28 July 2020 | ISSN 1023-7097

CONTENTS

1 | International background and outlook The outlook for the global economy remains uncertain as

the spread of Covid-19 continues. Most economies are

expected to show strong recoveries from the plunge in the

second quarter, as activity is gradually restored. However,

the trajectory beyond the third quarter is generally expected

to be slow.

6 | Domestic review and prospects The outlook for the domestic economy also remains bleak.

Lockdown restrictions have been eased as Covid-19

infection rates accelerate. Underlying conditions are likely

to improve in the second half of the year, but the recovery

is expected to be too timid and too late to prevent a sharp

contraction in GDP over calendar 2020. On the upside,

some stability returned to the domestic financial markets.

The rand pulled back and inflation moderated to well below

the 4.5% midpoint of the Reserve Bank’s inflation targeting

range, creating space for a further 25-basis-point cut in

interest rate in July. Interest rates are now expected to

remain steady for an extended period.

Facts and forecasts

11 | Annual

12 | Quarterly

International background and outlook The disruption to economic activity by the spread of the coronavirus (Covid-19) and the imposition of strict containment measures depressed the global economy at the fastest pace on record over the second quarter. Trade volumes have contracted at a rate more than double that seen in the aftermath of the 2008 global financial crisis. Unemployment is rising all over the world. Vulnerable economies are also facing severe external liquidity pressures. Financial markets have rebounded strongly from the sell-off in March on hopes that the pandemic will be defeated through either effective treatment or a vaccine and that the world economy will make a speedy recovery. However, the outlook remains uncertain, with evidence of a second wave of infections emerging in some countries and indirect effects of the period of global lockdown still unfolding.

Graph 1: The rapid spread of Covid-19 persists

Source: World Health Organization

The spread of Covid-19 has worsened in recent weeks, dimming hopes that the pandemic would be contained by the final quarter of this year. The macroeconomic effects are therefore worsening as some forms of containment measures remain in place across most of the world. Globally, the number of confirmed cases had breached 16 million and deaths surpassed 650 000 by 27 July. The resurgence in new infections followed a period between

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mid-April and late May, when new cases were contained below 100 000 per day. Since then, daily new infections have more than doubled to average nearly 204 000 around the start of July. The United States (US), Brazil and India have more than 1 million confirmed cases, with the US at just over 3.8 million and the other two at more than 2.1 million and 1.2 million respectively. Russia, South Africa, Peru, Mexico and Chile have each recorded more than 300 000 cases. Encouragingly, there are signs that the curve has been flattened – that is, new infections are declining rapidly − in the former epicentres: the United Kingdom, Italy, France, Germany, Spain and Turkey. Saudi Arabia, Pakistan and Egypt are also in the early phase of containing new infections.

These latest developments − of infections accelerating in highly affected countries and renewed outbreaks in nations that had contained the initial outbreaks − point towards economic downturns that could be more severe than even the latest growth forecasts suggest. The International Monetary Fund (IMF) has revised its projected world GDP contraction to 4.9% from the 3% anticipated in April. The World Bank expects a deeper recession of a 5.2% contraction in global output. The Organisation for Economic Cooperation and Development (OECD) has an even more pessimistic outlook. It expects a global contraction of 6% in a ‘single hit’ scenario, while in a ‘double hit’ scenario – where a second outbreak is assumed to be almost as severe as the first – the OECD forecasts a 7.6% global contraction. The outlook for developing economies is considerably worse than initially expected, as global restrictions on the movement of people and goods as well as domestic containment measures have reduced economic activity at a steep rate.

The World Trade Organization (WTO) estimates that world merchandise trade volumes contracted by 18.5% in the second quarter of 2020, following a 3% drop in the first quarter. This trajectory, which is much steeper than in the aftermath of the global financial crisis, suggests that the WTO’s worst-case scenario of a contraction of 32% in world trade during 2020 is now very likely.

Graph 2: Global merchandise trade volumes fell sharply in the

second quarter

Source: World Trade Organization

The OECD’s Employment Outlook 2020 predicts that the OECD unemployment rate, which has jumped to 8.5% from 5.3% at the end of 2019, will reach 9.4% by the end of this year. In a ‘double hit’ scenario the rate of joblessness in the world’s leading economies will rise to 12.6%, and a jobs recovery will be unlikely until after 2021. The impact on household incomes will be more pronounced as people work fewer hours or are temporarily furloughed.

Stimulatory fiscal and monetary measures to counter the effects of Covid-19 have not been expanded aggressively since the initial programmes were announced in March and April. The exception is the European Union, which has agreed on a €750 billion recovery plan for the most affected economies in the bloc. The plan, however, must still be ratified by the European parliament. Further interest rate reductions have been few as most central banks indicate that they have done enough to ameliorate the financial and economic effects of the pandemic. The exceptions were the major central banks in Europe. The European Central Bank increased the size of its emergency asset purchase programme to €1.35 trillion from €750 billion and extended its duration to June 2021, while the Bank of England (BoE) raised its programme to £745 billion from £645 billion. The US Federal Reserve (Fed) seems to be leaning towards capping the size of its balance sheet after some Federal Open Market Committee members expressed concern that further purchases would likely lead to ’potentially adverse implications for financial stability’. A renewed shock, however, would compel the Fed to do whatever it can to contain the economic effects of the shock.

