Background:
The macroeconomic environment in Namibia remains positive, with growth running at or above long term averages for the past five years. Historically low interest rates, expansive Government stimulus and the unprecedented levels of foreign direct investment into Namibia have driven this growth, with a key focus on construction in the short term, moving toward increased mining production and logistics, particularly, longer term (see our Economic Outlook, 2015). Moreover, this strong growth has resulted in increased employment which has coupled with increased Government spending on wages, personal income tax cuts and huge increases in private sector credit (see PSCE figures), to massively increase the disposable income of domestic consumers. Given a high marginal propensity to consume by Namibian consumers, this boom in disposable income has resulted in strong growth in retail activities, as indicated by many high frequency indicators (see PSCE, vehicle sales, business climate monitor).
As is to be expected, this above trend growth has resulted in some cracks appearing in the local economy when viewed more holistically. As is classic of an economy growing at above its trend level, we have seen the ongoing development of a number of macroeconomic imbalances. While these imbalances are far from critical as of yet, if left unchecked they may destabilise the future growth prospects of the country to some degree. While the imbalances are fairly numerable in nature, they have to date been largely shielded from view for various reason. However, as many of the current high frequency indicators followed in the country are starting to point to growth peeking out and starting to slow, many of these imbalances run the risk of becoming increasingly apparent.
1. Demand side inflation
Over the past few years, headline inflation has remained low, falling dramatically over recent months as global oil prices collapsed (see NCPI). However, pockets of high inflation remain, particularly in the demand side space (further elaborated on in our November 2014, and December 2014 NCPI reports). As most consumer goods in Namibia are imported and sold at market rates, these items prices tend to be driven by global factors and the local exchange rate. On the other hand, many of the local services prices are determined by domestic demand and supply, and as demand increases, so do prices. This is particularly notable in the housing market (although local house price indices, anecdotal evidence and formal rental inflation figures indicate divergent situations), municipal utilities, electricity, schooling and transport costs, many of which are leading overall inflation in the country. This inflation is, however, at present hidden by falling global food and fuel prices, but is classic of an overheating economy where demand for services grows fast than the supply thereof.
Table 1.1 Selected services inflation levels
Chart 1.1 Namibian and South African Inflation
At present, and somewhat peculiarly, Namibia’s overall inflation has fallen well below that of South Africa. This is strange given the fact that most of our cost-push inflation is imported directly from South Africa, while Namibia’s demand side inflation is abnormally high. Nevertheless, much of the decline in Namibia’s inflation was driven by the oil collapse, which we believe is now fully priced-in when it comes to first-round effects. Should oil stabilise (looks likely) or rebound, inflation is likely to pick up again, and may reverse aggressively, notwithstanding second round effects of low oil prices on food production.
Chart 1.2 Global Oil and Domestic Fuel Price Changes
2. The deficit, debt and funding the gap
As we noted in our 2015 budget review, Government plans to run another expansive budget through the current three year MTEF period, which comes on the back of a prolonged policy of expansive spending for the past five years. Because of the expansive budget pursued over the past five years, the country’s debt-to-GDP ratio has increased somewhat, from around 16% of GDP in 2010, to approximately 25% of GDP in 2014. Further to this, continued deficits in the current budget mean that this is expected to increase further over the next three years, approaching 35% of GDP by 2017. While deficits are not a problem per se, persistent or structural deficits, as well as sizable deficits, can be. In this vein, we are of the belief that current debt levels are not a problem, however should more debt be raised to fund recurrent expenditure, sustainability will fast become an issue.
Chart 2.1 Government Debt and Debt to GDP
We further noted in our budget review piece, that we were concerned about the ability of Government to fund the deficit this year, due to a number of factors. “We view the size of the domestic borrowing requirement as a big hurdle for the Government to overcome. The sheer size of N$8.9bn to be raised is a challenge in an environment where local investors’ demand for fixed income securities is becoming saturated. The start of an interest rate hiking cycle also does not bode well for the successful issuance of N$8.9bn worth of debt securities [into the domestic market].” We further noted that “…a number of SOEs, like NamPower, NamWater and NamPort might be looking at coming to the market with debt paper, further competing with government for funds.” Both of these expectations have played out or are currently playing. With regards to the former, demand for Government debt at recent auctions has been extremely low, with bid-to-cover ratios falling to some of the lowest levels seen in many years. This, coupled with Government’s policy to draw down on cash-reserves with the Central Bank has resulted in the Government being temporarily overdrawn with the Central Bank for the first time in many years. Moreover, the liquidity position of the local commercial banks (later discussed) has resulted in abnormally weak demand for government securities, particularly at the short end of the curve, where these banks are usually most active.
