TOUGH MEDICINE TO SWALLOW
In my last article prior to the Budget Speech I spoke about my view of the lay of the land. Mr Gordhan has since delivered this speech and many a verdict has been given. The ratings agencies seem to be happy for now. This has for all intents and purposes kept our investment grade rating in tact until June 2016 unless we do something dramatically stupid.
Now if you rewind back to your childhood I am sure most of you can remember at least one time that one of your parents forced you to take some kind of medicine that was so repulsive you literally had to force it down. The reason you were taking the medicine is that you were obviously ill. You subconsciously understood that in order not to feel ill any longer you had to medicate yourself. So unless you swallowed the awful tasting mixture you would continue to be sick. I am sure included in every person’s childhood memory a temper tantrum or some kind of protest, but in the end your parent would have won and the medicine went down.
The metaphor is pretty appropriate because not everything that is good for you is enjoyable. In fact it is often that the things that are good for you tend to be the least desirable. I could use eating one’s vegetables as an interchangeable metaphor, but medicine is more applicable because we are in fact ill. The South African economy and soon to be consumer is very ill. Its conditions have been worsening for a while and the Government needs to act like a parent. In the case of the sick child I can guarantee you that the parent understands why the child does not like the medicine it is getting but also understands it is necessary. If there were a better tasting alternative, most parents would opt for that to smooth the whole procedure. That being said, if a child is ill the parent has a responsibility to nurse it back to full health despite the protestations.
Now the budget in my opinion is the state telling its children whether or not they are in fact healthy and which action will be taken to nurse us back to health. The people of South Africa for the first time in a while understand how very sick they have become. (They are feeling it in their pockets, with the lack of ease and transparency of doing business and the dismal delivery of public goods like water and electricity) We, the collective children of RSA, are looking to our parent to see what medicine needs to be taken.
The medicine choices are all pretty awful and will all taste repulsive. So not only does the government have a tough choice to make when considering which medicine to dish out in fear of a unwanted reaction for the child but the child for the most part is confused about which medicine is in the child's best interest and therefore we have an inherent conflict of interests. In this model if enough of the children do not agree with the parents choice of medicine they can in fact decide that they want a new parent figure. It will then be this new parents choice to make. So unlike in real life where you cannot simply replace your parent which gives your parent absolute control over the medicine decision to a certain extent, in this scenario the parent is under as much pressure to deliver a medicine they deem the child willing to swallow while still being in the child best interest. (talk about being caught in between a rock and hard place!)
So what medicine did the sick child the South African economy get? The answer to that is the one that the parent thought would keep the illness at bay and the child happy. The budget announced that the fiscal policy will be to reduce the current budget deficit. This will be achieved by reducing their wage bill and spending less in general. While that seems logical, one of our biggest concerns is the current lack of demand in our economy. Demand pushes the economy forward and we also damage demand by making the unemployment picture worse. In order to get out of this economic slump, I would in fact suggest responsible expansionary fiscal policy on infrastructure projects. This helps the unemployment problem we have in this country while stimulating consumer demand and adding long term additional capacity to the economy as a whole. That would have gone against the wishes of the ratings agencies so we had to pull that option of f the table. Instead we have done the opposite. We have battoned down the hatches and this will become a self-fulfilling drag on demand and employment.
The budget needed to be harsh and respectful at the same time. We needed to sit down with ratings agencies so that they understood that austerity to any extent will not benefit our economy in the long term. One just has to look at the impact that austerity has had in Europe. Just think of Greece, Italy, Portugal and Spain.
On the other hand the Reserve Bank is in no position for a quantitative easing programme either, despite our debt to GDP levels being far lower than our international counterparts. Instead the best we could get is probably some form of structural reform.
As mentioned beforehand, the best medicine for this stagnating economy is simply to increase efficiency and output. This is done by removing barriers to entry when it comes to business. The sale of SOE’s would have been some of the medicine needed. We would have generated some much needed cash from the sales, the government would increase its tax collections and these companies would then be run for profit, which would mean cutting all the dead weight they currently carry in the form of unqualified and inefficient personnel . Who knows, this action may have even led to electricity production and supply that meets demand without rolling blackouts or an airline that is not loss making and continually needing bailouts.
That would have been great but the child would have protested too much and hence medicine could not be administered. Again we are at the mercy of two conflicting forces; the ratings agencies and the voters & unions. The long term impact of the choices made today will be felt one way or another.
The budget from my perspective was truly underwhelming. We will have to continue to tolerate missed opportunities and probably poor delivery of intended policy and service delivery. Unfortunately one child can be more tolerant than the other in this case. Ratings agencies will not tolerate failed attempts to resuscitate growth, a ratings downgrade would put our fiscus and economy in dire position which will deem a lot of the desires that the voters have improbable or impossible.
The South African treasury here is our parent and it seems to failing to be stern enough in the way it deals with the illness we have.
I hope I am wrong but it’s certainly not enough at this point.
The ALSI as a whole posted a 1.00% increase for the week. Continuing with the month of February’s positive momentum. These gains are still not sufficient to pull the market as a whole back into the green YTD. The RESI and INDI rose 1.15% and 1.58% respectively for the week while Financials were put on the back foot losing 1.54% for the week.
The budget was delivered eloquently enough to keep the ratings agencies at bay at least until June 2016. The verdict is however very much out whether the action take was sufficient. None of the politically hard calls were made such as privatization of SOE’s, increases in VAT or increases in personal income taxes.
The Rand fell off a cliff late on Friday as rumours that Pravin Gordhan was under scrutiny for his role while at SARS. The Government has quickly jumped behind Gordhan but its easier to lose confidence that gain it.
The UK FTSE ended the week 2.45% higher. Erasing half of the years losses despite the Brexit concerns and its impact on both the Pound and the Euro. The German DAX and EuroStoxx rose 1.33% and 2.02% respectively. The Euro continues to remain weak relative to the USD which has boosted prospects across Europe. The concern around the contagion of China is also beginning to wane.
The S&P 500, Dow Jones and NASDAQ posted gains of 1.58%,1.73% and 1.91% respectively as we get to the end of another earnings season. The market has rallied over the past few weeks. Oil has been notably higher after production seems to have been curtailed. The political battle has done little in the form of market jitters.
The Nikkei closed the week 1.39% higher while the Chinese Hang Seng closed 0.41% higher. The Chinese market concerns are not getting passed through to other markets as drastically. On Monday/Sunday we saw the PBOC cut its reserve requirements for banks trying to stimulate additional lending and spending which should boost global markets for now.
Gold dropped 0.34% but remains the best performing asset class for 2016 with a return of 15.14% YTD. The central banks around Asia have continued to purchase more reserves which is pushing prices to a higher support level. Oil finished the week 5.74% higher.
Sadly on a local front a lot of the good work done by the budget on Wednesday was undone in the very late trade on Friday as the Rand spiralled to R16.17/$. Not the first time we have seen these rates however the manner and speed at which it can depreciate damages investor confidence.