May 11, 2020
The COVID-19 pandemic is the defining global health crisis of our time and the greatest challenge we have faced since World War Two. This health crisis also has the potential to create devastating second order social and economic crises. However, if we work together – the public and private sectors, business, labour and our communities – there is nothing we can’t overcome.
This is already a much deeper economic crisis than the global financial crisis (GFC) of 2008-09. However, many lessons have been learnt from previous crises. The size and speed of government responses in providing support to businesses and employees are impressive. Monetary and fiscal support has already vastly exceeded that provided during the GFC and has been delivered in 6 weeks, rather than over the course of a year.
During the GFC, we were reminded that the state was the lender of last resort. But today the state is also the employer of last resort and the purchaser of last resort. Not since the second world war has this been the case in Western economies, which raises questions about the levels of government debt with which Western economies will be left. We are likely facing an extended period of loose monetary policy ahead. Long term, this should provide a benign backdrop for real returns for equities and other growth assets. While the volatility is unsettling, it creates opportunities for disciplined single asset class and multi-asset investors. It is in these environments that our clients need us most as active managers and custodians of capital.
Corporate resilience will become a new focus for all companies. Enhanced remote working facilities, diversified supply chains, longer-term funding, reduced leverage and among investors the wisdom of focusing solely on shareholder returns alone at the cost of sustainability, already being questioned, will receive even more focus.
The unfolding coronavirus pandemic has thwarted prospects of a moderate rebound in global economies and makes a global recession probable. The economic and financial impact of the COVID-19 outbreak are becoming clearer by the day for individuals, companies and countries. Alongside this, and more importantly, there has been untold human suffering and grief, as well as the risk that, unless decisive actions are taken the situation may deteriorate further. At the time of writing, the government had conducted 9540 tests and reported 23 confirmed cases, including one death.
So, how do you deal with a pandemic then? More specifically, how do we solve a healthcare and economic crisis. Most countries in the world have answered this question by instituting ‘shutdowns’ and launching stimulus packages of various sizes and shapes. In this way, Botswana has been no different from many countries in the region, and further afield. The government took the bold and decisive step to ‘lockdown’ the country, effective April 2, 2020. This measure was taken with a view to ‘flattening the curve’, i.e., reduce the number of infections without overwhelming the healthcare system. This decision also comes down to a trade-off between economic activity and lives saved.
The effects on economic activity have been immediate and severe. Sectors as diverse as tourism, manufacturing and transportation are already reporting halted operations. This has led to job losses, collapsing revenues, and liquidity challenges as a result of disrupted supply chains and reduced demand -all through the adverse impact of the necessary containment measures. Travel bans and lockdowns mean that normal economic interactions cannot take place. This, in turn, squeezes demand, supply and income across both households and firms. The informal sector has been particularly hard-hit and its contribution to local productive capacity and employment has been eviscerated with adverse human and economic consequences.
The impact of curve flattening measures will result in a 2020 recession that will dwarf any that we have seen before. The 4-week lockdown (from April 2 – 30, 2020) has already caused economic damage. We estimate it has cost the country around P15 billion or 7.7% of nominal GDP in terms of lost production. This forecast makes it clear that fiscal and monetary support is needed. It is also worth saying that even prior to the outbreak of COVID-19 the economy had been on a weakening trajectory, with real GDP growth slowing to +3% year-on-year in 2019, lower than 4.5% in 2018. This was mainly due to the ongoing contraction in diamond production and sales while domestic demand conditions remained tepid. More worrisome, though, has been the structural decline in the pace of growth since the start of the millennium.
Annual real GDP growth this year is likely to contract by at least -15% this year. The risks for even more severe outcomes, however, are substantial. We had previously estimated 2020 growth at 3.5%. The advent of COVID-19 has led us to substantially revise downwards our growth forecasts notwithstanding significant policy interventions. The pandemic adds a new and substantial source of downside risks to the growth outlook, in addition to risks related to weaknesses in the diamond market and slow(er) growth in key trading partner countries. Accordingly, significant uncertainties surrounding the medium-term outlook remain. Key to the outlook is the duration and scope of containment measures, as well as policy support measures put in place to mitigate the economic impact on individuals and businesses. In our baseline forecast we assume a total of several lockdown periods totalling around 10 weeks. This is entirely plausible given deficiencies in the public health system and the consequent need for stricter and longer containment measures.
We anticipate that the domestic economy will enter a recession in the third-quarter, when adding the direct and indirect effects of this crisis. It is forecast that real GDP growth will slow to 1% in 1Q, shrink by -40% in 2Q and -25% in 3Q on the back of the simultaneous shocks hitting the economy. Our forecasts for 4Q suggest a mild recovery in GDP growth numbers as normal economic activities resume (albeit gradually), although the economic damage is likely to linger longer. While this is our baseline forecast, we recognise the material risk of a protracted slowdown, particularly if the spread of the virus is not contained and policy interventions are ineffective. Our central scenario is that it will take at least two years for GDP to return to its pre-shock level based on the level and scope of supply and demand shocks that have hit the economy.
