JOHANNESBURG – Argentinians did not have much time to enjoy their recent victory over the Springboks in Mendoza. The country’s beleaguered currency, the peso, slumped to a new record low of 37 to the US dollar. This despite the central bank hiking short-term rates to the asphyxiating level of 60 percent.
The Argentinean government requested that the International Monetary Fund (IMF) accelerates payment of the record $50 billion bail-out. But rather than comfort markets, it had the opposite effect.
The market has seemingly lost faith in Argentina’s promise to gradually close the budget deficit – ie gradually reduce the amount it has to borrow every year. The only way to do so is to aggressively cut spending and raise taxes.
This will not only make them deeply unpopular, and risk derailing the government’s other reform efforts, but will also further cripple the economy. But the lack of a domestic capital market means that Argentina is at the mercy of global investors and the IMF, and therefore not only cruelly exposed to swings in its exchange rate, but to the vicious cycle of currency weakness further undermining its credit worthiness.
Other currencies sell off
Other emerging market currencies sold off in sympathy, especially the Turkish lira, but also the rand, which fell to R14.68. This means that the local currency lost 11 percent during August. This was in line with the Brazilian real and the Russian rouble, but worse than the Indian rupee’s 4 percent decline (though the rupee fell to a record low against the greenback).
The lira, in contrast, slumped 37 percent and the peso by a similar amount. While there has been a spillover from Turkey and Argentina to other emerging markets, it is still not a full-blown contagion. Markets are seemingly still drawing a distinction between countries that are in deep trouble and those that are merely vulnerable.
All this has been happening against the backdrop of three emerging market-unfriendly global developments in recent months: US interest rate hikes and a stronger dollar, trade disputes and a cooling of China’s economic growth rate. But there have been some positive developments on all three fronts over the past few days.
On the first issue, an important speech by US Federal Reserve chairpercon Jerome Powell at the annual Jackson Hole central banking conference confirmed that the current approach of gradually raising interest rates would continue.
He highlighted an awareness that there are risks to both raising rates too slowly and too quickly. Raising rates too slowly could lead to an economy overheating, while doing it too quickly could prematurely tip the economy into recession.
The Fed’s preferred inflation measure, the personal consumption expenditure price index, rose 2.3 percent year on year (2 percent excluding food and fuel), and, therefore, close to the inflation target. Growth is strong and unemployment low, but Powell noted that there is no sign of overheating.
He also emphasised that he will be guided by incoming economic data, and not rely on vague theoretical concepts. Following such a pragmatic approach reduces the risk of monetary policy overkill. Though emerging market currencies were weaker, the dollar has lost its upward momentum against the euro and other major currencies. The trade-weighted dollar index rose 8 percent between mid-April and mid-August, but has given back about 2 percent since then.
On the second issue, trade, there was a positive development in the form of an agreement between US president Donald Trump and his Mexican counterpart, potentially saving the North American Free Trade Agreement (Nafta, though the name will change if Trump has his way). Canada, the third Nafta member, still has to agree.
While there are still many details to be ironed out, it provides hope that Trump is amenable to a trade deal despite his continued bluster, and it provides Chinese leaders with a template on how to approach talks. It does, though, illustrate Trump’s preference for bilateral deals between two countries, rather than to work in a multi-lateral framework such as the World Trade Organisation, which he has threatened to pull out from.
On the third issue, China’s official purchasing managers’ indices rose for both services and manufacturing in August. After July’s steep decline, this provides some comfort that the world’s number two economy is still growing at a solid clip, even though its growth rate should slow down over time. Regulators in China have recently urged banks to boost lending into flagging sectors of the economy.
Despite this uncertain global macro backdrop, the US equity market has moved higher, with the benchmark S&P 500 breaching 2 900 points for the first time on the way to a 3 percent return in August. Locally, the JSE finally enjoyed some upward momentum until interrupted by news of MTN’s latest Nigerian setback.
The Central Bank of Nigeria wants MTN to return dividends taken out of the country between 2007 and 2015, illegally in its opinion. The all share index even closed above 60 000 points for the first time since early January, but ended the week 58 668, up 2.2 percent for the month. MTN’s share price in contrast fell to a nine-year low.
Why diversification matters
A large decline in the share price of a large company obviously catches the eye and causes concern, but this is the reality of investing in shares. Of the 168 members of the All Share Index, 35 have fallen more than 20 percent over the past year, and a further 21 declined by between 10 percent and 19 percent.
Yet the overall index has posted a positive return over the past year. Any individual share carries a lot of risk, but this is diluted and diminished in a diversified portfolio. At a balanced fund level of course, the risk of something going wrong in an individual company is further reduced by the inclusion of global shares and fixed income assets.
Fiscal risks contained
Finally, what about the risk of South Africa facing an Argentinian-style fiscal crisis? Ratings agency S&P Global noted this week that unlike Turkey, which it recently cut deeper into junk status, South Africa’s current rating was unlikely to change, due to moderately faster expected economic growth, a steady outlook for government debt and the expectation that government would gradually implement economic and social reforms.
Budget data for the first four months of the current fiscal year shows a R123 billion deficit. The good news is that this cumulative deficit is R5bn smaller than for the same four months last year. Also encouraging is that revenue growth is outpacing spending growth year over year with revenue growth of 11.6 percent against expenditure growth of 7.3 percent. This is also broadly in line with budgeted growth in revenue and spending.
However, there are some substantial deviations from target within the tax revenue category. Revenue from the fuel levy is growing faster than budgeted (10 percent year on year), something that few motorists will be happy about, especially given that another petrol price hike is in the works in September.
Revenue from customs duty is also growing much faster than planned. The three biggest tax items are personal income tax, VAT and company tax. All three are slightly lagging growth targets, but in the case of company tax, it is lagging a target that was very low to begin with (6 percent). This points to the weak business environment.
The upcoming October mini-Budget provides the Finance Minister with an opportunity to fine-tune revenue and spending estimates. Unfortunately, it is likely that he will have to project a larger deficit than the 3.6 percent estimate from the February Budget.
A number of unplanned spending items have crept up, including further bail-out requests from State Owned Enterprises, and a wage agreement beyond what was budgeted for. But at least there is some progress on fiscal consolidation. Importantly, there is also virtually no risk that the South African government will not be able to fund itself in the bond market.
Most borrowing (90 percent) is locally, and in the local market. Although foreigners have dumped South African bonds at a record pace since April (more than R80 billion), and government bond yields have increased in that time, they are still within the broad trading range of the past two years.
In the case of the benchmark 10-year bond, the latest yield of 9 percent is higher than earlier this year, but below the 2017 high of 9.4 percent. As foreigners have sold, locals seem to have been happy to buy. And why not at such attractive yields?
Dave Mohr is chief investment strategist and Izak Odendaal is an tnvestment strategist at Old Mutual Multi-Managers.