Graph 3: The Fed’s balance sheet has likely peaked for now

Source: St. Louis Federal Reserve Economic Data

Global manufacturing conditions showed signs of gradual improvement over May and June, helped by the gradual relaxation of containment measures across the globe. The JP Morgan global purchasing managers index (PMI) – the composite PMI of industrialised and developing economies that account for 98% of global manufacturing value added – rebounded from a record-low 26.5 in April to 42.4 in May and 47.8 in June, as activity expanded in 10 of the 45 economies surveyed. Although the June figure continued to reflect contracting aggregate

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manufacturing activity, strong increases in subindices for output, new orders and new export orders suggest that overall manufacturing activity will return to expansion in the next few months, barring any new global shocks. Worryingly, the employment subindex showed that manufacturing jobs had been shed for the seventh month in succession. The global PMI, however, concealed stark differences in the pace of rebound across regions. The US ISM index jumped to a 14-month high of 52.6 in June from a post-financial crisis low of 41.5 in April. The Eurozone PMI improved to a four-month high of 46.9 as France (52.1) and Ireland (51) recorded expanding activity. The German PMI improved to 45.2 from a low 36.6 in May, while Spain (49), Italy (47.5) and the Netherlands (45.2) reflected milder contractions relative to April and May. In contrast, the Japanese PMI remained depressed at 40.1 on the back of sharp contractions in output, new orders and purchasing activity.

Activity also remained generally subdued in South Korea. The Brazilian PMI returned to a moderate expansion, while India, Thailand, Indonesia and Taiwan showed slower contractions. Chinese PMIs continued to reflect an improvement, which was already visible at the start of the second quarter, as China started to ease restrictions earlier than the rest of the world. The official Chinese PMI for large, state-owned factories hovered close to 51 after rebounding from 35.7 in February, while the Chinese Caixin PMI of small, privately owned manufacturers rose further to 51.2 in June.

Graph 4: Export orders point to further improvement of

manufacturing output

Source: Bloomberg

The US economy entered a deep recession in March, as the record 128-month-long expansion was halted by local and global measures to contain the effects of Covid-19. The Federal Reserve Bank of Atlanta’s model estimates a 35% seasonally adjusted and annualised output plunge in the second quarter. Latest data points to a slow recovery from the precipitous contraction. Nonfarm payroll gains averaged 3.7 million per month in May and June, which brought the unemployment rate down to 13.3% in May and 11% in June from April’s post-depression high of 14.7%.

The Fed’s Beige Book showed that economic activity increased across the Fed’s 12 districts over the five weeks to early July. The reopening of nonessential businesses boosted retail sales, employment generally picked up although new layoffs were reported, while freight activity rebounded. Overall activity, however, remained well below pre-Covid-19 levels, suggesting that the US still has a long way to go to recreating the 22.2 million jobs shed over March and April. The Fed emphasised that the US economic outlook remained highly uncertain as a renewed surge in infections in some southern and western states is likely to halt and even reverse the lifting of restrictions on business.

In the Eurozone, exports of the large economies fell sharply over the first two months of the second quarter, while a significant drop in intra- and inter-European Union travel reduced tourist nights sold by 44% over the first four months of this year compared with the same period in 2019. The unemployment rate edged up only marginally to 6.7% from 6.4% in March, but there are indications that incomes are under intense pressure as more households report cuts in discretionary spending. The volume of retail sales expanded by 17.8 m-o-m in May, slashing the y-o-y contraction to 5.1% from 19.6% in April. Industrial production remained 21% below the level 12 months earlier following sharp contractions in March and April. The Ifo Institute estimates that German GDP contracted by 11.9% in the second quarter – the largest quarterly drop on record − after falling by 2.2% in the first. The Ifo forecasts a 6.7% contraction for the year.

Preliminary Chinese GDP data indicate that output expanded by 3.2% from the 6.8% decline in the first quarter, which brought the contraction for the first half of the year to 1.6% y-o-y. The Indian economy is projected to have contracted by 45% on a seasonally adjusted and annualised basis in the second quarter from a 3.1% expansion in the first quarter.

Elsewhere among developing economies, the rapid deterioration in fiscal and external accounts has resulted in a record number of rating downgrades. Fitch Ratings – among the three leading external rating agencies − reports that the number of its long-term external rating downgrades in the first half of 2020 exceeded the total number of downgrades in any of the previous full years. Most of the downgrades were in Africa, Latin America and the Middle East. Disconcertingly, 40 sovereigns are on negative outlook, which suggests a high likelihood of their ratings being downgraded further, as 56% of negative outlooks have historically resulted in rating downgrades within nine months of the outlook change. Foreign currency rating downgrades will raise the cost of borrowing for these sovereigns in an environment of tight global financial conditions.

Confirmed Covid-19 infections in sub-Saharan Africa have so far remained very low. Excluding South Africa,

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infection rates remain well below 20 people per 100 000 of the population. Nigeria has just over 36 600 cases, but the risk of an uncontrollable spread remains high. Reported deaths are even lower, but this probably does not reflect the real situation due to slow testing and limited reporting of confirmed cases.

The severity of Covid-19 on these economies is already apparent as depressed commodity prices and low global trade volumes are reducing the export earnings. Imports are expected to fall only marginally on the back of subdued global oil prices. However, purchases of essential goods, particularly health and personal protection equipment, will restrict the narrowing of the trade deficits. External financing pressures will therefore remain elevated. Some relief will come from the Group of 20-led Debt Service Suspension Initiative (DSSI). The DSSI suspended official debt service payments for eligible nations – the majority of which are the small, island states or in sub-Saharan Africa − until the end of 2020, but the programme could be extended for another year if the need arises. The World Bank estimates that the programme will enable the 36 eligible sub-Saharan nations to divert about $6.6 billion to more essential expenditure. The relief granted by the DSSI, however, is likely to be limited unless the participation of non-Paris Club bilateral creditors and private creditors is secured. China is a major creditor of many sub-Saharan governments, and its participation will be of paramount importance. Commercial creditors, particularly Eurobond holders, will also likely offer some relief to avoid outright defaults by the highly indebted sovereigns such as Angola and Ghana.

