SA ECONOMIC AND MARKET OUTLOOK - 2018

22 January 2018

Reezwana SumadReezwanaS@Nedbank.co.za

Walter De Wet, CFAWalterD2@Nedbank.co.za

CONFIDENTIAL | PAGE 2

The following is a list of planned local and global events and dates of significance. This is

a non-exhaustive list, which obviously excludes unscheduled one-off events, or

unplanned meetings such as Cabinet changes, court cases, leadership changes, other

political developments or any sort of Constitutional changes/reform.

Local and global

CALENDAR OF EVENT RISKSJanuary February March09 Jan – Commission of inquiry into State Capture announced15-26 Jan – US earnings season18 Jan - SARB MPC18-19 Jan – ANC NEC meeting20-21 Jan – ANC NEC Lekgotla23-26 Jan – WEF meeting in Davos25 Jan – ECB meeting31 Jan – US FOMC meeting

Feb – US Fed Chair semi-annual report to Congress08 Feb - BOE meeting08 Feb – SA State of the Nation address (SONA2018)21 Feb – SA Budget Speech

04 Mar – Italian general election08 Mar – ECB meeting18 Mar – Russian presidential election21 Mar – US FOMC meeting (+ press conference)22 Mar – BOE meeting23 Mar – Moody’s review of SA credit rating28 Mar – SARB MPC

April May June08 Apr – Hungarian parliamentary election26 Apr – ECB meeting16-27 Apr – US earnings season*

02 May – US FOMC meeting 10 May – BOE meeting24 May – SARB MPC25 May – S&P review of SA credit ratingFitch review of SA credit rating*

13 Jun – US FOMC meeting (+ press conference)11-22 Jun – US earnings season*14 Jun – ECB meeting21 Jun – BOE meeting

July August September16-27 July – US earnings season*19 Jul – SARB MPCJul – S Fed Chair semi-annual report to CongressJul – State Capture inquiry to conclude*

01 Aug – US FOMC meeting02 Aug – BOE meetingAug – Fed’s Jackson Hole symposium*

13 Sep – BOE meeting13 Sep – ECB meeting20 Sep – SARB MPC26 Sep – US FOMC meeting (+ press conference)Sep – BRICS Summit (hosted in SA)*

October November December07 Oct – Brazilian general election12 Oct – Moody’s review of SA credit rating15-26 Oct – US earnings season*24 Oct – SA MTBPS Speech*25 Oct – ECB meeting

01 Nov – BOE meeting08 Nov – US FOMC meeting22 Nov – SARB MPC23 Nov – S&P review of SA credit rating23 Nov – Fitch review of SA credit rating*

13 Dec – ECB meeting19 Dec – US FOMC meeting (+ press conference)20 Dec – BOE meeting

*IndicativeSource: Various media sources, Bloomberg

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• SA achieved real GDP growth of 2% qoq in 3Q17, with the main positive drivers being agriculture, mining and manufacturing. Negative contributors towards headline growth were utilities, trade and general government spending.

• While the ANC elective conference has restored some political certainty, the looming budget speech is now a key source of uncertainty in the local market, particularly after the announcement of free tertiary education by President Zuma in December 2017. Even though we anticipate upward revisions to the GDP growth profile, we believe that this is unlikely to lead to a commensurate revenue boost due to rising levels of tax avoidance and very low buoyancy levels. Furthermore, the added burden of funding free tertiary education to qualifying students would make expenditure restraint difficult.

• This means that we remain of the view that the February 2018 budget is unlikely to soothe ratings agencies over the long term outlook, however short-term measures such as tighter fiscal policy via expenditure cuts and higher tax revenue could reduce the chance of further credit rating downgrades in the near-term (see our detailed pre-Budget report). Although President Zuma reacted to the sharply negative MTBPS by directing National Treasury to raise R15 billion in revenue through various tax measures and to cut expenditure by R25 billion to fund the budget deficit and stabilise public debt at below 60% of GDP, ratings agencies still did not believe that these sorts of patchy, knee-jerk and belated interventions will place public finances on a sustainable path. Indeed, the announcement of free education without any consultation means that ratings agencies may have been correct in sounding warnings in November 2017.

• The low in the current business cycle may have passed in 1Q17 when SA experienced a technical recession for the first time since 2009. However, despite a gradual recovery expected, the potential growth rate of 1.2% (SARB) remains too low and uncompetitive (with peers growing in excess of 5% annually). Nedbank forecasts annual real GDP growth at 1.2% in 2018 and 1.7% in 2019, from an expected 0.9% in 2017.

