Short-term low growth is “new normal” but longer-term view holds positive signs
February 22, 2021
As the impact of the Covid-19 pandemic continues to ripple through 2021 and South Africa faces economic contraction and high levels of business risk, there are some positive signals that suggest business should be playing it safe for now while keeping an eye on the long game.
“When travelling over rough terrain it is often better to keep your eyes on the horizon as opposed to becoming obsessed with every pebble or rock in front of you,” University of Stellenbosch Business School (USB) guest lecturer, Jason Hamilton said.
Covid-19 could not have happened at a less opportune time for South Africa, already suffering from high consumer, corporate and sovereign debt, with credit ratings below investment grade, low savings rates and high unemployment. Although they were necessary, economic support and stimulus measures dipped the country deeper into deficit and lockdowns amplified the economic woes but there are reasons for optimism despite this negativity, he said.
Hamilton pointed to slow signs of recovery in global economic activity, with emerging market currencies strengthened by rising demand and commodity prices, and the rand, while still undervalued, expected to remain stable with some signs of strengthening in coming months.
“Inflation is expected to remain within the SA Reserve Bank’s target range and interest rates are likely to remain stable for this year. Globally, there has been an uptick in capital flows to emerging markets, which bodes well for South Africa, and we expect to see an increased appetite by global asset managers for emerging market fixed investment.”
Hamilton, a director at First River Capital, said the African Continental Free Trade Area (AfCFTA) which came into effect on 1 January 2021 was set to be a key driver of growth for the continent, a market of 1.3-billion people and a trading bloc worth at least $3-trillion – “an opportunity not to miss”.
On COVID-19 and low short-term growth
“The full impact of Covid-19 on global markets, the economy and society is yet to be experienced and understood. While the timelines and ability of vaccine roll-out plans remain unclear, it is expected for large-scale procurement and delivery by mid-2021. Until herd immunity through a vaccination programme has been achieved, not likely before 2022, the virus will continue to hamper growth.”
Pre-pandemic, key markets were already exhibiting major fault lines, said Hamilton, with rising debt and muted growth in the USA, the Brexit-embattled EU facing low inflation and economic activity, and “even China underperforming against expectations”.
“The impact of Covid-19 was profound. Lockdowns and global supply chain disruptions wreaked havoc, forcing governments to launch significant stimulus measures. According to the World Bank, the global economy contracted by 4% during 2020. There is expectation of a recovery with a forecasted 4% in 2021, primarily from emerging markets led by China, but the looming crisis as a result of the second wave of the virus and the challenges related to the roll-out of vaccines means that it is really unclear what 2021 may hold.”
South Africa’s economy contracted by 8% in 2020, one of the deepest globally, Hamilton said, and growth estimates for 2021, at about 2% are “not too great, especially coming off a low base”.
On market fundamentals: Focus on the long-term
Hamilton said that although global economic activity had started to show signs of recovery, a closer look at the global Purchasing Managers’ Index (IHS Markit) data indicates that “this remains precarious, and there has been continued slowing in many markets”.
South Africa’s PMI data (December 2020: Absa) is similarly positive, “but our fortunes will be tied to markets such as the US, EU and Asia, and will be impacted by a stunted global economic recovery”.
Local economic activity will also be hampered by continued electricity supply issues.
“On a positive note, inflation is expected to remain within the target range of the SARB, which affords greater fiscal and monetary policy wiggle room. Expected stable interest rates may even allow the Reserve Bank to lean against inflation if required. This is something we do not generally see globally, where rising production costs and Covid-19 stimulus has seen many markets running hot – something central banks are happy with over the short run, but the longevity of this approach is uncertain. There are clear signs of policy fatigue in the US and EU.”
Hamilton said this combination of factors made an exact determination of GDP growth difficult to achieve while South Africa’s economy remained sensitive to global market changes.
“A longer-term view may be required to gain a clearer understanding of the future.”
Market analysts Fitch Solutions expect emerging markets (excluding China) to take about two years to recover to pre-pandemic levels, while South Africa is projected to take as long as five years, and this lagging behind other emerging markets is a major concern that would contribute to greater social instability and could see capital flow to more attractive investment destinations.
However, Hamilton said, for context, developed economies such as France and the UK are also expected to take around five years to return to pre-pandemic levels.
“What we expect is an increased appetite by global asset managers for emerging market fixed investment, given the low yields found in the EU and US – but the preference may still remain with the Asia region given its better containing of the virus.
“All markets will have to consider two factors: The short-term recovery from the pandemic and the long-term position of the economy post-recovery. It is more prudent to work from the long-term position as an investor as opposed to try and predict and respond to a highly volatile and dynamic short-term view,” Hamilton said.
On the business environment
Reason to be optimistic over the long-term is tempered by expected “extremely tough” trading conditions for most companies over the next five years.
“As combatting the virus faces serious practical constraints, many markets can be expected to remain closed or partially-closed, continuing to limit the movement of goods and people for the coming 12 to 18 months.”
Hamilton said that companies that have weathered the storm so far have done so with significantly more debt, depleted financial resources and possibly diluted equity positions, seriously impeding their ability to access further funding for possible growth-oriented capital allocations.
“Those with the deepest pockets and strongest balance sheets – thus larger companies – are best placed to access further local and global capital to survive and possibly thrive. But we can expect to see an increase in liquidations and business rescue filings in 2021 as the pandemic drags on.
“This will require companies to simultaneously take both a conservative and a pragmatic view in plans and budgets for 2021 – incorporating careful risk analysis and developing contingency plans – while also devoting capital to future growth opportunities.”
Hamilton said a rebound in merger and acquisition (M&A) activity was being seen globally, with the US posting record high levels, but this had not yet flowed over to emerging markets.
“We expect these figures to rise in emerging markets during 2021 as larger firms embark on consolidation drives and others seek to off-load non-core assets and manage debt levels. Companies will need to restructure their balance sheets in order to maintain a base from which to embark on growth paths and limit job losses.
“The risk is naturally for overleverage, which creates the opportunity for funding from venture capital or private equity funders to fill the gap of traditional equity and lenders. This is especially the case in the buy-out market, where we see great opportunities.”
Hamilton said investors globally retained appetite for those industries least impacted by the pandemic, such as pharmaceuticals, health, essential industries with low demand elasticity such as food retail, and others able to continue operating under lockdown conditions, with technology a “major winner”.
“In South Africa, the tourism and travel industries as well as the alcohol and tobacco industries have been hard hit by the pandemic and government measures to contain the virus. The outlook on these industries remains negative until the virus has been brought under control. In addition to the winners in healthcare and technology, locally we can also expect agriculture, energy, renewables and infrastructure to enjoy strong growth in the coming years.”
While the uptick in capital flows to emerging markets bodes well for South Africa, this is a highly competitive market and the country is competing for investment against China, India, Brazil and Mexico – “so the fundamentals remain that South Africa should focus on improving its attractiveness as an investment destination,” said Hamilton.
On the launch of AfCFTA and Africa embarking on making itself a more attractive investment destination, Hamilton said the goal was to boost intra-Africa trade which remained extremely low compared to similar trade areas in Asia, Europe and the Americas.
“Africa is a market of 1.3-billion people and a trading bloc worth upwards of $3-trillion, but only 16% of current African exports are to other African countries, compared to 68% in Europe and 59% in Asia.
“AfCFTA will be a key driver of growth for all nations on the continent and companies must ensure that they are in a position to benefit from this. It is certainly not without practical and political concerns and issues, but a key investment drive should be made by local and global markets and companies to ensure that this agreement is successful. It is an opportunity that is too important to miss.”