27four Investment Managers
28th March 2016
A balancing of forces
Yesterday the SARB announced their decision to increase the REPO rate by a further 25bps taking it to 7%. While we have been poised to enter a rate hiking cycle for some time now, and with inflation breaching the upper target band of 6% set by the SARB, the decision has been questioned given that the South African economy is currently struggling to achieve any significant growth and interest rate hikes are generally seen as dampening for economic growth.
A low growth, high inflationary environment is termed stagflation and it puts the SARB is a difficult position because the tools at their disposal may alleviate one side of the equation but are likely to exacerbate the other side of the equation. Higher interest rates may well serve to dampen the inflationary pressure on the economy but they will not help to stimulate the growth that the economy so badly needs.
So the obvious question is then why did the SARB raise rates and what is the impact likely to be? If we look at their mandate it is to keep the inflation rate between 3% and 6%. With the latest inflation numbers coming in at 6.2%, then this move fulfils that mandate. However inflation has breached the target before and the SARB has guided that their mandate is indeed a dual one of inflation targeting but also being mindful of economic growth. The SARB is now trying to balance the forces which may impact growth of the local economy.
The economy has struggled to grow in a low interest rate environment and this speaks to the fact that it is more an issue of structural reform being needed in SA as opposed to low borrowing costs. Companies have not been investing and expanding in the low interest rate environment so the hurdle to growth has not been the cost of capital. The currency is always the pressure valve in any economy and this has been seen with the currency depreciating significantly over the past few months. This has served to drive inflation upwards given the large percentage of our inflation that is imported. What an increase in interest rates may do is to make SA yields look more attractive to investors on a relative basis. Given that our interest rate hikes have been ahead of the rates hiking cycle we are seeing in the US and are pre-emptive of the US hiking cycle, a higher interest rate will make our debt look more favourable to investors and this latest hike will hopefully serve to attract more investors back into the SA market.
If money starts to flow back to SA it will help in the financing of our current account deficit. So the deficit may well improve (albeit slightly) and this will help our case with the ratings agencies as our sovereign rating comes up for review. Portfolio flows are not the ideal way to finance a current account deficit as the money is of a temporary nature but it does show a willingness to the ratings agencies to try and address the problem.
Locally the consumer has been stretched and under pressure for a long time. Increasing interest rates are unlikely to help an over indebted consumer but the lower oil price and a stronger currency could help to balance the pressures being felt at home on the ground. The risks to inflation are all on the upside and this is what is likely to be the greatest problem faced by South Africans and where the poor will be most vulnerable. A severe and prolonged drought has already begun to impact food prices and here interest rate increases are unlikely to halt the upward spiral of food prices.
The consumer stocks (and specifically the credit retailers) are likely to be the hardest hit segment of the market as investors begin to price in the inability of these former darlings to grow their revenues and top lines at the multiples we have seen to date. Several of these stocks have already rerated and further earnings revisions may well be on the cards.
The banks are probably well positioned to deal with this latest increase and it will likely prove beneficial to their profitability. The probability of an increase in bad loans is heightened but the banks are well provisioned for this and it will take a much steeper and faster increase in rates to create a noticeable dent in their provisions. However bank share prices are often driven by sentiment around the state of the local economy and with the outlook still poor it may well take significant upward revisions of earnings to budge the share prices and the banks may well remain cheap.
So in summary was the decision good or bad for the economy? The short answer is probably good and the decision was the correct one by the SARB. It will help to stabilise the Rand in the short term, this will help the current account and will also assist in keeping a lid on inflation. It will not stop inflation breaching the band because food price inflation will continue to push inflation upwards but it does provide some counter balance that is better than doing nothing. It will be positive for banking stocks but negative for the retailers. It is unlikely to be a major dampener on economic growth. The economy needs to grow through structural reform and not through increased consumer spending. The consumer was stretched prior to the increase. This increase will put further pressures on the consumer but these pressures existed prior to the rate hike and will not dissipate only through low interest rates. The consumer needs to deleverage and increase savings.
Ms Fatima Vawda is the Founder and Managing Director of 27Four Investment Managers as well as a proud and long-serving member of ABSIP.