The subcontinent’s output growth will be weighed on by steep contractions in Nigeria and South Africa, which together account for almost 50% of its output in value terms. The IMF has revised the region’s GDP contraction to 3.2%, double the 1.6% dip anticipated in April. Among the oil exporters the economies of Nigeria and Angola are expected to contract by 5.4% and 4% respectively. The small oil-exporting nations − Congo Republic, Gabon and Equatorial Guinea – are experiencing deeper recessions.

The situation in the more diversified economies appears to be better. Ghana will be supported by the firm gold price and reasonable volumes of cocoa. However, subdued global demand for gold and low oil prices will keep aggregate export earnings growth muted. The IMF forecasts a growth rate of 1.5% in 2020 from more than 6% over the past two years, followed by a strong rebound to 5.9% in 2021. The Kenyan and Tanzanian economies are also expected to fare relatively better in the current environment. However, risks to this outlook are firmly to the downside. Significant tourism receipts will be forgone due to global travel restrictions, as the peak tourism season − coinciding with the migration of animals in the Masai Mara − is over July to August. Another key risk emanates from

lower agricultural production, with the locust infestation in the region likely to result in significant crop damage.

The downturn in Namibia, which commenced in 2016, has deepened and real GDP is expected to contract by 6% in 2020. Falling production and low prices of key exports – diamonds, uranium and zinc – coupled with drought-constrained agricultural output will ensure that the longest, and now the steepest downturn in history, is recorded. Similarly, Botswana’s sharply lower diamond production, which accounts for four fifths of export earnings, will result in an almost 10% GDP slump. The largest miner De Beers has revised its production guidance to between 25 million and 27 million carats in 2020 from 32 million to 34 million forecasted at the start of the year, and it has cancelled its third sales event of the year due to global travel restrictions. Lesotho will be hurt by low diamond export earnings, while exports of textiles have been dampened by disruptions to global supply chains. In eSwatini the central bank forecasts a 6.6% contraction in the worst-case scenario.

The situation in extremely fragile nations has become even bleaker. Export earnings in Zambia are falling sharply as some of the major copper mines have been put under care and maintenance due to subdued prices and unreliable power supply. Considerably lower mining royalties will worsen the situation for a government which has already suspended its external debt service payments. The IMF expects the Zimbabwean economy to contract by 10.4% in 2020. Deeper foreign exchange shortages, as export earnings slump, have compelled the Reserve Bank of Zimbabwe to introduce a weekly foreign exchange auction system, effectively depreciating its local dollar exchange rate to Z$69 to the US dollar from the unsustainable Z$25. Downside pressures on the currency remain elevated. The inflation rate has breached 700%, while US dollar export earnings were down by 1.5% over the first five months of this year compared with the same period in 2019.

On the monetary policy front, southern African central banks have reduced their policy rates dramatically, which primarily reflects the Common Monetary Area’s easing in line with the sharp cuts by the South African Reserve Bank. In West Africa, Nigeria reduced its policy interest rate to 12.5% from 13.5% in May. The space to reduce policy interest rates further is limited as inflation rates remain sticky just above 10% across most of sub-Saharan Africa.

Financial markets recovered strongly after the steep plunges in March, driven by significant fiscal and monetary stimulatory measures and hopes of the containment of the pandemic. Equity market volatility eased significantly, emerging market sentiment improved and equity indices in the major industrialised economies bounced back to within single digit losses from the record highs set in February. Emerging market equities outperformed their developed market counterparts over the quarter. The MSCI World Index ($) rose by 17.7% in the second quarter, reversing

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most of the 21.4% drop in the first quarter, while the MSCI Emerging Markets Index was up by 19.6% over the quarter.

US equity indices rallied strongly from their lows in late March. The S&P 500 and the Dow Jones Industrial Average had jumped by 44.5% and 48.3% in early June, rising to within 7% of the all-time highs reached in the second and third weeks of February. The Nasdaq was buoyed by expectations of upbeat earnings reports from technology counters. It has surged by over 55% from its low point in late-March to touch a new recorded high of 10 839.9. European equities staged an equally strong comeback, with the FTSE 100, the German Dax and the French CAC rising by at least 30%, while the Japanese Nikkei gained 40%.

Graph 5: Equity markets across all regions slumped

Source: Datastream

In currency markets the euro and the British pound fell marginally as their respective central banks announced additional bond buying in the first and third weeks of June. The euro fell to $1.13 from $1.08 in the second week of May, but it has since risen to $1.14, while the British pound eased to $1.23 in late June from $1.27 a week earlier, and it has hovered around $1.25 since the start of July. The Japanese yen has remained rangebound, touching ¥109 against the dollar in early June and gradually easing to ¥107 in the second week of July.

Commodity currencies were generally firmer over the second quarter, supported by firmer commodity prices. The Australian dollar and the New Zealand dollar firmed by 10.9% and 6.5% respectively, while the Hungarian forint gained 2.6%. Emerging market currencies were generally weaker despite some improvement in emerging market sentiment. The Brazilian real and the Turkish lira fell by 3.9% and 3.8% respectively, while the South African rand was up by 4% over the quarter. The Chinese yuan continued to fluctuate around CNY7.00 to the US dollar.

Sub-Saharan African central banks generally maintained their managed exchange rate regimes, despite intensifying external liquidity shortages and elevated inflation. Strong demand for dollars compelled Nigeria to devalue its currency further. The naira official rate was depreciated to

₦387.50 to the US dollar from ₦361 to the US dollar in early July, as the authorities hinted at the unification of the multiple exchange rates. Downward pressure will persist as the supply of foreign exchange remains limited due to the oil price slump.

