South Africa's night of the long knives .....

Friday 31st March 2017

He said he'd do it , and he did ! South Africa's night of the long knives .....

ref :- "South African Assets Tumble as Gloom Pervades Fiscal Outlook" , Bloomberg Markets

ref :- "Political drama plays out on South African stage" , The Financial Times , Markets and Investing

South African markets had taken quite a hit early in the week after President Jacob Zuma recalled Finance Minister Pravin Gordhan out of the blue from an investment roadshow in London, and then told members of the Communist Party that he intended to sack him. Mr Zuma has some form on the issue of replacing respected finance ministers and then having to reconsider, so some may have been hoping that would be the case once again. Not this time ....

Amongst a number of changes, the sacking of Mr Gordhan was by far the most important and as far as the investment and business communities are concerned, the most damaging. From the outside it certainly looks as though Mr Zuma has deliberately jeopardized South Africa's fiscal credibility in pursuit of a personal political agenda . Mr Gordhan had clashed with Mr Zuma over a number of issues ranging from the affordability of nuclear power plants to the management of state-owned companies, and we can safely assume that his adherence to fiscal responsibility was not matched by a president with rather looser ideas about spending (his critics might say !). Many also believe that Mr Gordhan's days were numbered anyway, as Mr Zuma packs his cabinet full of supporters to ensure his ability to hand-pick his successor(s) as leader of the the ANC in December, and as President in 2019. 

Mr Gordhan must take a lot of plaudits for fending off a downgrade in South Africa's credit rating to junk status. In contrast to the president, his commitment to curb both spending and government debt was welcomed by the credit ratings agencies and by investors. We'll have to wait and see what the agencies make of this latest development, but of course they're likely to take a dim view of it. That's a big worry ..... a downgrade of South Africa's credit rating to below investment-grade status and the consequent hike in borrowing costs would have a severe effect on the country's finances.

We don't have to wait to see investors' reaction to the news, and naturally enough shares have been marked lower with those of banks, retailers and listed property concerns likely to come under most pressure, according to Anchor Capital in Johannesburg. 10yr government debt yields have been up through 9.00 % (last at 8.90%)  --  remember they were at 8.28% early on Monday. And of course the Rand has been hit on foreign exchanges  --  USD / ZAR was last at about 13.38, but has been through 13.50 this morning. Taking absolute highs and lows (not generally recommended !) , that represents a 9.5% fall in the value of the South African currency this week.

Actually, some of the very concerned talking heads on the line from Johannesburg this morning sounded a bit surprised that the reaction hadn't been even stronger. One explanation was that the new finance minister, former Home Affairs Minister Malusi Gigaba, was unlikely to announce any great change of policy straight away. He'd probably wait until the ANC conference in June  --  which may of course mean another nasty shock round the corner.

As we've intimated, it's unclear whether a jump in bond yields would be of great concern to Mr Zuma, but if continued it certainly should be with 44% of government bonds in foreign hands, according to Morgan Stanley. The prospects for the Rand will have a role to play in that too of course, but for now at least the new powers-that-be are very unlikely to be too concerned about USD / ZAR popping up to 13.50. On one, very simple level that may be understandable. South African assets have been riding the emerging market and commodity-based waves (often one and the same thing) to such a degree that the currency has at times been the best performing of all. Even now it's still ranked about third best in the world this year, and we should bear in mind that in early 2015 USD / ZAR was almost 17.00. Against that sort of background a move back to 13.50 is of itself hardly disastrous.

Well, maybe so .... but things are likely to look pretty dark if the Rand experiences a much bigger sell-off, which is very possible if and when South Africa's debt is downgraded to junk status. Most judges would say that such an eventuality must be considered very likely.

South Africans and others would say that would be a crying shame, given how much South Africa has got going for it. That's true, but if you ever wondered why investors have to spend so much time studying political considerations then this would be a fine example. The hope must be that the administration, whatever form it eventually takes, will avoid the kind of economic mismanagement that the likes of Mr Gordhan kept them from in the past. Sadly, confidence in that happening is anything but rock solid.