Figure 1: GDP outlook
Against a background of increased global risk premia, the local equity market has been seemingly oblivious. This reflects the illiquidity of the local market and the related idiosyncratic factors which prevent a full-blown sell-off in tandem with global peers. It is, however, only a matter of time before the impacts of COVID-19 are felt within the local market, particularly as listed companies grapple with the supply and demand shock induced by the pandemic and resultant hit on earnings. At the start of the year, we were anticipating earnings growth in the high single-digits across the domestic board of the Botswana Stock Exchange. This was to be driven by a broad variety of sectors ranging from financial services and consumer staples, through to tourism and property. Current conditions, however, have led to a significant change in top-down and bottom-up views. We now expect material double-digit earnings declines across a number of counters, which will have a trickle-down effect on share prices. This means that there is now no end in sight to the DCI downtrend (which began almost 5 years ago). Travel bans and lockdowns are having a substantial impact on both demand and supply in a range of sectors. As consumers stay at home, restaurants and non-food retailers are suffering steep declines in demand. The restrictions on travel means that the tourism and hospitality industry have ground to a halt. Already some companies have seen revenues drop to zero amid cancelled orders (across tourism, manufacturing and construction). In this regard, there will be a narrower range of companies offering earnings growth this year. In this environment companies with significant financial and operational leverage, as well as low levels of capital and liquidity will face severe headwinds that will test their resilience. Similarly, we believe that a number of companies will suspend corporate actions such as dividend pay-outs, share buy-backs and capital spending to conserve cash as the outbreak unfolds. This suggests that the growth in dividend yields will slow and the bond market will look even more attractive. An oddity of the local market is that bonds have outperformed stocks over the past decade (on a total return basis). This trend shows no signs of reversal. Not surprisingly, bonds are generally expensive, where we think stock valuations are likely to cheapen further with a 12-month forward priceearnings ratio of 9x and a price-to-book ratio of 0.9x.
Figure 2: Dividend and bond yields
The Government has established the COVID-19 Pandemic Relief with a capitalisation of P2 billion. It currently stands at about P2.1 billion given contributions from other sources (primarily corporates). When we combine this fiscal policy measure (which comprise a wage subsidy and loan guarantee) along with monetary measures (capital and liquidity support) we estimate that the combined (initial) stimulus stands at around 1.3% of GDP.
Many countries have announced stimulus packages of around 10% of GDP to kickstart their economies in the post-lockdown period and ensure that they have a fighting chance to get back to pre-COVID-19 levels of growth, employment and capacity utilisation. The government will soon announce a larger stimulus package to protect the economy’s productive capacity and related benefits. The focus should be on the non-mining private sector and the informal sector. In addition, the negative economic impacts of the pandemic are falling disproportionately on poor Batswana, and the hard-hit service industries and informal sector, which tend to have more lower-wage jobs.
First, spending should be directed at retaining (and boosting) productive capacity, that is, businesses (regardless of size or sector) that employ people. This, in turn, will help underpin the economy’s long-term growth potential. Clearly SMMEs of various shapes and sizes should be a focal point, for the simple reason that if there is widespread closure of businesses due to lockdowns, then many more low-income workers will be left without jobs (and income) on a long-term (structural) basis. To this end, a simple and transparent process to identify qualifying business must be devised and then in collaboration with commercial banks the Ministry of Finance and Economic Development (MFED) could underwrite bank loans to qualifying businesses.
Second, support for vulnerable workers, many of whom are in the informal sector and do not necessarily benefit from government programmes, should be ramped up as a matter of urgency. In this connection, simple and novel ideas such as the introduction of a ‘universal basic income’ might be a most effective and easily administered measure. Given the very unequal income distribution in the country, this could reduce poverty and related depredations. It is important that this be done in an urgent fashion to avoid serious need and real hunger.
In the 2020 Budget speech, the government forecast a budget deficit of 2.4% of GDP. This has now been revised upwards to 5.9%. We think this is a conservative estimate, in light of ongoing headwinds and intensifying downside risks. This notwithstanding, we have significant fiscal space, to fund a recovery package that will lift business and consumer confidence and bolster longer-term economic activity. To achieve this, we believe that the local bond market should be the primary financier of the government of Botswana. Simple as this is, it is unfortunate that the benefits of doing so, are often not fully appreciated, from a cost, sustainability and prudential perspective. Nothing stops the authorities from launching tax-free COVID-19 bonds within the ambit of the government’s medium-term note programme. Priced appropriately, these bonds, could quickly attract investor demand and provide a basis to revitalise the economy.
Of course, government can’t do everything. Banks can only go so far. And, you and I can also only do so much. An ‘all hands-on deck’ approach is needed, and Ninety One (previously Investec Asset Management) is committed to engaging and partnering with government to navigate this crisis. Investors, like asset managers can play an important role in providing bridging finance to fundamentally sound (or solvent) businesses that are experiencing short-term financial challenges – for example funding pressures or liquidity bottlenecks. We estimate that local companies (both listed and unlisted) need at least P2 billion in short-term financing. In this setting, asset managers can inject fresh (or additional) equity or debt into such businesses thus giving them a lifeline. In the case of unlisted companies, this could potentially open the door for an initial public offering (IPO) in the medium to longterm. Through this process a firm can continue operating and our clients (almost entirely Batswana pensioners) could gain exposure to well-run businesses and the attendant benefits. This, in turn, further supports our long-term goal of deepening and widening local capital markets. To this end, we are working on the mechanics of establishing a fund to assist well-run and solid businesses that require capital.
Botswana needs a significant and well-thought-out stimulus package of around 5 to 10% of GDP to reboot the economy, otherwise we run the risk of permanently destroying the economy’s productive capacity. Luckily for us, we have the fiscal space to borrow locally on good terms. The key, however, relates to the quality of the fiscal (and monetary) interventions. Policy makers have their job cut out. We have outlined some basic ideas, which we believe could be useful. Central to these are the time-tested economic principles of efficiency, sustainability and good governance. To this effect, Ninety One is contributing P3.3 million to the COVID-19 Relief Fund and working on the creation of a fund to provide bridging finance to adversely affected companies in Botswana. Together these actions highlight our commitment to helping turn the economy around.
Last but not least, our staff have also been challenged to donate to charities of their choice, which are in dire straits, as a result of COVID-19. As a firm, we will match the donation made by our staff. By pulling together, we can make a difference.