Commodity prices were broadly more stable following the steep falls in late-March into April. The benchmark Brent crude price has hovered between $40 and $43.60 per barrel since mid-June, bouncing back from a brief plunge to below $10 per barrel in the third week of April. Prospects for a significant gain in the oil price will be contained by subdued global activity. Precious-metal prices were generally firmer. Gold touched a new all-time high of just under $1 950 per ounce as it surpassed the old record of $1 921 set in September 2011, buoyed by its safe-haven status as the acceleration of Covid-19 infections boosted expectations of further fiscal and monetary stimuli, while platinum has recovered to levels reached in early March. Copper has risen to the highest level in five months as Chinese demand recovers and concerns about Chilean supply persist. Further gains for metal prices, however, will also be limited due to the slow return to normal operations by key consumers such as China. Agricultural prices are showing signs of stabilisation. Non-food agricultural prices were headlined by the cotton price’s 24% jump from an 11-year low in March as Chinese demand recovered. The Food and Agricultural Organization’s (FAO) food price index rose for the first time this year, up by 2.4% in June, but it lost 2% over the quarter as gains in oils and sugar were more than offset by lower meat, dairy and cereals prices. The FAO expects output of food grains to be slightly lower over 2020, but the agri-food sector will be relatively resilient to the effects of Covid-19.

Graph 6: Food prices showing early signs of stabilisation

Source: Food and Agricultural Organization

Isaac Matshego

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Domestic review and prospects

Recent statistics confirm the devastating impact of Covid-19 and the lockdown on the local economy. Business and consumer confidence plummeted to historic lows. Production and sales in most industries fell by between 30% to 100% in April. The rebound in activity over May and June was stronger than expected, perhaps reflecting some pent-up demand, spurred on by attractive prices and sharply lower interest rates. Despite these encouraging signs, the lockdown is expected to trigger further job losses, reduce household incomes and hurt company earnings. As a result, consumer spending is forecast to decline, while the slide in fixed investment will deepen. Government finances will be eroded even further. The Supplementary Budget shows a dramatic deterioration in the fiscal and debt metrics. There have been some positive developments. Some calm returned to equity and bond markets, while the rand strengthened. Inflation receded to historic lows, suggesting that interest rates will probably remain at current low levels for an extended period. At this stage, our forecast is for the economy to contract by 6.6% in 2020, with considerable downside risk.

Graph 7: Number of Covid-19 deaths relative to confirmed cases

Source: World Health Organization

Covid-19 has spread rapidly throughout South Africa over the past two-and-a-half months. In April the number of confirmed cases totalled only 1 688. Since then, the rate of transmission has accelerated, with around 13 000 new cases reported daily over the past week, taking the total number of confirmed cases to around 452 529 by 27 July. A total of 2,8 million tests have been conducted nationwide, with 274 925 recoveries and 7 065 fatalities recorded so far. Although alarming, South Africa’s mortality rate is only 1.6%, among the lowest in the world, compared with a global average of around 4%. This may be predominantly due to the country’s young population, but it also suggests that the health services are holding up relatively well. From a public health perspective, the decision to implement one of the strictest social and economic lockdowns (called alert level 5) in the world now appears sound, buying the state much-needed time to strengthen and expand the country’s fragile and limited public health system to cope with the

anticipated surge in new cases currently unfolding. Predictably, the economic impact has been disastrous. The economy was subjected to 35 days at level 5 lockdown, from 27 March to 1 May, with only essential industries allowed to operate. This was followed by another 14 days until the end of May at alert level 4, which was only marginally less restrictive. Since then, the country has moved to alert level 3, under which most industries can operate, albeit at differing levels of staff capacity, depending on the nature of the business and the risk of virus transmission.

The various stages of lockdown have disrupted both production and consumption activities, placing tremendous strain on company earnings and household incomes. Covid-19 hit an economy already firmly stuck in recession caused by extended and persistent power outages, dilapidated infrastructure, decades of poor policy choices and deeply entrenched corruption. Prior to lockdown, real GDP shrunk by 0.8%, 1.4% and 2% in the third and fourth quarters of 2019 and the first quarter of 2020 respectively.

Households were also in a precarious financial position prior to the lockdown. Personal disposable income contracted by a seasonally adjusted and annualised 0.4% q-o-q and 0.8% y-o-y in the first quarter, as the unemployment rate shot up to a new record high of 30.1%, with the total number of employed falling by a further 38 000. This restricted growth in consumer spending to only 0.7% q-o-q from 1.4% in the last quarter of 2019. Covid-19 eroded household incomes further. Level 5 lockdown resulted in reduced working hours for most industries and the complete shutdown of others. The self-employed and those employed by small, medium and micro-enterprises are likely to bear the brunt of the pandemic. Government responded by implementing a set of financial and economic support measures. These included expansions to social welfare and Unemployment Insurance Fund payments, short-term tax relief in the form of deferrals and partnering with the South African Reserve Bank (SARB) and large commercial banks to offer a R200 billion loan guarantee scheme for small businesses in distress. The SARB also cut interest rates by an aggressive 300 basis points (bps) since the start of the year. These measures are unlikely to prevent an increase in net job losses but should help protect some jobs and soften the financial fallout for vulnerable individuals.

Unemployment will rise in the quarters ahead. Our estimates still suggest that the spike occurred in the second quarter, with job losses of around 1.8 million, after which a modest recovery is anticipated. This is unlikely to reverse the damage done to the labour market during the lockdown. Net job losses of 1.6 million are forecast for calendar 2020. The surge in job losses, coupled with heightened job insecurity, will probably continue to weigh on household sentiment and spending long after the pandemic has been defeated.

