INDEPENDENT ECONOMIC OVERVIEW

By: Mahir Hamdulay – Equity Analyst, ABSA Capital

 


South Africa

The South African economy was fragile heading into 2020, having slipped into a recession in the second half of 2019, and its growth prospects were severely constrained even before Covid-19.

The slow execution of structural reforms and growing uncertainty regarding sustainable electrical power supply were significant negative factors in the outlook for the year, while expanding fiscal vulnerabilities, low economic growth and the increasing financial burden created by Eskom and other state-owned enterprises meant there was little likelihood of public debt being stabilised. Factional ideological battles within the ANC meant scant prospect of the structural changes required to support growth being implemented.

With the global spread of Covid-19, South Africa was soon also embroiled in the pandemic, resulting in the government enforcing strict but necessary measures in an attempt to slow the spread of the virus and limit the loss of lives. With governments globally enforcing lockdown restrictions, economic activity has been and continues to be severely impacted by simultaneous demand, supply and financial shocks. With countries all being at different stages of lifting restrictions and opening up their respective economies, the situation remains fluid and the outlook inherently uncertain.

The IMF, in its June 2020 World Economic Outlook, forecast a global recession in 2020, projecting a 4.9% global contraction before a return to growth of 5.4% in 2021. Interestingly, the 2020 forecast was revised downwards by 1.9% from April 2020, indicating a more negative impact than previously anticipated and a more gradual recovery thereafter, despite the fact that policymakers around the world have provided extensive support to their economies in the form of relief packages and quantitative easing. To put the severity of this crisis into perspective, the IMF estimated that the global economy contracted by just 0.1% during the 2009 global financial crisis.

In South Africa, 2020 first quarter GDP contracted by 2.0% quarter-on-quarter on an annualised basis (but just 0.3% year-on-year), which shows that the economy was contracting even before lockdown restrictions were imposed. This also represented the third consecutive quarterly contraction, highlighting the fragility of the economy before adding the negative effects of the Covid-19 lockdown.

South Africa imposed one of the more stringent lockdowns globally and the economic cost is estimated to be severe. The government expects GDP to contract by 7.2% in 2020, resulting in an expansion of the main budget deficit to 14.2% of GDP from 6.7% in 2019.

To offset the negative impact of the lockdown, the government responded with a R500bn economic relief package, equating to approximately 10% of GDP. Furthermore, the SARB responded strongly by cutting the repo rate by a cumulative 300 basis points by end-July 2020 (275 at Growthpoint's 30 June year end) and introducing a range of measures to ease liquidity constraints in domestic financial markets, including its decision to purchase government bonds in the secondary market. However, with consumer inflation expected to hover around the lower end of the 3% to 6% target range, further stimulus may be required to support growth.

Job growth has remained a major macro-economic and social challenge in South Africa and this is likely to worsen. In its most recent Quarterly Labour Force Survey, Stats SA reported that the unemployment rate rose to 30.1% in the first quarter of 2020, the highest level since 2008, with 344 000 more people being unemployed than in the final quarter 2019. Of concern is that this was a period when the effects of Covid-19 were not yet even fully evident in the economy. Against the backdrop of rising Covid-19 infections, job losses and pay cuts, and a negative wealth shock via housing and financial markets, the Consumer Confidence Index compiled by the BER fell notably in Q2 2020 to -33, the lowest level since 1985. At the same time, investment growth, particularly in the private sector, is likely to remain constrained by low business confidence. The Business Confidence Index, also compiled by the BER, fell to a record low of five in the second quarter of 2020 from an already weak level of 18 in the first quarter.

