Monday, October 24, 2016/ 12.11pm /BMI Research
BMI View: In this article we examine four risk scenarios for SSA: the impact of Brexit contagion across the eurozone; an economic crisis in China; sooner-than-expected monetary tightening in developed markets; and a more powerful La Niña weather cycle than usual. While our core view is for a gradual rebound in growth across SSA, should any of these scenarios play out, it would significantly undermine the nascent economic recovery.
We see Sub-Saharan Africa (SSA) as having passed the worst of recent economic doldrums, and poised for a gradual economic recovery in the coming quarters. After bottoming in H116, we expect commodity prices will rebound, albeit slowly, in the years ahead, supporting fiscal revenues and bolstering willingness to invest in the region's major oil and metals producers.
That said, the risks to our forecast are decidedly skewed to the downside, with potential for a number of exogenous and domestic obstacles to knock the current nascent economic recovery off course.
Below, we outline four key challenges facing SSA and the impact they would have on the region, should they play out.
Brexit Contagion Hits Global Economy
One of the least likely but most impactful risks facing SSA would be if the UK eventual exit from the European Union (EU), so-called 'Brexit', leads to economic or political contagion in the eurozone.
At this stage, we have already factored the impact of Brexit into our forecasts, anticipating that moderately slower growth across Europe (especially the UK) will weigh on investment, aid and tourism across Africa.
That said, this scenario assumes that the impact of Brexit will be relatively contained, with limited ramifications on a global scale. Should we see Brexit ignite an economic crisis in the EU, either due to political contagion or severely increased banking sector instability, this would create far more severe systemic risks.
Aside from significantly reduced tourism and aid flows in SSA, such a scenario would also likely sharply constrain global risk appetite (in the short term) and weigh on demand for global commodities (in the longer term), reducing metals and oil prices.
This would feed through to severely increased pressure on fiscal revenues, trade and the investment dynamics of regional oil and metals producers, undermining the region's economic recovery.
Countries with already large fiscal and current account deficits, sizeable debt loads – especially external debt – and low foreign reserve stockpiles, such as the Democratic Republic of the Congo (DRC), Mozambique and Nigeria, are among the most vulnerable, and we cannot rule out the potential for sovereign debt or balance of payments crises in some regional economies.
China Growth Story Hits The Wall
A second major external threat to SSA would be an economic crisis in China. Our core view remains that Chinese economic growth will significantly decelerate in the year ahead, but that the government has the requisite resources to manage its slowdown.
However, after years of malinvestment, we cannot rule out that the scale of macroeconomic distortions in China is even greater than we expect. With the banking sector facing rising pressure, we could see the Chinese government unable to continue simultaneously supporting it, while bolstering growth and propping up the currency.
In such a scenario, we would expect to see a sharp slowdown in real GDP – even sharper than is currently priced into our growth forecast – and a sell-off of the yuan. Countries in SSA that would be most exposed are those that simultaneously send a large proportion of their exports to China and are heavily reliant on the production of heavy metals such as copper and iron ore to drive growth.
Indeed, while almost all commodity prices would fall in the event of a crisis in China, industrial metals are among the most exposed to Chinese demand, suggesting they would see some of the most lasting impacts.
Zambia and the DRC stand out as the most vulnerable in this regard, with copper exports comprising 73.8% and 57.3% of total exports, respectively.
DM Start Sudden Tightening Cycle
A more likely (if less harmful) risk scenario would involve sooner-than-expected monetary tightening in developed markets (DM). We forecast that DM monetary policy will remain loose in the coming quarters, with the US Federal Reserve poised to begin tightening gradually only toward end-2017 and the European Central Bank likely to forestall tightening until 2020.
However, recent statements by the US Federal Reserve suggest some upside risk to this view. Should we see inflation in either the US or Eurozone rise unexpectedly, this could prompt a sooner-than-anticipated tightening cycle, with a knock-on effect on SSA.
In recent years, appetite for return on investment in an environment of lower-for-longer DM yields has seen a surge of capital flowing into SSA. A reversal of such flows would likely hit regional exchange rates hard, especially more heavily traded currencies such as the South African rand and those currencies pegged to it, such as the Nambian dollar.
A dramatic exchange rate sell-off would forestall disinflation, leaving policymakers with the hard choice between permitting continued above-target price growth and choking off a fragile economic recovery.
La Niña Hits Hard
The aforementioned factors would only be exacerbated if we were to see continued severe weather conditions undermining food security in SSA.
After severe drought decimated staple crop harvests and prompted power shortfalls throughout much of the south and west of the continent in late 2015 and early 2016, we expect a return to more normal growing conditions in 2017, which will favour crops.
However, should we see a stronger-than-expected La Niña weather cycle, bringing severe flooding, it could be just as damaging to SSA as the recent droughts were, washing out staple crop harvests.
This would not only temper the pace of disinflation, but potentially even heighten social unrest as governments struggle to feed hungry populations. Moreover, agribusiness would not be the only sector that could face negative ramifications from a severe La Niña.
While the El Niño of 2015-2016 led to power shortfalls, which undermined mining sector activity, heavy flooding could be equally harmful, restricting drilling activity, damaging infrastructure and disrupting transport. Should this occur on a large enough scale, it could temper fiscal revenue growth – undermining fiscal consolidation in a number of key SSA economies – as well as weighing on headline growth.
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