0

2

4

6

8

10

12

14

16

18

03/

310

4/05

04/

100

4/15

04/

200

4/25

04/

300

5/05

05/

100

5/15

05/

200

5/25

05/

300

6/04

06/

090

6/14

06/

190

6/24

06/

290

7/04

07/

090

7/14

07/

210

7/28

08/

040

8/11

08/

180

8/25

USA

South Africa

France

Italy

Spain

UK

Australia

New Zealand

South Korea

Sweden

China

No of deaths as % total confirmed cases

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Recent monthly statistics provide a glimpse of the magnitude of the impact. Consumer confidence plunged to a 35-year low of -33 in the second quarter. Unsurprisingly, retail sales plummeted by 50.7% m-o-m and 50.4% y-o-y in April, while new-car sales imploded by an even more severe 98,3% m-o-m and 98,4% y-o-y. In our view April probably reflects the trough in consumer spending. Since then high-frequency statistics point to some resilience. Retail sales improved by leaps and bounds in May, rising by 74.2% m- o-m, although still down 12% y-o-y. Despite the underlying tough conditions, sales of textiles and clothing and furniture and appliances posted surprisingly strong recoveries in May. Total retail sales returned to about 88% of pre-Covid levels (defined as average monthly sales in 2019) in May.

A similar pattern emerged in new-vehicle sales. Although sales still declined y-o-y in both May and June, the rate of contraction moderated at a much faster pace than most expected, and sales returned to around 73% of pre-Covid levels by June. The resurgence in spending on semi-durables and durables probably reflects a degree of pent-up demand, which was unleashed when restrictions on the sale of these goods were lifted. This effect may prove temporary, with demand receding once the harsh realities of life after the lockdown hit home. The bounce in spending may also be driven by forces more nuanced than simply pent-up demand.

In our view Covid-19 and the lockdown probably affects various parts of South Africa’s highly fractured society and economy differently. For middle- to higher-income earners, secure in their jobs, the lockdown reduced travel costs and the stimulus measures provided a boost to income. The 300-bps cut in interest rates reduced debt service costs significantly, freeing up substantial funds for discretionary spending, debt reduction or savings. Equally, the moderation in inflation, reinforced by heavy discounting by many retailers, represented a unique opportunity to upgrade durable goods. In sharp contrast, lower-income groups are left either unemployed, unable to generate income through informal trade, or forced to accept lower pay or unpaid leave. Government’s support measures will help preserve basic living standards for some as long the provisions remain place, but many more will be left without any safety net. Once this tap runs dry, low-income households are likely to cut back on spending, which will hurt overall demand, affecting sales in some regions and for certain types of goods and services more than others. In the third quarter the boost delivered by sharply lower inflation and interest rates to middle- to higher-income earners will probably dominate. Thereafter, the overall negative impact on the economy and earnings prospects in general are expected to catch up with all households. These forces are expected to translate into a decline in consumer spending of around 3% in calendar 2020.

Table 1: GDP sector breakdown

Source: Statistics South Africa

Lockdown also inflicted significant damage to companies. As mentioned, prior to lockdown trading conditions were already exceptionally challenging, with the economy stuck in recession. The impact of the pandemic struck the export-orientated mining and manufacturing sectors sooner that the rest of the economy. China’s strictest lockdown occurred in January and February, while Europe and the US imposed similar restrictions in March. As a result, real value added by mining and manufacturing plunged by 21.5% q-o-q and 8.5% respectively in the first quarter. Given that these two sectors are the largest energy consumers, demand for electricity also dropped, while demand for transport, storage and logistics slowed, restricting growth in these industries to 0.5%. Ironically, the global panic caused by the virus in March probably supported the finance industry as trading volumes increased sharply, with investors scrambling to restructure portfolios to minimise losses. Equally, the banking industry benefited from the imposition of level 5 lockdown in late March, with companies rushing to secure credit lines to prop up cashflows. This effect was also visible in the bank credit figures in March, reflected in surges in ‘bills and investments’, company overdrafts and unsecured loans to companies. These preserve benefits are likely to be temporary. The direct hit delivered by lockdown will be visible in all industries in the second quarter. Dramatic declines in value added are forecast for most major sectors, except ‘finance, real estate and business services’, where softer contractions are expected. Monthly statistics show that mining and manufacturing production plunged by 36.8% and 22% respectively over April, which translates into y-o- y declines of 50.3% and 49.4% respectively. Like retail and new-vehicle sales, mining production rebounded in May, rising by 44% m-o-m, but remained 30% lower than in May 2019. This gradual climb towards normal production levels is likely to occur in most industries over May and June, but output is still forecast to fall short of pre-lockdown levels by the end of June. At this stage, GDP is estimated to contract by more than 30% q-o-q in the second quarter. Thereafter, the recovery will probably continue. Value added by all industries will rebound strongly off a low base in the third quarter. Once these huge base effects caused by switching the economy off and on again are in the numbers, the outlook remains murky.

Industries Size% of GDP

2019 2017 2018 2019 Q1'2019 Q2'2019 Q3'2019 Q4'2019 Q1'2020Agriculture 1.9 21.1 -4.8 -6.9 -16.8 -4.9 -4.5 -7.6 27.8Mining 7.4 4.2 -1.7 -1.9 -10.8 17.4 -6.1 1.8 -21.5Manufacturing 11.8 -0.2 1.0 -0.8 -8.8 2.1 -4.4 -1.8 -8.5Electricity & Water 3.4 0.6 0.9 -2.0 -7.4 3.2 -4.9 -4.0 -5.6Construction 3.4 -0.6 -1.2 -3.3 -5.3 -2.4 -6.9 -5.9 -4.7Domestic trade 13.5 -0.3 0.6 0.0 -3.6 3.4 2.6 -3.8 -1.2Transports & Comms 8.7 1.4 1.6 -0.4 -4.4 -0.3 -5.4 -7.2 0.5Finance 17.5 2.1 1.8 2.3 1.1 4.1 1.6 2.7 3.7General government 16.2 0.3 1.3 1.7 2.5 3.3 2.4 -0.4 1.0Personal Services 5.3 1.3 1.0 1.0 1.1 0.8 0.4 0.7 0.5Value added 89.1 1.5 0.7 0.2 -3.2 3.5 -0.9 -1.3 -1.8GDP 100.0 1.4 0.8 0.2 -3.2 3.3 -0.8 -1.4 -2.0

