An unfortunate one-year anniversary

Highlights

• The war in Ukraine one year on: Aside from the physical destruction, Russia’s invasion has led to a significant loss of life and the spillover effects on the greater global economy have been immense. However, glimmers of hope are beginning to emerge.
• Russian fossil fuel still flows to various nations worldwide despite its Ukraine invasion.
• China’s growth target for this year is around 5%. It’s prioritising economic stability, which year to date has seemingly been rebounding, given its recently lifted zero-Covid policy having kept 2022 growth at 3%. The 5% target doesn’t seem particularly ambitious. Is China entering a form of ‘economic slumber’? Why does this matter to the greater global economy?
• According to the latest economic growth and unemployment data, South Africans are still rolling in the economic doldrums. As material job creation has typically only occurred when GDP growth approaches 3% pa, the economy isn’t growing at an adequate rate to sustainably boost long-term employment.

Russia’s war on Ukraine

On 26 February, the world marked an unfortunate anniversary in global political history: one year since Russia’s invasion of Ukraine began. Aside from the obvious physical destruction, the invasion has also led to a significant loss of life for the Ukrainian and Russian armies, as well as a high number of Ukrainian civilians.

Moreover, the spillover effects on the greater global economy have been immense – most notably through reduced gas flows from Russia to Europe, having turbo-charged and prolonged the inflation surge that initially began with supply chain disruptions through the Covid-19 pandemic.

Unfortunately, the war doesn’t appear to be coming to a resolution anytime soon; the fighting is ongoing with limited military progress on either side. Russian President Vladimir Putin shows no willingness to back down either.

Nonetheless, Russia’s leadership no longer appears to be trying to oust Ukrainian President Volodymyr Zelensky from power. Instead, the short-term goal seems to be gaining control over the territories Russia annexed last autumn.

Putin has said he is open to negotiations while Russian troops continue to attack Ukraine’s cities. Meanwhile, Ukrainian officials have been unwavering in their stance that a peace settlement is impossible until Russia withdraws from within Ukraine’s internationally recognised borders.

This would mean leaving Crimea and regions that had been under the control of Russian-backed separatists since 2014. A stalemate indeed.

Aside from the political posturing in the background, the war itself has had significant economic ramifications. It has cost Ukraine hundreds of billions of dollars in damaged infrastructure and caused its GDP to plummet by 30% in 2022.

Russia’s output contracted by just over 2%, surprising financial markets that believed a meltdown was imminent. However, we would caution against using GDP to measure the performance of a wartime economy, since military expenditures can distort the big picture.

If one considers the significant decline in Russia’s consumer spending and a higher-than-expected increase in its government’s budget deficit, Russia’s economy is worse off than it seems. Furthermore, Russians now have to shop abroad to snag a Big Mac or a pair of Levi jeans.

The latest estimates indicate that the corporate exodus from Russia is six times bigger than during the Apartheid era in SA, which in 1988 was the largest in history.

However, the most damming outcome for the Russian economy thus far has been the action of governments abroad. Due to its invasion of Ukraine, Russia is now the most sanctioned country in the world, with restrictions on its energy exports, strategic imports, and overall access to the global financial system. Overall, the war in Ukraine has formed the biggest international conflict since World War II, spurring many countries to reconsider their approach to national defence.

The bottom line

As UK prime minister from 1937 to 1940 Neville Chamberlain once famously remarked, “In war, whichever side may call itself the victor, there are no winners, but all are losers.” There are indeed no winners here. However, despite the dark clouds that continue to hang over the conflict (and all those involved), glimmers of hope are beginning to emerge. With regards to Ukraine, China presented a 12-point plan calling for a ‘political settlement’ of the conflict, including a ceasefire and renewed negotiations.

While this may not be acted upon, increased pressure from Beijing on Russia to end the war may be helpful. Even with respect to energy prices, the newsflow has since turned more positive – Europe has managed (through a mix of speedy infrastructure enhancements, energy savings and luck [in the form of a mild winter]) to attract and maintain natural gas stocks to meet its needs through its current winter season, sending wholesale prices sharply lower from their peak.

As a result, inflationary pressures are slowly starting to trend downward. However, overall inflation across the globe remains too high relative to most central banks’ targets, and pressure to redistribute the pain to some extent away from workers (through higher wages) remains. As a result, it, unfortunately, appears that a restrictive policy stance by central banks is still needed for some time.