• Underpinning this forecast is an assumption that political tensions will ease but not disappear completely. Furthermore, the rate of recovery is likely to remain slow given the pedestrian progress of structural reform implementation and an sluggish improvement in confidence levels. Despite this, consumer activity will likely rebound, as inflation is expected to remain low and prospective interest rate cuts should aid household consumption. Continued global growth and the recovery in some of our key trading partner regions (the Eurozone) would provide some support to SA exports to these regions. In contrast, growth in government consumption and capital expenditure will remain constrained given mounting pressures to restore fiscal discipline and the precarious financial position of most SOEs. Marginal revisions to the GDP forecast are due to an improvement in the 4Q17 outlook, as well as adjustments for base effects in the outer years. The Reserve Bank has revised its GDP forecast for 2017 up slightly to 0.9% (from 0.7%) and those for 2018 and 2019 to 1.4% and 1.6% respectively (from 1.2% and 1.5% previously).

2018 bears a bit more optimism, with GDP growth likely rising close to potential

ECONOMIC OUTLOOK

CONFIDENTIAL | PAGE 4

• The MPC kept interest rates unchanged in January 2018. After a very hawkish statement in November 2017, the MPC tempered their tone, with a more neutral to marginally dovish response recently (given the upside risks to the inflation outlook having eased). The inflation profile was tempered marginally, but core inflation showed the biggest adjustment with the projection falling to 4.6% for 2018 (from 5.1% previously). The SARB now sees headline inflation averaging 4.9% in 2018 (from 5.2% previously), while it is expected to average 5.4% in 2019.

• Following the conclusion of the ANC elective conference, almost all of the upside risks cited by the SARB have been eliminated. The USDZAR has strengthened quite sharply after the conference, NERSA has allowed Eskom a tariff hike that is sharply lower than expectations, and the stronger rand mitigated the effect of a higher international oil price on the local petrol price. The only lingering concerns for the inflation outlook, in our opinion, are the wage negotiations that are still on-going, and the uncertainty over whether the February Budget will introduce significant fiscal consolidation or slippage.

• We believe the bias for inflation will come in lower than the SARB’s recent estimate, seeing as the abovementioned upside risks have subsided. While the inflation profile is still most sensitive to fluctuations in the rand exchange rate, we contextualise this by stress-testing our inflation forecast to get an idea of the upside risks presented by the rand. We have found that a movement in the rand exchange rate of between R0.50-R0.60/$ in either direction (above or below our baseline), changes the inflation profile by between 10 and 20bps. We believe this is negligible with only a significant (and sustained) depreciation of the rand exchange rate likely to have a lasting impact on inflation.

• We believe the market is too optimistic around SARB interest rate cuts in 1H18. We feel there is much uncertainty due to the looming budget and credit reviews. The FRA market is currently pricing in a 80% probability of a 25bps cut in March 2018, and a 25bps cut with certainty by June 2018. The SARB will likely take a cautious stance on monetary policy rather than capitulating so soon (after ending 2017 on a hawkish note). We believe that the bias for the repo rate is lower, particularly if inflation and the rand continue to surprise on the downside.

• While the FRA curve previously seemed too steep given the developments in the SARB’s forecasting tools, it looks like the FRAs are now too dovish in their pricing of immediate interest rate cuts after the conclusion of the ANC conference. Our bias for 2018 is still for interest rate cuts as opposed to hikes, although we only see these materialising in 2H18.

• On the ratings front, should the February budget maintain MTBPS estimates, this, in our view, could be construed as marginally positive (as no further deterioration is envisaged in the near term), which could differ a potential downgrade by Moody’s. Nonetheless, the medium to longer term fiscal trajectory will remain dire if there are no meaningful structural reform, SOE reform or expenditure restraint put in place, or if growth remains below potential.

Inflation risks have subsided which could open the door for further monetary policy easing

FIXED INCOME AND CREDIT RATINGS

CONFIDENTIAL | PAGE 5

• The rand dropped sharply immediately after S&P downgraded SA’s rand-denominated debt rating to junk status in November 2017, with the unit falling 2% against the US dollar on the announcement. However, the currency bounced back quickly on Moody’s decision to wait and see how the country’s politics, policy and budget unfold before making a decision. Further appreciation was fuelled by the perceived positive outcome from the ANC elective conference in December 2017.