Y-o-y % changeQuarterly growth

Q-o-q % change (saar)*Annual growth

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The lockdown is likely to impact on all components of final demand long after it ends. The slide in gross fixed capital formation (GFCF), which fell by 10% in the final quarter of 2019 and a historic 20.5% in the first quarter of this year, is likely to intensify. The lockdown placed enormous strain on companies’ cashflows, forcing even large firms to cut costs dramatically and secure some form of bridging finance. The quickest way to reduce costs to prop up cashflows and restore earnings growth is by trimming capital expenditure. Fixed investment is therefore forecast to implode in the second quarter, registering declines far greater than the alarming drop recorded in the first quarter. A quick recovery also appears unlikely given recessionary conditions in both the local and global markets. Most companies will probably sit with ample spare capacity throughout the year. As a result, fixed investment is forecast to shrink by a record 27% in 2020. Beyond this year the old, but fundamental, constraints to any expansionary activity will need to be resolved, starting with electricity supply, but extending to all other economic infrastructure from road, rail, port to ICT capacity. Significant progress on other structural and policy reforms will also be required to improve business and investor confidence, thereby helping to reduce risk and lowering hurdle rates for new investment projects. These include addressing clear legislative and regulatory disincentives, establishing policy certainty and stabilising the country’s public finances. A growing public debt burden is not only crowding out the private sector from the capital markets but is also raising the cost of capital through the sovereign risk rating downgrades.

Graph 8: Fixed-investment plans at a standstill

Source: Nedbank Group Economic Unit

Nedbank's Capital Expenditure Project Listing suggests that fixed-investment plans almost evaporated so far this year. Research shows that an annualised total of 32 new projects worth a meagre R29.7 billion were announced in the first half of the year. The number of projects is the lowest since the listing started in 1993, while the value is the smallest since 2001. The private sector accounted for 56% of the number and 93% of the value of new projects that were captured. However, the value of private sector

projects recorded, at R27.8 billion, is the lowest since 2003. The government and public corporations’ projects are usually highly volatile, but so far this year few new projects have been observed. Given that most capital projects have relatively significant lead times, the drop in this year’s announced plans will result in lower outlays from 2021 onwards. Fixed investment is therefore forecast to be slow to recover. Government finances will deteriorate dramatically in 2020, The Supplementary Budget, presented in June, painted a dismal picture of the country’s finances, with the consolidated budget deficit doubling to 15.7% of GDP in 2020/21 from the already high 6,8% estimated at the time of the 2020 National Budget in February. National Treasury expects the economy to contract by 7.2% in 2020 (compared with February’s estimate of 0.9% growth). The recession and the Covid-19 tax concessions are estimated to reduce main budget revenue to R1,1 trillion, a massive 21.4% less than in February. Main budget expenditure is forecast to rise to R1.8 trillion, 2.4% higher than in February, due to the bailouts offered to state-owned enterprises (SOEs) earlier this year, Covid-19 spending and higher debt service costs. The debt picture looks even worse. Gross government debt is projected to climb to 81.8% of GDP in 2020/21 from February’s projection of 65.6%, before rising to 86% by 2022/23. Increased government spending will support the economy in 2020, but thereafter government aims to cut spending in order to gradually reduce the budget deficit and stabilise the public debt burden. There are many obstacles on this path to fiscal sustainability, including union opposition to cuts in public sector pay, factional politics and vested interest hindering progress with the SOE reforms, and the paralysing impact of South Africa’s complex mix of ideological beliefs, political influence and social dynamics on the state’s economic policies. Success is by no means guaranteed. Lack of progress will, however, be reflected in country’s credit ratings, with negative feedback loops to the rest of the economy over the medium to longer term. On average, real GDP is forecast to shrink by around 6.7% in 2020 before growing by a modest 2.5% in 2021. Given the unpredictable and unprecedented nature of the current health and economic challenges, there is a far greater degree of uncertainty surrounding this year’s forecast than in previous years.

On the bright side, the country’s balance of payment position improved significantly in early 2020. The current account recorded a surplus for the first time in 17 years in the first quarter. The surplus amounted to 1.3% of GDP. This was a result of a much narrower deficit on the services, income and transfers account, due to poor corporate earnings and therefore lower dividend payments. A doubling in the trade surplus to R208 billion also

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Nedbank Guide to the Economy | 9

contributed. Exports rose by 3.3% q-o-q, while imports declined by 4.9% ─ the third consecutive quarterly contraction ─ due to weak consumer demand and shrinking fixed investment. The terms of trade (the ratio of export prices to import prices) improved by 3.8%, primarily reflecting the implosion in global oil prices in late March. The current account is likely to remain in surplus for the remainder of this year. The local recession is forecast to subdue dividend payments and imports by more than the global recession and any Covid- related disruptions will undermine exports and tourism receipts. The terms of trade will remain supportive in the months ahead. Further substantial improvements are, however, unlikely as oil prices have recovered some lost ground in recent months. We expect a current account surplus of 1.3% this year ─ the first surplus since 2002.

