Category Archives: Team Commentary

Global Developments

The global economy remains on a knife edge, with downward revisions to growth expectations becoming the norm, rather than the exception. Many advanced economies are struggling to regain their pre-global crisis growth and employment rates, while a number of emerging economies have seen major and painful short term adjustment over the past two years. The US economy remains relatively robust, with employment levels and growth slowly returning to long-term trend levels. Europe remains fragile, with uncertainty much increased due to the recent vote by Britain to leave the European Union. In addition, many of the problems of the Eurozone remain boiling barely below the surface, most of which can be expected to resurface at some point in the next half decade. As such, little growth recovery is expected from key advanced economies in 2016 and 2017, with risks heavily slanted to the downside.

Emerging economies, the previous drivers of global growth, have stuttered over the past year, driven by various domestic issues, collapsing commodity prices and the exhaustion of fiscal and monetary policy space. As such, a number of large emerging market economies have seen contraction in 2015 and 2016. Notable amongst these are Brazil and Russia, while the economies of China and South Africa continue to see ever lower rates of growth.

Source: IMF WEO April 2016

Source: IMF WEO April 2016, *IJG Securities Economic Outlook 2016

Domestic Developments

Between 2009 and 2015, Namibia posted some of its strongest ever growth, with consecutive growth of between 5.1 and 6.3 percent, compounding each year over the six-year period. As such, the economy grew from a N$77.9 billion economy to a N$108.3 billion economy in real terms. This abnormally strong growth was driven by three key factors. Firstly, Namibia has been through a prolonged period of historically low interest rates, which drove unprecedented uptake of credit by the private sector; secondly, major fiscal expansion from 2011 until early 2016, drove money into the pockets of the public, as well as major civil works programmes; finally, unprecedented levels of foreign direct investment into the country, driven by the consecutive construction of three foreign funded mines. These factors resulted in a consumption and construction boom, which saw a major expansion in the local economy.

However, subsequently, the macroeconomic environment in Namibia has started to deteriorated notably, as a combination of factors have come together to dampen growth and drive imbalances within the local economy. The unwinding of historically low interest rates, lower levels of Government spending, less foreign direct investment into the country, fewer Angolan retail tourists, a reduction in diamond output, weak commodity prices, drought, water supply constraints, inflation and a high base, are a notable few.

While no single factor (bar, perhaps, government spending) would have been likely to drive a major growth slowdown on its own, the combination of all of the above have resulted in the brakes being fast applied. As a result, the growth outlook for the current years is significantly worse than has been the case for a number of years.

The broad macroeconomic policy tools, namely fiscal and monetary policy, usually used to smooth the business cycle, have ended up amplifying it. The reason for this is that the hand of the monetary and fiscal policymakers was forced towards the end of 2015, with government running low on funds and South Africa driving up interest rates for the Common Monetary Area. This comes at an inopportune time, as government spending is being cut, and interest rates risen, into economic weakness. That this situation could have been avoided through more prudent monetary and fiscal policy in recent years, no doubt can exist. However, given the current situation, such policy tightening is unquestionably, the right thing to be doing.

The growth slowdown can be visible in a number of sectors of the local economy. Within the primary sectors, drought is likely to keep agricultural production low, while a decline in diamond output is likely to be but partially offset by increased uranium output. The collapse in copper concentrate output as a result of the closure of the two copper concentrate mines in late 2015 will be offset by output from the new copper cathode mine, however little growth is to be expected overall. In the secondary sector, little growth is expected in manufacturing, with water supply issues in the central area of Namibia driving the possibility of reduced beverage manufacturing. From a construction perspective, Namibia has already started the process of normalisation following a flurry of construction growth through 2013 and 2014. The construction of the Tschudi Copper Mine, the Otjikoto Gold Mine and the Husab Uranium Mine, coupled with enormous Government spending on infrastructure and extensive retail floor space development, drove a construction boom. However, construction is transitory in nature, meaning that a large spike up in growth is seen when construction starts, but a similarly large spike down is seen when construction is completed. In the tertiary sectors, the two main contributors to GDP, namely wholesale and retail trade, and public administration, are both likely to contract in 2016. Government spending is to decline by 1.1% in nominal terms, which when adjusted for inflation is likely to be approximately 7%. Because of higher interest rates, lower government spending, fewer people employed in construction and less Angolan retail activity in Namibia, the real value of wholesale and retail trade is unlikely to increase when compared to 2015.

