Zuma’s abrupt change of plans showed clearly that his control of power is not as complete as was thought. His wavering should instil South Africans with new hope: there is a future after the Zuma era.
Late on December 9, Zuma announced van Rooyen’s appointment as finance minister. Four days later, again late in the evening, he announced van Rooyen’s recall and brought back Pravin Gordhan to the role.
The weekend-and-a-bit between the two appointments made all the difference.
The financial markets responded sharply to Zuma’s initial announcement. The reaction was to be expected and it is surprising that he did not foresee what would happen. Nhlanhla Nene, the man Zuma removed, had instilled trust as finance minister. Van Rooyen was not known to anybody.
Zuma exacerbated uncertainty by not given clear reasons for his decision. The general conclusion was that Nene was recalled owing to his resistance to plans for nuclear power generation and for the restructuring of a financing deal for aircraft for South African Airways. His opposition was seen as a commitment to fiscal austerity. His removal was perceived as an indication that the South African government was abandoning such austerity.
The rand’s exchange rate dropped sharply, bond yields increased and share prices of South African companies, particularly banks, dropped dramatically. The share prices of companies with offshore activities increased owing to the decline in the rand’s value.
Counting the cost
This turmoil did not come without a cost. Zuma’s bad decision imposed a heavy penalty on the South African economy. The full cost, not counting lost confidence by investors, is impossible to calculate. Even the direct financial cost of Zuma’s bad decision-making can hardly be calculated.
As far as direct costs are concerned, Johannesburg Stock Exchange chief executive Nicky Newton-King said that the exchange’s market capitalisation declined by 169 billion rand in the two days following the announcement. This meant that the value of savings, held either directly or indirectly through investment funds such as pensions, had dropped dramatically
South Africans are therefore poorer than they were on December 9.
There will be a direct impact on the country’s struggling middle class. The challenge for South Africa is not only to grow its middle class to ensure more people achieve a middle-class lifestyle, but also to maintain it.
Abandoning fiscal austerity will inevitably increase the tax burden on an already over-burdened middle class. Personal income taxes were increased in February 2015 and more increases are inevitable if government spending is not contained.
Poor people in South Africa will also be worse off, mainly as a result of accelerating inflation on the back of price increases. Poor people have little means to protect themselves against rising prices.
In short: bad policy decisions affect everybody, whether rich, middle class or poor.
The exchange rate of the rand also dropped to record lows against major currencies, declining briefly to just below R16 to the US dollar. A lower exchange rate has benefits for exporters, but also pushes up the cost of imports, with a concomitant impact on inflation. South Africa’s biggest import is fuel, which hits all – including the poor – directly and indirectly.
As is evident from bond prices, the market clearly expected higher interest rates to contain inflation. The yield on South African government bonds increased sharply. The yield on the R186 South African government bond moved from below 8.8% per annum to above 10.5% per annum.
Given the inverse relationship between bond prices and bond yields, bond prices fell in tandem with the increase in yields.
This increase of 1.7 percentage points (170 basis points) has serious implications for the South African government’s borrowing costs. According to calculations done by myself and Mike Lamontat Stellenbosch University, total new borrowing and roll-overs (refinancing of maturing bonds) amount to some R230 billion per annum. A permanent increase of 1.7 percentage points implies an additional annual interest burden of some R3.9 billion.
Junk status expected
This sharp increase in yields also served as a clear warning that the market expects a downgrade of South African government debt to junk status. International risk-rating agencies attach default possibilities (credit risk ratings) to government bonds, bonds of other institutions such as municipalities or water boards, and private companies.
The big difference between investment grade and junk bonds is in the default risk. Junk status indicates a larger risk that capital might not be repaid. Such bonds therefore pay a higher rate of interest to compensate for this larger risk.
The current rating of South Africans bonds are marginally above junk bond status and the market clearly expected a downgrade of South African bonds to junk bond status under van Rooyen’s stewardship.
The fear of a downgrade was driven by an expectation that the South African government would discard austerity fiscal measures under his watch, specifically with large and unaffordable spending on a nuclear power program and new aircraft for South African Airways.
After the announcement of the appointment of Gordhan as finance minister, the yield on the R186 bond declined to around 9.5%. Clearly yields are not back at their level before Zuma’s shock announcement, but the market has already given a clear indication of its confidence in Gordhan.
Lessons learnt
In his mishandling of the initial announcement, Zuma has reconfirmed one very important point: holding office does not bring greatness. The office of the president cannot and does not confer respect on Zuma. He must earn it. At present he is failing dismally.
The massive cost to the economy of a president that is the laughing stock of many inside and outside South Africa is unquantifiable.
Although the cost of the two days running up to the weekend-and-a-bit can hardly be measured, the full benefits of these events can also hardly be measured.
Zuma’s announcement was followed by a shocked reaction from civil society. This became such an avalanche that he had no option but to announce a change of plans within four days.
The fact that he had to change course so abruptly and quickly suggests that Zuma’s grip on power has been weakened. The tumultuous events of the last week in South African politics may indeed have a silver lining.
This article was written in collaboration with Carina Rossouw, a Bachelor of Accounting LLB student at Stellenbosch University.