Real GDP growth rate (%)

Real GDP growth rate (%)

Sources: Absa Research, Stats SA

Debt to GDP (%)

Debt to GDP (%)

Sources: Absa Research, National Treasury

Main budget deficit (Rbn)

Unemployment rate (%)

Sources: Absa Research, National Treasury

Unemployment rate (%)

IMF 2020 world eco nomic forecast revisions YTB (%))

Source: Stats SA

IMF 2020 world economic forecast revisions YTB (%)

IMF 2020 world eco nomic forecast revisions YTB (%))

Source: IMF


Our economists expect GDP to contract by 8.3% in 2020, and recover to 2.4% in 2021. As a consequence of diminishing tax receipts and the cost of the government’s Covid-19 economic response package, public finances are expected to come under added pressure, with the main budget deficit expected to expand to 16.6% of GDP and the debt-to-GDP ratio expected to expand to a sobering 85% in FY21.

Despite Moody’s having already lowered South Africa’s last investment grade rating in March to sub-investment grade (from Baa3 to Ba1) with a negative outlook, further ratings downgrades are not inconceivable should the economic outlook continue to deteriorate and there be no plausible plan for growth.

The outlook for the property sector, much like the economic outlook, is clouded by uncertainty that will continue to weigh negatively on property fundamentals. While the retail sector was most severely impacted during the initial stages of the lockdown, the far-reaching impact of Covid-19 will be felt in all property sectors and could act as a catalyst for an acceleration in the deterioration of property fundamentals.

As businesses and consumers navigate the uncertainty, the demand for space in an already oversupplied property market is likely to be negatively affected. Furthermore, with a lack of net new demand, the bargaining power will be further skewed towards tenants, placing pressure on both near-term and longerterm rental growth. Of particular relevance at present is the effect that a depressed economy with a weaker outlook will have on independent property valuers’ assumptions, and the impact that any negative revaluations will have on already constrained balance sheets across the property sector.

Sources: Absa Research, IMF, Bloomberg

CEE, Poland and Romania

Central and Eastern Europe (CEE) continued as the fastest growing region in Europe during 2019, averaging GDP growth of 3.6% across the CEE-6 (Bulgaria, Romania, Slovakia, Hungary, Poland and the Czech Republic), well ahead of the EU’s 1.7% growth for the same period. This performance was largely driven by strong consumption growth due to robust real wage growth and the continued relocation of production from Western Europe to the CEE region.

Poland is the biggest market in the CEE region in terms of economy and population size. It remained one of the fastest growing countries in the region in 2019, with GDP growth of 4.1% and household consumption growth of 3.9%. This was fuelled by sustained increases in budgetary expenditures, a tight labour market with low unemployment of 5.2% and rising wages, combined with continued low interest rates and strong investment growth. Poland remains an attractive destination for business process outsourcing and back-end IT services due to its skilled workforce, strategic geographic location and a stable political and economic climate. This has resulted in a continued increase in demand for office space, with almost 50% of real estate investment in 2019 being made in the office sector. Poland also accounted for 55% of the real estate investment flows in the CEE region during 2019.

Following the onset of the Covid-19 pandemic, the IMF now estimates that Poland’s GDP will decline by 4.6% in 2020, compared with the rest of the EU, which is expected to contract by 7.1% over the same period. Given Poland’s strong economic position and record low debt-to-GDP ratio of 46%, it had the fiscal headroom to launch one of the biggest stimulus packages in Europe (11.3% of GDP) to mitigate the demand- and supply-side shocks of Covid-19. Poland’s economy is expected to rebound strongly in 2021, with initial estimated GDP growth of 4.2%, according to IMF forecasts.

Unemployment rate (%)

Real GDP growth rate (%)

Sources: Bloomberg, IMF, World Bank

GDP growth rate (%)

Debt to GDP (%)

Sources: Bloomberg, IMF, World Bank


Sources: Absa Research, IMF, Bloomberg, JLL, Colliers, ING, World Bank

Despite a slowdown in growth during 2019, Romania was still among the fastest growing economies in Europe with GDP growth of 4.1%. This was driven by an increase in both public and private minimum wages and strong investment flows in the real estate sector. Construction of residential and commercial real estate, especially office and warehouse spaces, was another key contributor.