Forecasts for growth in 2016 are highly varied, however given the factors abovementioned, it is all-but impossible that we will see growth in the range of that of the past six years. Despite the apparent picture of gloom, every economy in the world experiences similar cyclicality in growth, and given the enormous growth in the Namibian economy over the past half-decade, this period of normalisation is far from abnormal. Moreover, unlike the growth constraints in the economy of our southern neighbour, Namibia’s current growth constraints are largely transitory, rather than structural. With Husab coming on-stream in 2017, and a number of base effects and expected improved rainfall being removed from the immediate outlook, the Namibian economy is expected to return to a path of positive growth.

GDP Growth

As is our custom, we have recently conducted a half-year revision of our growth and other forecasts for the year, making use of information and data gathered over the first six months of 2016. The details of the revisions, and their logic, are given below.

2015 Nowcast:

With regards to our 2015 figures, we have decided not to update our “nowcast”, despite the release of preliminary national account figures by the NSA. A number of the key lines in the supply side tables released by the NSA appear to be far higher than we believe is accurate based on the data in our possession, and as such we expect to see a major downward revision in the final numbers for 2015 (expected in early August). Moreover, we do not expect to see the full downward revision in the final release, but for these figures to be revised down for the next two or more years, as has happened on previous occasions.

Revised 2016 outlook

We have revised our growth forecast for 2016 down from 2.5% to 1.6% for the core reasons given in the table below. Our forecasts remain well below consensus, as has been the case since the start of the year. We have now started to see other institutions revising their forecasts down, with many coming more in-line with our initial forecasts. However, we believe that the situation has actually deteriorated further and faster than we initially expected, requiring us to revise our expectations down even further. Risks remain slanted to the downside as well, most notably with regards to water, construction and government spending.

We do not believe that the majority of the growth constraints witnessed at present are structural, however do note a large number of downside risks for both our 2016 outlook and thereafter. These are noted in section.

With our growth expectations now at 1.6%, we remain highly aware of potential further downside risks, and stand ready to revise expectations down further if required.

Inflation

Inflation expectations for the upcoming fiscal year are notably higher than was the case in 2015. There are a number of reasons for this. Firstly, major rand weakens through 2015 has driven up the cost of imports into the Common Monetary Area in rand terms; secondly, oil prices, which fell dramatically through 2014 and 2015 now appear to be stabilising, and the pass-through of base effects is likely to see an upward rebasing in inflation; third, rand weakness and other factors have driven up costs for many services in the country, including many critical utilities such as electricity and water; fourth, drought and poor harvests in the region mean that food prices are likely to increase, particularly if basic grain imports are required; and fifth, increasing interest rates are likely to see some pass-through of increased borrowing costs to consumers, and reduce consumer disposable income.

The first half of 2016 saw notably higher inflation than was the case through 2015, primarily for the aforementioned reasons, as well as a notable increase in rental inflation rates. The same inflation pickup was seen in both Namibia and South Africa, with South Africa’s inflation moving out of the target 3-6% band for the first time in over 18 months, prompting interest rate tightening from the South African Reserve Bank.

Contrary to popular belief, we are of the view that inflation will remain relatively high for the rest of the year, and into 2017. This view is primarily driven by the enormous administered price increases we have seen for services over recent months. Municipal services, water and electricity have all seen at least high-teen percentage increases in prices over the past few months. These increases will remain for the next 12 months, until the base is reset with their inclusion. These increases are likely to more than offset the improvement in transport inflation due to a stronger rand, and the expected slowing of increases in food prices due to more favourable grain prices.

Inflation forecasts:

Due to the aforementioned factors, we have revised our inflation expectations for 2016 up to 6.5% (6.3% in the first half of the year) from our previous expectation of 5.8%. The main reason for the major increase comes from the increase seen in administered prices, but also the large step-up in rental inflation seen since January 2016. As this is recorded once a year, the current high inflation for rental payments, at 7%, up from 1.5% in 2015, will provide buoyancy to the overall inflation number for the rest of the year.