• At current levels, the USDZAR is below its long term mean of R12.65/$. However momentum indicators are overbought, which could imply some downside in the currency in the near-term. Based on Nedbank estimates of purchasing power parity, the rand is 6% overvalued.

• The gains in the rand were due to a change in leadership within the ANC, but also due to optimism surrounding policies which could turn around the economy. The rand was also supported by favourable risk conditions, which have been supportive of EM FX over the last three months. Consequently, the rand is amongst the best-performing currencies in the world on a one month basis, and the best performer on a three month basis (4.31% and 11.38% respectively). The rand has also been the world’s most volatile currency in 2017, after the Mexican Peso and Brazilian Real, with a 12 month implied volatility of 14.8. This materialised in an environment of low and falling global currency volatility levels. The rand and the volatility levels have subsequently improved, closing the gap that was seen for most of 4Q17.

• Should we see conditions in the local context remain dire (no policy reform, a difficult political climate ahead of the 2019 national elections, little to no fiscal consolidation), while foreign investor interest in EM assets persists, this could further fuel volatility. Moreover, any shift in foreign investor sentiment away from EM risk assets could also impact the rand as it is a high-beta currency in a highly liquid financial market.

• Global factors will also play a key role in 2018, with the ‘carry trade’ potentially becoming less attractive as US interest rates rise further and other advanced countries start reducing quantitative easing.

• The rand is expected to remain in a subdued trading range this year, possibly ending the year close to R13.42/$. Any form of positive outcome from the February budget speech, an upside surprise in growth and confidence, or an aversion of further credit rating downgrades could keep the rand relatively upbeat in the near-term. Local political developments will also impact the rand substantially over the medium term. Possible levels we would be watching for on the USDZAR cross over the next six to 12 months are R11.70/$ and R11.30/$ on the downside, and R12.55/$ and R13.20/$ on a weaker end.

The rand will likely remain anchored through 2018

CURRENCY OUTLOOK

CONFIDENTIAL | PAGE 6

Higher confidence levels, lower inflation and better fixed investment should set the scene for higher growth

KEY CHARTS DETAILING OUR 2018 OUTLOOK

6.3

5.3

4.84.7 4.6

4.84.6 4.6 4.7

4.9

5.2 5.3

4.8 4.94.7

5.1

5.65.4 5.5 5.5 5.6 5.6

4.0

4.5

5.0

5.5

6.0

6.5

7.0

Q1:17A

Q2:17A

Q3:17A

Q4:17F

Q1:18F

Q2:18F

Q3:18F

Q4:18F

Q1:19F

Q2:19F

Q3:19F

Q4:19F

%

SA CPI forecasts

Nedbank CIB Markets SARB Nov 2017 SARB Jan 2018

Brazil

Mexico

Turkey

Russia

South Africa

ThailandPoland

IndiaIndonesia

Philippines

Malaysia

Kazakhstan

Chile

Panama

Colombia

Peru

0

20

40

60

80

100

120

140

160

180

0 2 4 6 8 10bp

sS&P FC rating

A+ A A- BBB- BBB BBB- BB+ BB BB-

SARB now closer to our CPI forecasts Business confidence needs to recover to propel growth above potential

Better business confidence should lead to higher fixed investment growth SA credit risk is priced in line with EM peers

Source: Nedbank CIB Markets Research, Bloomberg

CONFIDENTIAL | PAGE 7

The rand could outperform should SA avert credit rating downgrades

KEY CHARTS DETAILING OUR 2018 OUTLOOK

5

7

9

11

13

15

17

2001M01

2002M04

2003M07

2004M10

2006M01

2007M04

2008M07

2009M10

2011M01

2012M04

2013M07

2014M10

2016M01

2017M04

USD

ZAR

Fitted Actual

USDZAR – actual vs fitted… the gap has widened in recent years USDZAR remains below long-term mean

SA credit rating is still above a ‘universal’ junk rating A change to global conditions or a repricing of risk would impact the rand

