Looming current account and fiscal deficits
- When the rand pushed above the R10 to the dollar level, it became the worst performing emerging market currency this year – highlighting SA’s particular fragilities.
- At the heart of the problem is SA’s large current account deficit and the complete erosion of any fiscal financial progress made by former Finance Minister Trevor Manual during his tenure.
- Now the country sits with a budget deficit that will be hard to finance during the years ahead in an environment of lacklustre growth. In fact, the fiscal situation is unlikely to be turned around without increasing the government’s tax take.
- The lack of savings on behalf of South Africans, government and the private sector has exposed the country to serious vulnerability to offshore investor sentiment because it will have to continue relying on foreign investment inflows to fund these twin shortfalls: the huge current account and budget deficits.
- Given SA’s reliance on the mining sector, the country has also been subjected to the worst of the turn in sentiment against emerging markets because of the sudden and steep decline in commodity prices during the second quarter, which could signal the end of the secular boom in commodities.
- It will take some careful macro-economic management to win back the substantial ground lost over the last five years and to make matters worse, it will need to happen within a precarious and unnerving global and emerging market economic environment.
What this means for equities
When it comes to equities, from a long-term perspective some market commentators believe the SA stock market is now trading slightly above fair value, i.e. equities are generally expensive. This means that the stock market return over the medium term may be lower than what investors have become used to over the past few years. In addition, the divergent trend of the various indices of late (such as the Industrial Index gaining ground, the Financial Index effectively flat and the Resources Index losing significant ground) could persist for a while.
For the economy, it is clear central bank balance sheet expansion in developed markets has failed to ignite a strong recovery in real economic activity. Global real GDP growth has continued to disappoint in the aftermath of the Great Recession. Ultimately, economists do not believe the current environment of a high level of government claims on available savings; restraint of financial sector activity and weakened productivity growth are conducive to a robust global economic upswing.
Meanwhile, with investors now concerned that the Fed and other central banks may remove stimulus from the global economy at too fast a pace, the era of excess liquidity and low funding rates is indeed coming to an end and this could provide another headwind to company earnings growth. In addition, the Chinese economy is showing signs of sputtering, which is negative for commodity demand. Markets could accordingly remain rocked by emotions.