Source: Namibia Statistics Agency, Stats SA

External position

The balance of payments of Namibia has remained under pressure for a number of years driven, particularly, by exceptional import volumes when compared to the historical norms of the country. In part, this is due to the abnormally high levels of construction activity that took place between 2012 and 2015, led by the construction of three mines, major public works programmes and retail floor space development. In addition to this, however, major fiscal and monetary expansion has also spurred private purchases of imported goods, as low interest rates, high government spending, wage settlements above inflation, and income tax cuts, buoyed the disposable income of local consumers. While the growth in imports has run rampant over recent years, export growth has been largely stagnant over the same period, and as a result, the current account has experienced huge deficits.

While the capital and financial account has been positive, on an annual basis, every year since 2008, the magnitude of the inflow has not been adequate to offset the net outflows on the current account, and as such the overall balance of payments was negative in 2014, and would have been highly negative in 2015 had it not been for external debt issuance by the Government. As a result of the major deterioration in the external position through 2015, the Ministry of Finance was forced to issue hard currency debt in order to protect the country’s external position, as months of important cover fell well below the three-month prudential limit, to a low of 1.6 months in September 2015, presenting a very real rating downgrade risk to the country. As such, a sizable component of the external funds raised are to be ring-fenced to protect the external position. The end result is that the necessary action was taken to ensure that the balance of payments and currency peg remains supported in the short term, while longer term, growth in exports from new mines should see a trade balance recovery and a more stable balance of payments.

Interest rates

Interest rates in South Africa and Namibia have been at or near historically low levels since the global financial crisis. Rates bottomed out in 2012 with the Namibia repo rate dropping to 5.5% during the year. Since then, the Bank of Namibia has administered six rate hikes of 25 basis points each. Thus, following a sustained period of expansive monetary policy, the tightening cycle has now come into full effect. The recent hikes in Namibia, however, have been driven by the South African Reserve Bank’s position, rather than by domestic forces. Following extensive rand weakness through 2015, driving expectations of an inflation blowout, the South African Reserve Bank started hiking rates aggressively in early 2016. The Bank of Namibia was required to follow these hikes in order to ensure that the reserve position of the country remained tenable, and that capital outflows did not occur.

Going forward, it appears that we are approaching the top of the interest rate cycle, as a weak regional growth outlook and improving rand and inflation outlooks -largely due to the Brexit vote and resultant lower-for-longer interest rate positions of the UK, US and Eurozone- mean more monetary space exists for interest rate easing.

Our base case scenario sees interest rates remain flat for the remainder of 2016, as fund flows into South Africa support the Rand, alleviating some of the inflationary pressures, while weak economic growth keeps the SARB on hold. The threat of a ratings downgrade in December (see risk 4 below) is likely prevent the Reserve Bank from cutting rates in 2016 in order to stimulate growth.

Our second scenario is built around a ratings downgrade by at least two of the ratings agencies. This immediately leads to fund flows out of South Africa leading to a violent depreciation in the Rand. Inflationary pressures driven by a spiraling currency force the hand of the SARB, which immediately hikes rates by 50 basis points followed by further hiking through the year. Should we see such a reaction to a ratings downgrade, we may see much more aggressive hiking than we currently predict.

A third scenario, fueled by the British exit from the European Union leads to worldwide economic weakness and monetary easing in the UK and Japan. Looser monetary policy leads to fund flows into EM nations including South Africa lending support to the Rand and allowing the SARB to focus on stimulating the South African economy. The SARB cuts rates on two occasions during 2017.

Source: IJG Securities

Core risks:

While our base case for the economy is broadly outlined above, there are a number of major downside risks to the outlook. At present, our primary concerns are fourfold:

Firstly, a great deal of economically damaging policy/regulation/legislation has been muted, drafted or introduced over the past year. Many examples of this exist, from the Investment Promotion Bill, Export Levy Act, The New Equitable Economic Empowerment Framework (NEEEF, and the related NEEEB bill), rent control and visa regulations for South Africans visiting on business. All of the aforementioned, if not cautiously implemented, are likely to have a negative impact on investment in Namibia (both by domestic and international investors), and will likely drive a slowdown in the local economy, job losses and fewer jobs being created.

