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South Africa: Inflation risks undermine case for equity investors, research says

By David Whitehouse
Posted on Monday, 25 October 2021 17:57

South Africa's central bank Governor Lesetja Kganyago looks on next to finance minister Tito Mboweni as they attend an event to launch a commemorative coin, in Johannesburg
South Africa's central bank governor Lesetja Kganyago. REUTERS/Mfuneko Toyana

The danger that interest rates will need to rise to combat inflation undermines the case for investing in South African equities, new analyst research says.

“The prospect of stagflation as South Africa experiences relatively low economic growth with rising inflation” dims prospects across the board, with the exception of food retail, according to analysis from UK-based Salmour Research. “Should interest rates have to rise due to rising inflation, the effect could potentially be devastating for South Africa.”

South Africa’s key interest rate stands at a record low of 3.5% following a series of cuts in 2020 to counter the fall-out from Covid-19. This year, the monetary policy committee has consistently indicated that the next move will be up. Annual inflation rate rose to 5.0% in September from 4.9% in August, above the midpoint of the central bank’s target range of 3% to 6%.

Higher interest rates would lead to “substantial bad debt provisions” at banks and other lenders, Salmour’s research says. Banks also face increased competition, meaning they should be avoided along with retail credit providers, it adds.

  • With taxation likely to rise and the rand predicted to weaken, investors should favour export-driven companies and those who get most of their income outside the country, it says.
  • Domestically, discretionary retailers will be hurt by inflationary pressures and weak spending, the report says.
  • Food retailers are likely to be able to sustain their earnings in an inflationary environment, according to the research. Shoprite, perceived as South Africa’s leading low-price grocery retailer, is “likely to be the biggest beneficiary”, it says.

Windfall over

Some investors voiced optimism after the appointment of Enoch Godongwana as finance minister in August. Investors such as Mesh Pillay, CEO of YW Capital investment in Johannesburg, see Godongwana as both business-friendly and politically astute. Salmour has little confidence that ready solutions are at hand. Years of poor economic policies have left high structural unemployment and low economic growth, the report says.

South Africa, the research points out, now has more unemployed people than the United States, where the population is six times larger. A real long-term reduction in South African unemployment would require economic growth of between 5% to 7% for the next 20 to 30 years, it says.

  • According to the Bureau for Economic Research (BER) at Stellenbosch University, the country’s GDP likely contracted in the third quarter.

In the last 18 months, South Africa has had a windfall from surging commodity prices and mining export receipts, which has helped to prop up balance of payments and the rand, the report says.

That windfall is now seen as being over.

  • Kumba Iron Ore, Anglo American and Glencore were among beneficiaries from higher iron ore prices that have now slid back, while the price of rhodium has also slumped.
  • China’s infrastructure spending has largely ground to a halt due to weakness in the property sector, exposing South African miners to further commodity-price declines.
  • Strong copper prices, the research notes, are of little help, given South Africa’s lack of direct exposure.

Bottom line

Salmour sees food retail as the only domestic bright spot in a gloomy outlook for South African equities.

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