Three scenarios for South Africa's post-Covid economy
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While there is some optimism and a chance that the South African and global economies will emerge positively from the Covid-19 socio-economic crisis, there is a 65% chance that South Africa will continue to “muddle” its way through the next few years of economic challenges.
This is according to Herman van Papendorp, head of investment research and asset allocation at Momentum Investments, who recently outlined how the company’s scenario planning informed its investment strategy and provided insights into what the socio-economic future of South Africa may look like in the wake of Covid-19.
“We must be humble enough to acknowledge that our ability to see the future is as limited as everybody else’s. As a result, we guard against putting all our investment eggs in one proverbial basket, knowing that we cannot ‘back’ only one specific future envisaged outcome for our investments. We construct portfolios in a way that takes into account the fact that an expected outcome may not materialise, and that other scenarios could come to be in the future.
“In essence, we invest for the central most probable base-case scenario, but also take cognisance of the positive and negative pair risks incorporated in two other possible scenarios – a worst case scenario, and a best case scenario,” Van Papendorp said.
The scenarios are as follows::
1. Base-case scenario: Muddle Through (65% probability)
What will happen? In this case, South Africa initially experiences an economic growth rebound, but this is off a low base due to the significant economic downturn during the Covid-19 lockdowns, as opposed to structural reforms, which leads to more sustained growth. Slow reforms and vaccination hesitancy prevents a positive trend from continuing in the medium- to long term.
2. Worst-case scenario: Deflation (20% probability)
What will happen? Weak global growth and the absence of any local economic reform agenda causes South Africa’s growth potential to plunge towards zero. A sovereign credit rating downgrade spiral ensues and there is an increased probability of an IMF or World Bank bailout.
3. Best-case scenario: Reflation (15% probability)
What will happen? Fast economic reforms initiated by the government and strong global economic growth will lift SA’s growth potential. This enables the country’s credit rating to gradually move closer towards investment grade in the longer term.
What will determine which path South Africa takes?
“There are four main factors that we believe will drive which scenario comes into being in the coming years. Two of these factors are global, and two are local to South Africa,” said Van Papendorp, adding: “On the global front, the relative success of the vaccination process across the world (including in South Africa) will be the first factor impacting global economic growth, and the second will be the future path that global fiscal and monetary policy takes.”
1. How successful the global vaccine rollout is: whether the world can realise a more even rollout of the Covid-19 vaccines, and whether the vaccine continues to be effective against possible future strains.
2. How global monetary and fiscal policies evolve in the near future: the results of economic stimulation policies may differ between developed and emerging markets, but initially they are likely to forcefully counter Covid-19’s contraction. However, the differences will come in a bit later, when recovery becomes uneven due to uneven vaccination rollouts in different markets. A rise in protectionism, inflation and a hesitancy to rely on global supply chains may also factor in.
3. The ANC’s electoral performance in the next few years: differing scenarios for the ruling party’s electoral performance have been factored into the Momentum Investments’ scenarios, covering whether the ANC retains a healthy majority, all the way through to the ANC potentially losing its majority and being forced to govern in a coalition with the EFF. The ANC’s majority is directly linked to its ability to implement economic reforms.
4. The likelihood of South Africa implementing economic reforms: economic reforms have long been recognised by the private sector as being needed to stimulate growth. Momentum Investments’ three scenarios take into account whether the needed reforms are likely to be effected or not. Reforms are needed to move the country closer to regaining an investment grade rating from international ratings agencies, which will be a significant factor in the future performance of investment asset classes.
Considering the three scenarios and the four factors that will affect which comes to pass, Van Papendorp said that Momentum Investments favoured a diversified investment portfolio, to mitigate the risks of each scenario. Some of the tools available to portfolio managers include dynamic asset allocation, and adding alternative asset classes to portfolios.
This article is based on a presentation by Van Papendorp delivered at Momentum’s 2021 Investment Matters Conference, entitled “Future-proofing your investments”. Watch the full presentation here.