Our second major concern is the on-going drought and water challenges across the country, and particularly in the central area. The baseline assumption at present is that we will return to normal or above-normal rainfall in the 2016/17 rainfall year. However, should this not materialise, the economy stands to slow further in 2017. A number of industries are likely to suffer substantially from prolonged periods of water restrictions. Pervasive water shortages are thus likely to drive an increase in unemployment, crime, not to mention increased and unnecessary human suffering. Finally, while many industries can withstand short-term downturns in revenues and profits, should these continue for extended periods of time, business closure is far from impossible. Should this happen, contagion through to the banking sector is all but certain.

Our third concern remains the fiscal position of the state (discussed extensively here: IJG Economic Outlook 2016, here: IJG Budget Review, here: IPPR Budget Review, and here: Namibian Public Debt). We are highly aware of the efforts being undertaken within the Ministry of Finance to ensure that the situation remains stable, however we believe that this is driven by a handful of individuals who may fast exhaust their political capital if not adequately supported. Naturally, the process of fiscal consolidation is unpopular with civil servants, the public and politicians alike, however it is undoubtedly needed to ensure the country’s longer-term outlook remains positive.

Despite the consolidation efforts, our earlier concerns about unrealistic revenue expectations remain valid, as the cash-flow position of the state has deteriorated as expected. Thus, in order to maintain a reasonable deficit (albeit larger than planned), we believe that Government will be forced to cut spending more aggressively than originally intended.

We believe this will be partially motivated by deficit management and attempts to avert a rating downgrade due to the rate of growth of the debt stock, but also due to the fact that avenues through which to fund the deficit are becoming increasingly few in number. With the rapid growth in external debt over the past year, it has become difficult for the government to borrow from international markets, while the growth in the supply of domestic debt has been outstripping the supply therefore for the past 18 months. However, with the expected changed in regulation 28, the ability of the government to fund the deficit will likely improve, albeit at the expense of the owners of the regulated capital.

The final issue worth noting is that the continued deterioration in the growth environment means that the denominator of the debt-to-GDP ratio is all but static in real terms (but still expanding in nominal terms). This means that the ratio will blow-out far faster than would be the case if strong growth was being experienced, particularly should we run a sizable budget deficit, as we expect we will. Thus, a debt-to-GDP ratio of over 40% towards the end of the fiscal year, is not out of the question, but will largely depend on currency movements due to unhedged debt.

Our final concern is the remaining possibility that South Africa will be downgraded to “junk” status in December of 2016. Unlike others, we do not believe that Namibia would be immune to an event such as this, and we are of the view that should South Africa be downgraded to “junk”, Namibia would likely follow.

However, our view of the likelihood of a downgrade has changed slightly since the Brexit vote. The reasons for this are given in the following two commentaries: Brexit: A storm in a teacup? and Brexit and Namibia: Contrary to popular belief… In short, our view is that fund flow reversals, due to lower-for-longer interest rate expectations in advanced economies, will provide South Africa with some economic support, which might just be enough to avoid a rating downgrade, by reducing borrowing cost for Government, reducing inflation and allowing lower or flat interest rates. This should allow South Africa to buy some time to implement further pro-growth fiscal reform (an apparent oxymoron). At the same time, however, South Africa’s tragic growth picture means that a ratings downgrade is far from out of the question. In reality, the South African economy will contract in 2016, a situation that will not be viewed favourably by rating agencies. Moreover, social and political unrest can be expected around the August elections, which will also put South Africa in the limelight for all the wrong reasons.

Our assumption for Namibia’s downgrade, should South Africa be downgraded, however, hinges on Fitch downgrading South Africa. Should this happen, Fitch will also downgrade Namibia, and as such we would be without two investment grade ratings, and would be considered “junk”. That said, Fitch still has South Africa on a stable outlook, and thus it is unlikely that they will jump to a downgrade in the next six months.

It should be noted, however, that our view remains that Namibia is on a fragile path with regards to her own rating, due to the lower growth environment, introduction of increasingly poor economic policy (as mentioned in risk 1), the rate of growth of the debt stock and the unhedged hard currency debt of the country.

Current ratings: