Having spent a week in South Africa, it was very refreshing to escape the European economic doom and gloom and visit a country with stunning natural beauty and fantastic culinary experiences. With the British pound having appreciated by more than 10.4% against the rand year-to-date (ytd), South Africa’s world famous beef steaks tasted even juicier. In that respect I was very lucky, because with the British economy slipping into recession, there remain only a handful of currencies in the world - the Turkmenistan manat (51.7% ytd), the Icelandic krona (38.7%), the Korean won (12.1%) and the Turkish lira (5.4%) – against which the pound has gained in value since the beginning of the year.

Given the steep increase in interest rates and the sharp depreciation of the rand against major currencies, I was slightly surprised by the ongoing economic optimism among South African consumers, with major cities like Johannesburg and Pretoria seemingly buzzing with economic activity. While leading indicators suggest that private consumption remains under immense pressure, the deceleration in inflationary pressures and expectations of further decreases have given a (short-term) boost to consumer sentiment. In particular in Johannesburg, where people largely depend on their cars to get around (due to a lack of a developed public transport system and high levels of crime), the recent cut in fuel prices has led to a jump in disposable incomes. That said, I fear that the bounce in consumer sentiment is likely to be relatively short lived, as ongoing tight credit conditions and the threat of a global recession will weigh heavily on economic activity and consumer confidence alike over the coming six to twelve months.

While I do not believe that South Africa is just yet at the brink of sliding into recession in 2009, the risks to economic growth will remain firmly to the downside over course of the next year. According to forecasts provided by Business Monitor International, South Africa’s real GDP growth is likely to come in at 2.7% in 2009, which will mark a considerable deceleration from an estimated 3.6% and 5.1% in 2008 and 2007, respectively. However, several South African analysts I have been talking to over the past week suggested (off the record) that the risks of a recession cannot be entirely discounted, a point of view I increasingly subscribe to. This is mainly because there remains a wide range of unknowns which could have a massively negative impact on South Africa’s real GDP growth going forward.

First, with South Africa exporting more than 63% of its goods to the US, Japan and the European Union, the economic downturn in these regions will hardly bode well for export revenues and domestic manufacturing activity. Indeed, the US, Japan, Germany and the UK account for almost 40% of total South Africa exports, and all of these economies are scheduled to fall further into recession over the coming few quarters. In particular, following a massive 150bps cut in the benchmark interest rate, the Bank of England announced last week that the British economy could contract by as much as 2% in 2009.

Second, it remains highly unclear what impact a global recession will have on risk appetite and portfolio inflows into South Africa. Given that the country depends heavily on hot money to finance its gaping current account deficit, the South African Reserve Bank might not have a choice but to postpone the expected interest rate cut in Q209 longer than currently anticipated. This would undoubtedly further curtail private consumption and gross fixed capital formation over the medium term. Furthermore, aside from the fact that the sharp sell-off in South African equities has greatly reduced companies’ capacity to raise capital, ongoing tight credit conditions in international financial markets will also continue to hamper investment decisions. Indeed, the Airports Company South Africa (ACSA) announced on November 10 that sourcing funds over the coming 18 months will be very difficult due to external financing constraints.

Recession scenarios put aside, one of South Africa’s greatest assets is the robustness of its domestic banking sector, a key advantage which is likely to greatly reduce the risk of a recession. While commercial banks have been suffering a decline in profitability in light of rising interest rates, the banking sector is by no means as over-leveraged as Eastern European banks, for example, and stringent exchange controls have prevented South African banks from gaining exposure to the US subprime disaster. Against this backdrop, South Africa is significantly better protected from a potential recession than countries which could experience a complete disappearance of capital on the back of a collapsing banking sector.

Tags: Johannesburg, recession, south africa, Steak
Posted in: Africa, Currencies, Emerging Europe, Equities, Financials, General, Inflation/Deflation
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