S&P maintained Romania’s investment grade rating (BBB-) with a negative outlook in June 2020, citing the need for significant fiscal consolidation to combat the effects of a Covid-19 induced recession. The size of the fiscal stimulus package announced thus far is about 3% of the 2019 GDP, which is among the weakest in the region. The IMF expects the Romanian economy to contract by 5% in 2020, with the fiscal budget deficit widening to around 8% of GDP and the current account deficit reaching about 5% of GDP, according to S&P estimates.

Real estate investment volumes in Romania dipped in 2019 to their lowest level in six years, with South African capital inflows accounting for the largest portion of real estate transactions at 28%. Despite the low overall volume, modern office stock expanded by 12% during the year, nearly double the increase seen in 2018, with net new demand for office space also improving by 8% from the previous year.

Sources: Absa Research, S&P, IMF, Colliers

Australia

Australia's GDP growth slowed to 1.8% in 2019, down approximately 1% from the previous year as government spending softened and household consumption growth remained weak. This was despite a cut in personal tax rates and three downward interest rate revisions by the Reserve Bank of Australia (RBA) in an attempt to stimulate growth.

Hopes of a recovery in the first quarter of 2020 were dealt a blow by devastating bushfires and the early effects of Covid-19 on tourism and domestic demand. China is the biggest source of international visitors to Australia, accounting for 27% of tourism spend. Consequently, the Australian economy contracted by 0.3% in the first three months of 2020, marking the first quarterly decline in GDP since 2011.

The government announced a range of fiscal measures totalling around AUD260bn (or some 13% of 2019 GDP) to soften the impact of the Covid-19 shock and provide income support to households and businesses. Measures included a fortnightly payment of AUD1 500 per employee to cover wages and an AUD25 000 grant to home buyers and renovators in an attempt to revive the construction industry.

Monetary policy support has come through two further rate cuts by the RBA to a record low cash rate of 0.25% as well as the launch of an “unlimited” bond buying programme to try to stabilise yields. The near-zero rate leaves limited scope for further monetary policy stimulus.

Household debt to income ratio (%)

Household debt to i ncome ratio (%)

Sources: Australian Bureau of Statistics, IMF

GDP growth rate (%)

GDP growth rate (%)

Sources: Australian Bureau of Statistics, IMF


Despite these stimulus efforts, the Australian economy is expected to contract by 6.7% in 2020, according to IMF forecasts. The projected GDP contraction will end a run of 29 consecutive years of economic growth, the longest period of uninterrupted growth by any country on record.

A factor that may exacerbate the predicted recession is the high level of household debt, which was 187% of disposable income in December 2019. An expected rise in unemployment rates could affect households’ ability to service debt and potentially lead to a reduction in spending in an effort to avoid defaults.

Sources: Absa Research, IMF, Bloomberg, KPMG Australia, Australian Bureau of Statistics

United Kingdom

Following the United Kingdom's third general election in five years in December 2019, the Conservative party led by Boris Johnson claimed a resounding victory and won a crucial majority in the House of Commons. This cleared the way to ending a three-year stalemate on the issue of Brexit, with the UK officially leaving the EU on 1 February 2020 and entering into a transition period during which the terms of the new relationship will be agreed. A new free trade agreement is the priority.

The uncertainty around Brexit and its knock-on effects continued to cause a slowdown in economic growth for the UK, with GDP growing by 1.4% in 2019. Business investment remained weak, in keeping with the trend seen since the 2016 Brexit referendum, with companies reluctant to spend in the light of the uncertainty. Despite softer growth, unemployment reached an all-time low of 3.8% in 2019. However, slowing wage growth and rising household debt were consequences of the weak growth environment and placed downward pressure on consumer spending. The UK has also suffered from a persistent decline in productivity, a measure of output per worker, which has further hampered economic growth.

