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Throwing everything at getting out of the COVID-19 hole

30 Sep 2020

Wikus Furstenberg, Refilwe Rakale, Yunus January, Daphne Botha, Aidan Kilian / Interest Rate Team

Economic & bond market review

Globally, most central banks are still pulling out all the stops

The global economic and financial crisis has forced central banks to remain on the back foot.  In the case of the most recent monetary policy meetings, two developments deserve mention.  In the United Kingdom, the Bank of England noted that it would begin formal talks with private sector financial institutions on the operational challenges regarding negative rates.  On the other side of the Atlantic Ocean, the Federal Reserve, in stating its usual forward guidance, indicated that it would leave interest rates near zero for the foreseeable future. It also tweaked the reference to inflation by adding that this would be allowed to moderately exceed a rate of 2% for some time, in order to anchor inflation expectations at the 2% target.  While both central banks left their policy rates unchanged, the respective messages about negative rates and reflation are worth flagging.  These served to underline the strong intention to maintain an unprecedented accommodative monetary policy stance for as long as it takes to help engineer a more sustainable economic recovery.     

The South African central bank adopted a more cautious stance

Back home, the South African Reserve Bank (SARB) opted to keep the repo rate unchanged at 3.50% at the September Monetary Policy Committee (MPC) meeting.  The more conservative approach of the SARB is demonstrated by the fact that its own growth and inflation forecasts have been revised lower since the July MPC meeting when it cut the repo rate by 25 basis points.  Moreover, a sharp drop in inflation expectations in the third quarter to a new 15-year low, including that of organised labour, points to inflation expectations being anchored lower.  In another development, the Bank opted to halt its purchases of government securities in the secondary market in response to improved market conditions.  This confirmed the clear intention not to use its balance sheet to assist, in a stealth manner, with the funding of the national budget deficit.

Figure 1: Impact of CV19-induced national lockdown worse than expected
(SA Gross Domestic Product: year-on-year change)

Impact of CV19-induced national lockdown
Source: StatsSA, Futuregrowth

Confirmation of the economic carnage caused by the
CV19-induced national lockdown

The release of Gross Domestic Production data for the second quarter of this year undoubtedly stole the limelight.  The national lockdown was the main cause of the broad-based 15.2% (year-on-year) collapse in economic activity which, in turn, had a ripple effect elsewhere, including a large negative impact on tax revenue collection by the state.  On the other side, the exceptionally weak economic growth backdrop lends a helping hand to a muted inflationary environment.  While the July year-on-year rate of increase for both the Consumer and Producer Price Indices accelerated for the first time since the end of 2019, detailed analysis still points to very muted underlying inflationary pressure.  In the case of the Consumer Price Index (CPI), the year-on-year rate of increase accelerated from 2.2% in June to 3.2% the next month, before dipping to 3.1% in August.    

More recent improvement in economic activity points to a rebound, but South Africa is not out of the woods yet

Indicators such as electricity demand, new vehicle sales and manufacturing activity all rebounded from the collapsed levels in April.  Even though this is welcome news, the sustainability of the rebound remains questionable.  One indicator calling for caution is the continued sharp slowdown in underlying corporate and household credit extension, a clear signal that both sectors are under significant duress, while lenders have also become more risk averse.  In the case of private sector credit extension growth, the year-on-year rate of increase continued to slow, with the August data down to 3.9%, dropping for the fifth consecutive month, after having peaked at 7.7% in March this year.  Household credit extension remained particularly lacklustre at 3.0%.      

Another large merchandise trade surplus

Data for the three months ending August showed impressive surpluses of R47- , R37- and R39- billion respectively.  While imports rebounded in August by 7% month-on-month, this increase was coupled with an improvement in exports of 6.6%.  In light of this, the continued strong performance of some of the export categories is particularly pleasing.  This development continues to bode well for a current account surplus for this and next year and might, in combination with a weaker US-dollar, lend some support to the currency. 

Figure 2: Current account position relapsed into negative territory in Q2 but the outlook for the remainder of 2020 looks more promising

Current account position
Source: South African Reserve Bank, Futuregrowth

Latest fiscal data release confirms the fiscal slide

July and August fiscal data continued to confirm the impact of the anaemic economic environment.  Revenue collections remain in the red, with a cumulative year-on-year collapse of 20% in August continuing to reflect the dire economic consequences of the COVID-19-induced crisis.  On the expenditure side, initial slow spending started to pick up in the third quarter with the relaxation of lockdown restrictions, with August year-on-year growth coming in higher than the budgeted growth of 7%, at 10%.  Overall, fiscal data thus far suggests that the risks to debt sustainability remain elevated, highlighting the urgent need for significant expenditure cuts and structural reforms.

Figure 3: A primary deficit is an unsustainable situation (Consolidated national budget balance excluding interest payments on outstanding debt)

Consolidated national budget balance excluding interest payments on outstanding debt
Source: National Treasury, Futuregrowth

A marginally better quarter for the South African government bond market

Although foreign net selling of rand-denominated government bonds reached R74 billion for the first nine months of this year, the pace of foreign selling slowed during the third quarter.  This, combined with stronger local investor demand in response to more attractive market levels and steeper yield curve slopes, brought about some stability in both the nominal and inflation-linked bonds markets.  On the nominal side, the FTSE JSE All Bond Index (ALBI) rendered a return of 1.45% for the quarter ending September.  Better performance since August also helped inflation-linked bonds with a tentative comeback.  The FTSE JSE Government Inflation-linked Index (IGOV) managed to eke out a return of 1.00%, marginally beating cash which returned 0.91% over this period.  Returns for the first nine months of the year show cash still firmly in first position at 3.62%, followed by the ALBI (1.82%) and, in last place, the -1.45% rendered by the IGOV.      

Table 1: Bond market returns (periods ending 30 September 2020)

Bond market returns (periods ending 30 September 2020)


Although inflation is slowly regaining positive momentum, strong disinflationary forces are undoubtedly still at play.  Even so, a cautious central bank opted to keep the repo rate unchanged at the last MPC meeting, following a series of unprecedented cuts that left the repo rate at an all-time low of 3.50%.  While economic activity appears to be picking up following the devastating impact of the national lockdown in the second quarter, it is still well below pre-lockdown levels.  This does not bode well for a fiscal situation that is already the most fragile in many years, and unfortunately supports our scepticism about government’s ambitious expenditure reduction plan.  The combination of stable monetary policy and an increasingly slippery fiscal path imply an anchored short end, but upside risks to the yields of longer-dated fixed and inflation-linked instruments.      

Key economic indicators and forecasts (annual averages)


    2016 2017 2018 2019 2020 2021
Gobal GDP   2.5% 3.4% 3.3% 2.6% -3.8% 5.0%
SA GDP   0.4% 1.4% 0.8% 0.4% -8.1% 5.2%
SA Headline CPI   6.3% 5.3% 4.6% 4.1% 3.1% 4.0%
SA Current Account (% of GDP)   -2.9% -2.5% -3.5% -3.2% 1.5% -1.0%

Source: Old Mutual Investment Group