Graph 9: The current account recorded a surplus in the first quarter

Source: South African Reserve Bank

The surplus on the financial account rose to 1.3% of GDP in the first quarter, after dropping to a three-year low of 0.8% of GDP in the fourth quarter of 2019. Large net capital inflows were recorded in net direct investments after two quarters of outflows, while net other investments and net portfolio investments recorded outflows. Capital flows are likely to be even more volatile in 2020, hurt by volatile global risk appetites given the many uncertainties surrounding the progression of the pandemic, concerns about global economic prospects and worries about further downgrades to South Africa’s sovereign risk ratings given the country’s bleak fiscal metrics.

Bank credit growth slowed to 6.3% y-o-y in May from 7.2% in April and 6% at the end of 2019. The relaxation of some of the lockdown measures helped activity, but the general nervousness about the spread of Covid-19 and worries about loss of income and earnings made both households and companies wary of taking on more debt. Growth in loans to households moderated to 3.8% y-o-y, the lowest since October 2017, while that to companies eased 3%, the weakest since March 2011. In asset-based finance, mortgages eased to 5.3% in May from 6.2% at the end of 2019. Instalment sales and leasing grew by only 3% y-o-y, down from 7.4% at the end of last year. Sharply lower interest rates and the easing in prudential requirements

should translate in some credit growth. Nonetheless, underlying conditions are unsupportive. Household credit demand will be undermined by job losses, shrinking incomes and weak confidence. Corporate credit demand will decline in line with the drop in earnings and remain contained by expectations of a slow recovery.

Inflation fell to a historic low of 2.1% in May, dragged down by the implosion in global oil prices and domestic demand. Core inflation (which excludes food, fuel and electricity) eased to 3.1% y-o-y, the lowest since March 2011, suggesting that underlying price pressures are well contained. Inflation probably troughed in May and is expected to start drifting higher, ending the year around 3.2% and averaging only 3.3% in calendar 2020. The mild upward trend is forecast to continue in 2021 and 2022, with headline inflation forecast to average 4.2% and 4.1% respectively. Weak demand conditions are expected to limit the pass-through of any rand weakness and other cost-push factors to consumer prices over the forecast period.

The Reserve Bank’s Monetary Policy Committee (MPC) eased monetary policy even further in response to the deepening recession and benign inflationary environment. In May the MPC cut interest rates by 50 bps. This was followed by a further 25 bps reduction in July, taking the cumulative decline since the start of the year to an aggressive 300 bps. The May and July decisions were outcomes of split votes. In May three Committee members voted for a 50 bps cut and two favoured a more modest 25 bps. In July three members voted a 25 bps cut and two preferred no change. The lack of consensus within the MPC suggests that the interest rates cycle is nearing its trough, with the future trajectory from these low levels less apparent.

Graph 10: Interest rates reduced by a further 25 basis points in

July, against our forecast for unchanged rates

Sources: Statistics SA and South African Reserve Bank

There were no major changes in the underlying economic fundamentals or the Committee’s interpretations of these between the May and July policy meetings. Historical inflation outcomes were broadly in line with the Bank’s

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Nedbank Guide to the Economy | 10

expectations, while the inflation outlook remained benign. The Reserve Bank still expected headline inflation to remain below the 4.5% midpoint of the target range during the remainder of the year, averaging 3.4% in 2020 (unchanged from the forecast produced in May), 4.3% in 2021 and 2022 (from 4.4% previously). The economy was still forecast to contract sharply in 2020. The Bank revised its GDP forecast down to -7.3% for 2020 from the -7% anticipated in May. The recovery projected for 2021 and 2022 was also expected to be slightly slower than May’s estimates suggested, revised to 3.7% and 2.8% respectively from 3.8% and 2.9% previously. Predictably, given the SARB’s inflation and GDP projections, the Quarterly Projection Model indicated that there was space for one more 25 bps cut in the final quarter of this year. Our forecast is for interest rates to remain unchanged at these low levels, with downside risks over the short term. Inflation is subdued and likely to remain so over the next three years. The economy is shrinking, placing considerable pressure on firms to absorb costs rather than sacrifice volumes by raising prices. The underlying dynamics are supportive of an accommodative monetary policy stance. So far, the doves on the MPC have trumped the hawks. If this trend continues, then another 25 bps cut is likely in either September or November.

Graph 11: Equity prices are recovering after sharp losses

Source: Thomson Reuters

Local equity prices recovered some lost ground in the second quarter and early July, supported by improved sentiment on the back of the rally in global stock markets and the easing of lockdown restrictions in the domestic economy and the world at large. The JSE all-share index (ALSI) gained 22.5% over the quarter, after plunging by 39.7% in the first. The recovery was mainly driven by a surge in basic materials (up by 41.1%), fuelled by the rise in gold prices to lofty heights and the upturn in most other commodity prices off the lows of March. Industrials (up 16.2%) and financial stocks (9.4%) also posted modest gains but remain well below pre-lockdown levels. As a result, the ALSI is still 4.8% weaker over the year to date. The outlook is uncertain. The rebound in global equity markets appears unsustainable, driven mainly by exceptionally stimulatory macroeconomic policies and hopes of a speedy global recovery. If the latter fails to

materialise and company earnings disappoint, a correction is likely. These dynamics and South Africa’s weak growth prospects increase the risk of some consolidation over the short term.

The bond market strengthened as global risk aversion receded and some degree of calm returned. The SARB bought government bonds worth R11.4 billion in April, R10.2 billion in May and R5.1 billion in June. The SARB’s total holdings of government bonds amounted to R35.9 billion, of which R27.8 billion was acquired this year alone. Yields on the medium- to long-dated government benchmark bonds declined, with the R186 (2025) and R213 (2031) ending June at 7.70% and 9.72% respectively from 9.96% and 11.28% at the end of March. Going forward, South Africa offers among the highest real yields in the emerging market universe, which should attract foreign interest in a world of low global interest rates and ample liquidity. However, the country’s poor fiscal metrics, weak growth outlook and uncertain credit rating trajectory are likely to cap the upside.