Source: Nedbank CIB Markets Research, Bloomberg

Long-term Short-term Long-term Short-term Long-term Short-term

Aaa AAA AAA Prime

Aa1 AA+ AA+

Aa2 AA AA

Aa3 AA- AA-

A1 A+ A+

A2 A A

A3 A- A-

Baa1 BBB+ BBB+

Baa2 BBB BBB

Baa3 (downgrade watch) FC+LC

BBB- BBB-

Ba1 BB+ (stable) LC BB+ (stable) FC+LC

Ba2 BB (stable) FC BB

Ba3 BB- BB- speculative

B1 B+ B+

B2 B B

B3 B- B-

Caa1 CCC+ Substantia l ri sks

Caa2 CCC Extremely speculative

Caa3 CCC-Defaul t imminent

with l i ttle

Ca CC prospect for recovery

C

C DDD

/ DD

Source: Fi tch, S&P ratings , Moody's , Nedbank

Moody's S&P Fitch

P-1

A-1+ F1+

P-2 A-2 F2

Lower medium gradeP-3 A-3 F3

CCC C

D /

High grade

A-1 F1Upper medium grade

Non-investment grade

/ In defaul t

Not prime

B B

Highly speculative

C -2

-1.5

-1

-0.5

0

0.5

1 US 5y inflation-linked bond yield

CONFIDENTIAL | PAGE 8

NEDBANK GROUP ECONOMIC UNIT FACTS AND FORECASTS

Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4

GDP q/q SAAR -0.58 2.83 1.97 1.50 0.90 0.50 1.00 1.10 1.10 1.20 1.70 2.00 2.50 2.30 1.70 2.30

Current account as a % of GDP -2.40 -2.40 -2.50 -2.70

Gold $/oz. (EOP) 1241.78 1242.73 1286.74 1295.11 1295.11 1269.21 1281.90 1307.54 1294.46 1294.46 1268.57 1281.26 1306.88 1293.82 1293.82 1293.17

Exchange rates (EOP)

USDZAR 13.413 13.080 13.497 12.410 12.410 12.906 12.777 13.033 13.424 13.424 13.692 14.240 14.098 14.380 14.380 14.813

EURZAR 14.325 14.949 15.924 14.837 14.837 15.278 15.050 15.320 15.702 15.702 15.857 16.409 16.213 16.455 16.455 16.616

GBPZAR 16.715 17.023 18.111 16.714 16.714 17.296 17.021 17.448 17.972 17.972 18.240 18.970 18.687 19.060 19.060 18.963

AUDZAR 10.274 10.047 10.591 9.682 9.682 10.124 10.022 10.243 10.519 10.519 10.676 11.081 10.959 11.223 11.223 11.504

ZARJPY 8.339 8.554 8.345 9.080 9.080 8.774 8.863 8.732 8.478 8.478 8.353 8.032 8.154 7.994 7.994 7.877

GBPUSD 1.246 1.301 1.342 1.347 1.347 1.340 1.332 1.339 1.339 1.339 1.332 1.332 1.326 1.326 1.326 1.280

EURUSD 1.068 1.143 1.180 1.196 1.196 1.184 1.178 1.176 1.170 1.170 1.158 1.152 1.150 1.144 1.144 1.122

USDJPY 111.85 111.89 112.63 112.68 112.68 113.24 113.24 113.81 113.81 113.81 114.38 114.38 114.95 114.95 114.95 116.68

USDCNY 6.891 6.774 6.668 6.508 6.508 6.515 6.547 6.560 6.567 6.567 6.573 6.606 6.619 6.626 6.626 6.686

USDCHF 1.001 0.958 0.970 0.978 0.978 0.986 0.989 0.989 0.992 0.992 1.000 1.003 1.003 1.006 1.006 1.022

USDAUD 1.305 1.302 1.274 1.282 1.282 1.275 1.275 1.272 1.276 1.276 1.283 1.285 1.286 1.281 1.281 1.288

SA Interest rates (EOP)

3-month JIBAR 7.36 7.34 6.99 7.16 7.16 7.06 7.01 7.06 7.06 7.06 7.06 7.06 7.40 7.32 7.32 7.33

Prime 10.50 10.50 10.25 10.25 10.25 10.25 10.25 10.25 10.25 10.25 10.25 10.25 10.50 10.50 10.50 10.50

Long bond (10-yr) 8.89 8.89 8.72 8.82 8.82 9.25 9.05 9.15 8.95 8.95 9.25 9.05 9.15 8.95 8.95 8.75

CPI % (EOP) 6.12 5.11 5.06 4.74 4.74 4.75 5.03 5.39 5.17 5.17 5.38 5.52 5.53 5.58 5.58 5.51

EOP = End of period rate Source: Nedbank Group Economic Unit

While every care is taken to ensure the accuracy of the information and views contained in this document, no responsibility can be assumed for any action based thereon.

20202017

20172018

20182019

2019

*Note that the above forecasts represents the Nedbank house view – Nedbank CIB Market Research estimates could differ somewhat from these

CONFIDENTIAL | PAGE 9

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