go!

Instead of seeing any interest rate cuts as poison pills, lessening carry-trade attractiveness and weakening the Rand, they should be more seen as compensatory moves.

No foreigner is going to push less capital our way when we cut rates, indeed he may push more our way, as the growth story improves.

And that is probably the main story. As the firming Rand erodes growth viability via the export sector, domestic interest rate cuts assists the domestic economy to gain more traction in other sectors of the economy, potentially keeping a certain amount of growth going.


But it takes no genius to realize that somebody is getting penalized by this course of events and will have to work a lot harder, while others are getting it easier.

The winners/losers balance is shifting once again, and with a vengeance, reflecting impenetrable global forces and our policy responses thereto.

At least our mining sector may find itself (partially? Fully? More than fully?) hedged by events, if export commodity prices can keep pace with the firming Rand, and gaining if outperforming it. If volumes don’t fall off, most of mining may be safe.

That may not be true of manufacturing, where exporters have specific niches. With most of it going into Europe, the good news here is that the Euro is now gaining along with the Rand, while European growth has found a new leash of life in German exports to China.

So whereas our precious metals benefit directly from US and Chinese mayhem, and our non-precious commodities benefit most from China’s growth story directly, our non-commodity exports probably benefit most from China’s growth story via another stomach (Europe’s).

Complicated, neh? The things you have to do to make a living in this world.

Meanwhile the entire household sector is taking four steps forward as the windfall largesse is finally coming into view. And there are many angles.

Falling inflation is boosting purchasing power directly. The SARB is cutting interest rates steadily, making it easier to deleverage and increasingly easy to start thinking about more fun things to do.

Also, the state keeps handing out money hand over fist (a few people even helping themselves here), while our asset markets (bonds, equities) are starting to smell of boom.

With mindsets ever so glacially thawing, business keeps spending money, households dare to ask for more credit, and banks ever so tentatively (for surely this can’t be for real?) are starting to hand it out faster, though one drip at the time.

Credit is growing again, very slowly, but a trend has to start somewhere and it is usually at the bottom of a trough when all have lost it.

Car sales are roaring, building merchants and clothing retailers are doing well, and the consumer recovery is broadening as we speak, though the world cup was a nice diversion.

Construction will have to await the government’s return from being away, but SARB Governor Marcus has already indicated now is the time for the state to fill its boots with expensive foreign infrastructure goods while prices are still so low overseas (not for long!!!) and the Rand getting stronger (probably much longer). If that isn’t an incentive, what is?

So if the state could once again get its act together (nice) and the private sector could get tempted, in mining and possibly other areas (though there are a few minor political issues to consider, nationalization for instance, for those who don’t quite grasp irony), even the construction story could get back on the road within a year or two.

That leaves the property and building industries.

These areas are currently still heavily oversupplied, with a deeply negative mindset and big debt legacy. One wonders what it will take to unfreeze this fresco?


Forever is a long time in the presence of falling interest rates lightening debt burdens, rising nominal and real incomes and recovering asset markets, re-infusing wealth engines dependent on bonds and equities.

These current black sheep of the family stand to gain, and probably gain most, from the steadily arriving global windfall as it forces down our still exceptionally high interest level. With most exposure to debt, property (and banking) also has the biggest positive leverage effect from falling interest rates.

And with the down-leg of the rate cycle apparently not yet finished, the wholesale rehabilitation of this most stricken of neighborhoods still awaits the rejuvenating change, like a drought-wrecked farmer awaiting the rains.

And it looks like it is coming.

That leaves real agriculture, and here the story is yet different.

At least global agricultural commodity prices are increasing again, a combination of drought and growth effects, and at least matching the firming Rand. Also, we aren’t primarily exporting to the US but elsewhere in the world, where currencies are behaving more like our Rand.

On balance, this may not quite sink us as much as what a sinking Dollar or firming Rand is suggesting.

Perhaps more problematic are production surplusses from previous seasons and whether the rains will be good, bad or indifferent, the traditional farmer uncertainty.


Overall, the Finance Minister’s coffers are filling faster than expected as his revenues and a recovering economy are doing better than expected.

Though this will not prevent specialized tax tweaking, the big structure may remain mostly untouched (for now, until structural ambitions kick in more ambitiously, health, education, infrastructure, other unmentionables).

Households are in the throes of a progressive cyclical awakening, so far without noticeable employment gains.

Fixed investment gains will be slow, but look for evidence of the pace starting to change.

Most industry sectors will be doing steadily better, either because of a favourable global exposure (mining) or because the domestic exposure starts to do progressively better (the rest).

Is this cheerleading for its own sake?

No, unless you want to present a large windfall arriving and the flexible policy response thereto as a funeral.

If the latter you have reason to worry. But we aren’t primarily into funerals now. The windfall condition suggests something quite different coming our way.

The economy looks like having a respectable growth run ahead of it, though winners and losers are changing positions all the time.

This doesn’t always make it easy to fully appreciate where the overall system is heading next. At least the financial markets look pretty confident about the outlook. Up and away.

Source: Cees Bruggemans, First National Bank, October 18, 2010.

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