The appointment of Gigaba came as a complete surprise, as his name was not mentioned in the run-up to this morning’s announcement. Our new Finance Minister is a former ANC Youth League leader, and is reportedly a close ally of Zuma. It is most perturbing that he is completely untested in the world of finance and the Treasury – he certainly does not appear to have the credentials required for his new position.
Our biggest concern is around National Treasury itself, however. Treasury is one of the few state departments run in an efficient manner until now, with competent staff members that have proven themselves over time. They’ve had to deal with many changes and challenges since the Nenegate debacle in December 2015. This sudden removal of Treasury’s trusted political leadership can be highly demoralising, to say the least, and we may see an exit of good people as a result.
The pattern that we’ve witnessed at the South African Revenue Services, where questions have emerged about the competency of this once highly effective state department, may just repeat itself at National Treasury.
Another potential consequence of Zuma’s latest shenanigans is that the new political leadership may institute a witch-hunt against those not aligned with the particular agenda of the Zuma faction. What is certainly clear is that this morning’s Cabinet reshuffle represents the actions of a desperate leader pulling out all the stops to remain in control of a deeply divided party and government, and seemingly stopping at nothing to get full control of the State purse. It may, however, yet backfire on the President.
Besides the impact on the Treasury, we are concerned that much damage may yet be done in the eight months leading up to the ANC elective conference at the end of the year. Now that the public purse has been handed over, it isn’t inconceivable that the planned nuclear programme could be fast-tracked and a deal signed before the end of the year, burdening the fiscus for generations to come. The anti-Zuma camp within the ANC needs the Wisdom of Solomon to decide on the most appropriate strategy for damage control over the next few months. Further actions and events will most certainly unfold in the next couple of days, and weeks and should further enhance current uncertainties.
VOLATILITY AND A LIKELY CREDIT DOWNGRADE
In a recent series of client events we highlighted that the ‘soap operas’ and noise at macro level are likely to test markets and will introduce increased financial market volatility. We narrowly escaped a sovereign credit downgrade in December, but this morning’s Cabinet reshuffle is likely to be the catalyst for the three main rating agencies to downgrade South Africa at their next round of reviews, one of which may be as early as next week.
The South African economy is caught in a low-growth trap and this morning’s announcement certainly won’t change this. In fact the increased macro-uncertainty will dampen already low business confidence and therefore economic growth prospects. The rating agencies will build this into their decision-making models. Add to this that much bandied-about phrase – ‘radical economic transformation’ – and one can understand that the rhetoric may lead the rating agencies and market participants to perceive a greater level of policy uncertainty over the near term. Also, reform initiatives driven by the Finance Ministry, including procurements and state-owned enterprise governance reforms, are unlikely to gain momentum and will therefore have a negative impact on South Africa’s fiscal position.
We have to measure the excellent work that Gordhan did to ensure what he himself described as ‘the best possible deal’ with foreign investors and rating agencies against the concerns mentioned above. Rating agency Moody’s was scheduled for a ratings announcement next week, and the general view is that it will announce a one-notch downgrade, which will still leave South Africa’s credit rating as investment grade. Time will tell whether Standard & Poor’s and Fitch will follow this example later in the year; a one-notch downgrade would imply a non-investment grade rating from these two agencies.
Gordhan had an excellent working relationship with business leaders and the financial community in general. This relationship provided confidence and legitimacy to the sector. It would be premature to not give the new incumbent the opportunity to establish a decent relationship with business and the investment fraternity, and to continue the commendable effort of the outgoing minister with the rating agencies and foreign investors.
The South African Reserve Bank demonstrated caution yesterday when it left interest rates unchanged. These events will have a negative impact on the currency, which will have a knock-on effect on inflation rate prospects and also monetary policy. Again not good news for economic growth prospects for the remainder of the year. We’ve argued that the rand traded at fair value against the dollar when it traded in the R12.50-range earlier this year. With these new events, the rand is once again the victim of reckless political action, and we can only offer the view that the risk is undoubtedly skewed to the downside. Hence, our call during the recent client events that clients should ensure that their portfolios are appropriately diversified for their particular financial circumstances.
The latest political moves are likely to stir up emotions immensely, not only from a political perspective but also from an investment perspective. In our local equity portfolios we have a substantial rand-hedge component. We’ve also recently added to BHP Billiton and Mondi which are both rand-hedge stocks. However, the banks are likely to be the biggest victims of the uncertainty created by political action. We don’t intend to sell these shares, as they don’t appear too expensive despite the negative macro-environment. Should the market become irrational in the pricing of these assets, we might even consider adding more to these shares.
Within our balanced mandates we maintained a foreign component in excess of 20% – we are only allowed to invest 25% offshore in compliance with Regulation 28. We will maintain a full offshore weighting. The local bond exposure was increased as bond yields appeared to be attractive. This worked well for the portfolios. However, the increased probability of a credit downgrade will weigh on these assets. Should investors overreact, we’ll use the opportunity to add more to this asset class.
Finally, it would be fair to ask if this cabinet reshuffle is the tipping point for South Africa and the economy. We believe it is too early to make this call. We still believe – as a base case – that fundamental principles will dictate market prices over the longer term. Against this background, we will stay true to our investment philosophy that price levels will be the most important factor driving prospective returns.
