Adri Senekal de Wet in discussion with Chris Harmse, an economist of Sequoia Capital Management
De Wet: Looking back on the high's and low's on the economic front during 2022, what stands out for you?
Harmse: On the positive side: The better-than-expected economic growth rate of 1.6% in quarter three (Q3), lower unemployment over each quarter namely 34.9% a year ago, coming down to 33.9% in Q1, to 32.9% in Q3.
Few are aware that the economy in fact created more than 1 million jobs over the past year as employment increased 1.4 million from 14.282m in September 2021 to 15.765m at the end of September.
Although the lifting of the Covid-19 lockdown rules contributed towards this, the strength in the economy also played a role.
Another high was the effects of the two primary sectors on the economy. Both sectors are currently experiencing a super cycle of growth.
With the gold price hovering at around $1800 (R315 108) and platinum near $1100, profits of these two sectors, as well as other non-metals like coal and iron boosted profits.
Together with a better-than-average agriculture crop, the SA Revenue Service could earn more than R186 billion in tax income over the past 18 months. The total revenue of the mining sector has grown by 63% during the first six months of the 2021/2022 tax year alone. The Minister of Finance could finance the initial “Covid-19” grant or R350 per month to 8m people to prevent them from starvation and utter poverty.
The “low” of this year’s economy remains the Eskom tragedy.
Not only is the company’s inability to deliver electricity in a state of collapse, but the company faces internal sabotage and external, and the company is used as a political weapon between various factions in the ANC.
Eskom, together with Transnet’s inability to provide adequate port and rail facilities for the lucrative mining and agriculture export demand, led the economy and the government to loose billions in extra revenue.
The effects of the Russia-Ukraine war also added to the above structural problems in the economy, so that the South African economy remains on the brink of a possible recession.
This as the sharp increase in fuel and food prices contributed to stagflation in the economy and forced the SA Reserve’s Bank Monetary Policy Committee (MPC) to increase its repo rate seven consecutive times, more than doubling it from 3.0% to 7.0% in November 2022.
The increase in fuel prices during 2022 was also a 'low'. The price for 95 ULP petrol increased by R3.85 or 19.6% during the first 11 months of 2022. The diesel price increased over the same time with R6.67% per litre or a whopping 38.6%. Fuel prices currently are contributing more than 2.0% of the 7.4% inflation rate.
De Wet: We have seen high inflation globally, followed by higher interest rates. Do you agree with this monetary policy?
Harmse: The monetary policy of higher interest rates by the US US Federal Reserve (Fed) is the correct policy as the US’ low unemployment rate in reaction to the enormous fiscal stimulation in 2021, led to increasing wage and salaries, as consumers in the US continue to over spend. This has fed demand - pull inflation as consumers continue to spend and firms experience a shortage of labour to keep up with higher demand. Therefore, wages became an issue, In this sense the Fed had no choice.
The effects of this sharp increase in the Fed rate from 0.5% to 4.5% within ten months is due to the stronger dollar. This in returns put pressure on the rand and South Africa experienced big increases in import inflation.
In turn the cost chain due to higher input costs in most sectors, especially the food chain pushed up food inflation to a record high 13.0%. Together with the almost doubling in fuel prices, the reserve Bank ‘s MPC had no choice but to also increase its repo rate. Secondly, the MPC is out of its mandate if the inflation rate is above 6.0% and is obliged to increase interest rates as well.
Scholars, analysts and economists agree that South Africa’s inflation rate is cost pushing inflation (PPI of higher than 16.0%) and that by increasing interest rates, inflation can escalate as interest for especially small and medium companies becomes almost unbearable and may lead to closures. The MPC, however, seems to follow either exchange rate targets and will keep the repo rate rather high to absorb possible bond selling and capital flight.
3. De Wet: South Africa was (and still is) in the news regarding President Cyril Ramaphosa and the Phala Phala debacle where billions of rands were stolen from his farm, and the fact that he didn't declared his income to SA Revenue Service, and didn't bank the money. There were also numerous corruption cases exposed following the Zondo commission during the year. Did these cases have any impact on South Africa's credibility and credit rating?
Not as yet. Share prices on the JSE mostly followed the US inflation rate, unemployment rate, the Fed’s decisions on interest rates and the Covid-19 restrictions in China.
In fact, three days after the Phala Phala announcement on December 1, the All Share index on the JSE increased by more than 200 points to break through the 75 000 level for the first time since February 2022.
The index remained there and even increased by another 800 points to test the 76 000 point level on December 13, the day that the Fed announced yet another steep increase of 0.5% in its bank rate. Together with weaker commodity prices, the All Share index declined somewhat again to 73 000 points on December 15.
It seems that the Russia-Ukraine war, global recession, US interest rates and uncertainty in China plays a major role on the rand, equity prices and bond rates. Domestic political issues do not seem to have big effects but may change if there comes a split in the ANC, or the Zondo commissions report is rejected or not implemented.
4. De Wet: What do you foresee in your crystal ball for 2023? Will we still be faced with higher interest rates, higher fuel prices and continued political instability?
The more likely scenario for the South African economy for 2023 may surprise a lot of people. My expectations are that the South African economy will not move into a recession, due to further growth in both the mining and resources sectors, agriculture and industrial sectors.
The increase in employment is set to continue and the unemployment rate will shrink even further. This will boost domestic spending and, therefore, retail sales are likely to recover.
This is likely to play out against the global recovery as it is expected that the oil price will continue to decrease to levels around $60 per barrel. This will not only contribute to a big decrease in world and US inflation rates, but together with a possible end to the Russia-Ukraine conflict also to decreasing food prices. Therefore, interest rates may increase one time during the beginning of 2023, but should turn around and move down from the second quarter of 2023.
It is also expected that the Chinese economy will rebound and, therefore, the South African exports of minerals and coal will remain high. Given the expected better agriculture crop, total exports will remain high to finance the expected increase in imports as the rand exchange rate is expected to move to levels of around R16 to the dollar or even stronger.
In such a scenario it is expected that the inflation rate will return to under 6% as fuel prices will return to normal. The price for diesel is expected to decrease at the beginning of 2023 already by at least R2.50 per litre. I also expect no tax increases during the Budget, and that government finance may prove to be somewhat better with the debt to gross domestic product ratio stabilizing at 70%.
5. De Wet: What is your expectation regarding job creation for 2023. How is it possible for an entrepreneur to survive in a climate of high interest rates, energy shortages and low investor confidence?
Harmse:It seems that job creation overall will remain positive during 2023 as the economy is likely to grow at a level near to 1.6%. Mining and industrial employment will likely continue to improve as most industries are to move off the Eskom grid and move to their own sources of electricity. Small, medium and micro-sized entrepreneurs (SMMEs), however, will feel the full brink of continuing phase 6 to 8 load shedding. These sectors will lay off workers.
The sadness of this is that the South African economy would have had the best change in two decades to have grown at levels exceeding 4.0% as the global economy is expected to rebound strongly next year.
Lack of investor confidence, useless government policies to help the SMMe’s, continuous mudslinging between the ANC members themselves as well as between political parties, the collapse of local service delivery and rail and road transport services, will hamper this likely opportunity.
6. De Wet: What will be South Africa's biggest challenges in 2023?
Harmse: The biggest challenge will be to keep the lights on. Eskom may collapse totally. This may push the economy in energy as crime and looting like the KwaZulu-Natal and Gauteng saga of last year may re-appear.
Political mudslinging and self interest the year before the election will drive away any foreign direct investment interest. The lack of implementing the Zondo commission report will also drive away potential investors. We, therefore, need strong leadership that seems to continue to be absent.
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