How fragile is the South African economy? How fragile are you?
Periodically, the South African Reserve Bank (SARB) releases a “Financial Stability Review” and the most recent report was presented recently.
The SARB has its own “stress test”, called the Financial Stress Index (FSI), which consists of 17 variables that measure our “financial stability”.
In conjunction with this FSI they have also developed a Risk Assessment Matrix (RAM), where key risks to the financial system and economic spillovers are assessed.
RAM is used to identify certain scenarios that the SARB has outlined and to report not only the potential threat, but also the likelihood of the scenario’s occurrence.
Contained in the SARB’s RAM report were these five scenarios:
• Sovereign rating downgrade to non-investment grade SA debt
The SARB has a medium to high likelihood of this happening. They expect this event to have a high impact on our economy. While we may witness a negative impact on the actual announcement, it is widely believed that the event has already been priced into our bond market over the last year or so.
• Spillovers from excessive volatility and risk aversion in global financial markets
The SARB has a “high” likelihood of this occurring, however, the impact will largely be felt in financial markets with a lower or “medium” impact on our economy.
• Protracted period of slow growth in China, the Euro area and spillback to the US economy
According to the SARB, should this scenario play out, it would have a high impact on our economy. Our major trade partner’s economy is in a rebalancing phase and has become extremely leveraged. This “trade risk” poses a large threat to our economy as our revenue drops, due to less demand.
• Low domestic economic growth
The credit impulse indicator is monitored for signs of local economic growth. This indicator has been in decline since 2011, which implies a rather weak environment. Low economic growth, rising inflation and high unemployment are evidence of this weakness. The SARB view is obviously “high occurrence”, but with a medium impact on the economy. The additional threat, though, is that we could see a spillover into the financial sector through impairments. For example, a meat packing plant may have recently spent large amounts for capital expenditures and then experienced a dramatic drop in the plant’s value, due to business and community conditions.
• Fragility of global banks
The SARB has a low to medium likelihood of this event occurring, but obviously the impact on the economy would be huge. Negative interest rates, increasing cost of regulation, the slowing down of the velocity of money and the exposure to the energy sector have continued to weigh on banking stocks.
Overall, the SARB concludes that the SA financial system remains robust despite the serious headwinds, mainly due to well-capitalised, liquid and profitable financial institutions.
The health of SA’s household sector
The health of SA’s household sector is a source of concern for financial stability. Consumers are becoming extremely exposed and by that I mean “getting squeezed”.
Now is not the time to get yourself into large amounts of debt. Economic cycles turn, but right now we are in a contraction phase and it could be for a prolonged period.
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