The UK economy contracted by 1.8% in 2020’s initial quarter as the early stage impacts of the Covid-19 pandemic began to be felt and the IMF forecasts a 6.5% contraction in GDP for the year as a whole because the UK’s largely service-based economy is likely to be particularly badly affected. The services sector, including financial services, hospitality and tourism, makes up about three-quarters of the UK’s GDP, according to the OECD.

Unemployment rate (%)

Unemployment rate (%)

Sources: IMF, Bloomberg, OECD, Office for National Statistics

GDP growth rate (%)

GDP growth rate (%)

Sources: IMF, Bloomberg, OECD, Office for National Statistics


In response to the crisis, the UK government launched a fiscal relief package of close to GBP400bn. The Bank of England (BOE) also responded by cutting interest rates to 0.1% and launching an additional GBP200bn worth of bond buying under its QE scheme. Despite these efforts, the unemployment rate could increase by the end of 2020, according to the OECD.

The pandemic is likely to have a significant negative impact on the retail property market and amplify pre-existing issues. Reduced consumer footfall and spending, accelerated online penetration and growing vacancies as a result of increased company voluntary arrangements and space rationalisation will significantly impede recovery in the retail property sector and are likely to further accelerate the downward momentum in property valuations that was evident prior to Covid-19.


TIMELINE

South Africa

South African Flag
  • 15 March

    Covid-19 pandemic declared a national disaster

  • 18 March

    Patron numbers limited at restaurants, clubs and pubs

  • 19 March
    • Price controls introduced on essential items after panic buying, with price gouging penalties
    • Almost all land and sea entry points to South Africa close
  • 20 March

    SARB decreases repo rate 100bps to 5.25%

  • 23 March
    • Nationwide 21 days lockdown from midnight 26 March announced
    • Growthpoint shifts to remote working
  • 26 March
    • Growthpoint confirms HY20 distribution and withdraws FY20 guidance
    • All air travel to and within South Africa is suspended
    • Major hospital operators start suspending elective surgeries
  • 27 March
    • Lockdown begins. Only retail deemed essential is allowed, being basic foods, groceries and pharmacy items, petrol/diesel and banking. Only essential work allowed, such as emergency healthcare, security services, those performing or supporting essential retail, and limited function of industries that cannot be shut down, such as agriculture and mining.
    • All borders are closed during the lockdown, except for a handful for the transportation of fuel, cargo, and goods
    • Ratings agency Moody’s downgrades South Africa’s credit rating to sub-investment grade
  • 6 April

    In tandem with the sovereign rating, Moody’s downgrades Growthpoint’s credit ratings

  • 7 April

    The Property Industry (PI) Group, announces industry-wide assistance and relief for retail tenants, focused on SMMEs

  • 9 April

    Lockdown is extended by 14 days

  • 15 April

    SARB decreases repo rate 100bps to 4.25%

  • 21 April

    Announcement of R500bn Covid-19 package

  • 23 April

    Risk-adjusted strategy to reopening the economy is announced

  • 28 April

    The PI Group increases and extends its assistance and relief guideline for retail tenants

  • 1 May
    • The staged reopening of the economy starts with Level 4. Restaurants and fast food outlets allowed to deliver with restricted hours. Permitted retail categories increased to include children’s clothing, adult winter clothing, bedding, heaters, personal ICT and home office equipment, baby and toddler care products, stationery and education books, toiletries, hardware, and vehicle parts
    • Hospitals allowed to recommence with medically necessary time sensitive surgical procedures
  • 22 May

    SARB decreases repo rate 50bps to 3.75%

  • 1 June

    Lockdown eased to level 3. Retailers can sell their full merchandise. Curfew temporarily ended. Alcohol sales temporarily unbanned. Most retailers and businesses may operate, with limitations

  • 29 June

    Lockdown loosened further to accommodate “Enhanced level 3” regulations. Restaurants for sit-down meals with limited capacity. Personal care services, including hairdressers, can open. Cinemas and galleries can open with limited capacity


Romania and Poland

Australia

United Kingdom