We further noted that “It is our expectation that we [will] see spreads of government bond yields increasing over the South African benchmarks due to sheer volume of supply. It is also expected that the corporate sector will start to pay up for listed debt as corporate paper is benchmarked off the government yield curve. Therefore funding in general in Namibia is set to become more expensive and liquidity will slowly start drying up in our economy.” Once again, we see this playing out as expected, with much of the corporate debt currently being placed seeing weak demand and being pushed on pricing, in a classic “crowding-out” type move.
3. Household debt
Over the past few years, and through the bottom of the interest rate cycle, household debt levels increased quite significantly, taking overall household debt relative to disposable income well above the levels seen in neighbouring South Africa, whose levels have often been perceived to be concerning high. However, In Namibia, strong growth in disposable income has kept this ratio relatively more favourable from a forward perspective. Recent indicators of household income growth, however, have started to show a changing picture, and it appears that the household disposable income position, which had improved massively over the past 5 years, may be topping out, at least from a disposable income growth perspective. Logically, this makes sense, as the delta of new stimulus has also flattened out, and even started to reverse as the Central Bank tightens interest rates. Given current high levels of household debt, it is possible that some duress may be witnessed should interest rates continue to increase and disposable income growth slow or contract. However, at the present point in time this looks fairly unlikely, unless Government reduces spending in a significant manner, interest rates climb aggressively or unemployment spikes up for whatever reason. However, it seems most likely that current liquidity challenges in the banking sector may result in a slowdown of new credit issued to the private sector, which should help to protect against households becoming unsustainably indebted.
Chart 3.1 Household Income
Chart 3.2 Household Debt Issuance
In most economies, these imbalances would be addressed through the tightening of monetary (and at times, fiscal) policy, however in this regard, Namibia is somewhat hampered by the fixed exchange rate regime it shares with South Africa, Lesotho and Swaziland. Due to this, Namibia is unable to implement completely independent monetary policy, and is required to remain fairly close to the rates seen in the common monetary area in order to ensure that unstable capital flows between the countries do not occur. As such, despite the clear need for tighter monetary policy in the country, interest rate increases have been fairly slow. Nevertheless, the Bank of Namibia is in an interest rate hiking cycle, having increased rates by 75 basis points, in the form of three 25 basis point hikes, over the past 12 months.
4. International reserves and financial sector liquidity
Strong growth in PSCE to households, along with large imports for various Government and private sector projects have resulted in abnormally high import volumes for Namibia, which imports have not been matched by equally strong exports, resulting in a trade deficit. Moreover, the capital and financial account has remained fairly weak, and unable to offset the deficit in the current account. As such, the external position of the country remains fragile, with international reserve levels falling well below prudential levels to their lowest since mid-2012 in Namibia Dollar terms, and to 2008 levels in US Dollar terms (see previous discussions).
Chart 4.1 International Reserves
On the back of this large net outflow of funds, a multi-faceted situation of liquidity tightening is developing, with liquidity growth slowing (and may yet contract) as funds are withdrawn from the country and financial system.
Chart 4.2 Money Supply
Not only has the currency in circulation and the base money supply started to stagnate and possibly even contract, but the money multiplier from both M0 and MB to M2 have seen long term decline. The M2/M0 multiplier is down to little over 20x (from a peak of well over 30x in early 2010), while the M2/MB multiplier is approximately 12x (from almost 25x in 2009).
Chart 4.3 Money Multiplier
The effect of the liquidity withdrawal is a drying up of banking sector liquidity, as illustrated by the close to 100% aggregate loan to deposit ratio now being seen across the sector, as well as the liquidity position, reported on by the Bank of Namibia. Of course, the banks remain adequately funded, however some are becoming increasingly reliant on debt securities to fund their loan book growth.
Chart 4.4 Banking sector loan-to-deposit ratio
Chart 4.5 Banking sector liquidity position
The decline in banking sector liquidity has two main impacts on the local economy. Firstly, the banks have become more cautious when lending, and while PSCE growth remains relatively strong, the bulk of new extension is being granted to businesses rather than households; and secondly, demand for Government securities by the banks has slowed notably. Given current liquidity trends, it further appears that the situation may deteriorate further over coming months, resulting in a notable slowdown in future credit extension, which will act as a much-needed break on the local economy.
Chart 4.6 PSCE and PSCE Growth
Despite the aforementioned imbalances, the Namibian economy continues to perform well, and is expected to continue to do so through 2015 and beyond. However, this strong, above trend, growth seen in the local economy signifies that the time for counter cyclical policy is behind us, and that the previously countercyclical policy is no longer such, but procyclical. Thus, the process of interest rate normalization too needs to continue, and more reticence from the fiscus is required to ensure that the current economic imbalances do not become exacerbated. Nevertheless, the outlook remains rosy for the country, and despite a number of the high frequency indicators suggesting that economic growth is currently slowing, this is likely to be transitory, driven by the completion of a number of construction projects.