The rand has been volatile, but generally recovered in the second quarter, benefiting from a weaker US dollar and some improvement in global risk appetites. The rand gained 2.6% on a trade- weighted basis in the second quarter, up 2.8% against the US dollar, a modest 0.4% against the euro and 3.2% against the British pound. However, the local unit is still 17.4% weaker on a trade-weighted basis over the year to date. The rand will probably remain volatile for as long as the Covid-19 crisis persists. It will benefit from the weaker US dollar, some improvement in emerging market risk appetites and the country’s relatively high interest rates – which will attract some speculative investment. However, the upside will be contained by concerns about government’s unfolding debt crisis and ability to implement much-needed structural reforms.

Graph 12: The rand recovered significantly

Source: Thomson Reuters

Johannes Khosa and Nicky Weimar

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FACTS AND FORECASTS OF KEY ECONOMIC VARIABLES

28 July 2020

Note 1: Financial account excludes reserves and includes unrecorded transactions While every care is taken to ensure the accuracy of the information and views contained in this document, no responsibility can be assumed for any action based thereon.

2016 2017 2018 2019 2020 2021 2022

Growth (real, % change)

GDP 0.4 1.4 0.8 0.2 -6.7 2.5 1.8GDE -0.9 1.9 0.9 0.6 -7.0 2.8 1.5HCE 0.6 2.1 1.8 1.0 -3.0 1.8 2.6GDFI -3.5 1.0 -1.4 -0.9 -26.7 -2.9 5.3Exports 0.4 -0.7 2.6 -2.5 -6.9 6.4 3.9Imports -3.9 1.0 3.3 -0.5 -7.9 7.3 2.7

Balance of payments (Rbn)

Exports 1122 1169 1247 1303 1141 1283 1373Imports 1091 1104 1223 1264 931 1089 1170Trade balance 31 65 24 39 210 193 204Net services -156 -183 -197 -192 -149 -159 -160Current account -125 -118 -173 -153 61 34 44Financial account 1 165 144 184 178 -21 167 146Change net reserves 40 26 11 25 41 202 190

Current account as a % of GDP -2.9 -2.5 -3.5 -3.0 1.3 0.7 0.8

Gold price (average per ounce)

Dollar 1249 1258 1269 1404 1783 1807 1760Rand 18380 16754 16809 20315 29418 30827 30209

Exchange rates

Dollar-rand 14.71 13.32 13.25 14.47 16.50 17.06 17.16Euro-dollar 1.107 1.130 1.182 1.121 1.208 1.203 1.230Dollar-yen 108.77 112.19 110.50 109.11 106.93 103.23 101.7British pound-dollar 1.350 1.287 1.334 1.277 1.266 1.257 1.251Euro-rand 16.29 15.05 15.65 16.23 19.94 20.52 21.11Rand-yen 7.39 8.42 8.34 7.54 6.48 6.05 5.93GBP-rand 19.87 17.21 17.58 18.49 19.63 21.44 21.47

Interest rates (end of period)

Three-month JIBAR 7.40 7.20 7.23 6.88 3.84 3.91 3.84Prime 10.50 10.25 10.25 10.00 7.00 7.00 7.00Long bond 8.92 8.82 9.22 8.96 9.12 8.65 8.21

Inflation (average)

CPI 6.4 5.3 4.7 4.1 3.3 4.2 4.1

FACTS AND FORECASTS OF KEY ECONOMIC VARIABLES

28 July 2020

While every care is taken to ensure the accuracy of the information and views contained in this document, no responsibility can be assumed for any action based thereon.

Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4

GDP (q-o-q annual %) -3.2 3.3 -0.8 -1.4 -2.0 -40.3 29.3 1.2 3.2 5.1 3.1 3.6

Interest ratesThree-month JIBAR 7.15 7.03 6.79 6.80 5.61 3.90 3.75 3.75 3.77 3.79 3.81 3.82

Prime 10.25 10.25 10.00 10.00 8.75 7.25 7.00 7.00 7.00 7.00 7.00 7.00

Long bond (10 yr) 8.99 8.68 8.90 8.96 12.11 9.28 9.15 9.12 8.88 8.83 8.73 8.65

InflationCPI 4.5 4.5 4.1 4.0 4.1 2.2 3.0 3.2 3.5 4.9 4.3 4.4

Exchange rates

Dollar-rand 14.59 14.15 15.19 14.13 18.03 17.31 16.43 16.64 17.11 17.28 16.88 17.12

Euro-dollar 1.124 1.138 1.095 1.121 1.100 1.122 1.188 1.172 1.199 1.190 1.220 1.217

Dollar-yen 110.60 107.74 107.85 108.7 108.38 107.66 104.97 105.49 104.07 103.76 101.68 102.34

British pound-dollar 1.308 1.267 1.230 1.312 1.232 1.228 1.282 1.249 1.259 1.245 1.268 1.257

Euro-rand 16.40 16.10 16.62 15.84 19.84 19.42 19.52 19.50 20.52 20.56 20.60 20.83

Rand-yen 7.58 7.61 7.10 7.69 6.01 6.22 6.39 6.34 6.08 6.00 6.02 5.98

GBP-rand 19.08 17.93 18.68 18.53 22.20 21.26 21.06 20.79 21.54 21.52 21.41 21.52

Gold price per ounce$ 1288 1412 1491 1524 1617 1772 2012 1899 1817 1785 1790 1804Rand 18779 19976 22644 21525 29153 30688 33054 31609 31097 30842 30223 30892

2019 2020 2021