Nonetheless, the end of monetary tightening now looks closer than before, and economic prospects are that little bit brighter.

War = profit: Who is still buying Russia’s fossil fuels?

Contrary to most expectations, a year after Russia’s initial invasion of Ukraine, Russian fossil fuel exports still flow to various nations.

According to the Centre for Research on Energy and Clean Air’s estimates, since the invasion started Russia has made more than US$315 billion in revenue from fossil fuel exports worldwide, with nearly half (US$149 billion) coming from EU nations. 

The quote, “there’s no such thing as bad publicity”, appears true for the oil business. China has been the top buyer of Russian fossil fuels since the start of the invasion. As Russia’s neighbour and de facto informal ally, China has primarily imported crude oil, which has made up more than 80% of its imports totalling more than US$55 billion since the start of the invasion. The EU’s largest economy, Germany, is the second-largest importer, mainly due to its natural gas imports worth more than US$12 billion alone. Turkey, a member of the North Atlantic Treaty Organisation, closely follows Germany. However, it is likely to overtake Germany soon, as not being part of the EU means it isn’t affected by the bloc’s Russian import bans.

However, while more than half of the top-20 fossil fuel importing nations are from the EU, countries from the bloc and the rest of Europe have been curtailing their imports as bans and price caps on Russian coal imports, crude oil seaborne shipments, and petroleum product imports have come into effect. The EU’s bans and price caps have resulted in a decline of daily fossil fuel revenues from the bloc of nearly 85%, falling from their March 2022 peak of US$774 million/day to US$119 million/day as of 22 February 2023.

In the meantime India has stepped up its fossil fuel imports from US$3 million/day on the day of the invasion to US$81 million/day by the end of February 2023. Notably, this increase isn’t close to making up the US$655 million hole left by EU nations’ import reduction. Even if African countries have doubled their Russian fuel imports since December 2022, Russian seaborne oil product exports have still declined by 21% overall since January 2022, according to S&P Global.

The bottom line

Overall, from a peak on 24 March 2022 of around US$1.17 billion in daily revenue, Russian fossil fuel revenues have declined by more than 50% to just US$560 million/day.

Along with the EU’s reductions in purchases, a key contributing factor has been the decline in Russian crude oil’s price, which has dropped by c. 50% since the invasion, from US$99/bbl to US$50/bbl today. The EU’s tenth set of sanctions (announced 25 February) ban the import of bitumen and related materials like asphalt, synthetic rubbers, and carbon blacks and are estimated to reduce overall Russian export revenues by almost US$1.4 billion. Perhaps war is not profitable for the oil game – at least in Russia’s case.

Slumber time for China?

“Let China Sleep, for when she wakes, she will shake the world,” states a quote often attributed to Napoleon Bonaparte. In recent years, the Chinese Communist Party has created a very concerning reality to this statement. However, if the latest newsflow is anything to go by, China appears to be returning to her past historical slumber – or at least some version of nap time.

China’s recent annual NPC opened with outgoing Prime Minister Li Keqiang presenting a growth target of around 5% for this year (the lowest in over three decades), with the focus being to ‘prioritise economic stability’. Given that the country’s recently disbanded zero-COVID strategy kept growth last year at just 3%, economic activity year to date has seemingly been rebounding. In light of this, the 5% target does not seem ambitious. However, aside from the demographic challenges of an ageing population, China is still grappling with the woes of its property development sector and the latest available data show China’s exports have fallen in each of the final three months of 2022.

Remember, China weathered the early stages of the COVID-19 pandemic better than many of its peers, as high export demand propped up the economy despite weaker consumption. In 2021, the country’s GDP expanded 8.1% YoY (year-on-year), though that figure was boosted by the comparison with early 2020 when activity collapsed. A significant portion of that growth was also bolstered by net exports, which are weakening as other big economies struggle to contain inflation.

However, the prospect of stimulus in China sits uneasily with the current political rhetoric to push to contain high debt levels. Housing sales in China have declined since mid-2021 following a wave of defaults among its biggest developers (most famously Evergrande). The decline slowed in January and February 2023. Nonetheless, the central authorities in Beijing appear reluctant to allow local governments, which rely on land sales for much of their income, to borrow more and has not increased the limits on how much they can raise through new bond sales this year.

The bottom line 

Why does this matter? Well, shortly after the announcement of China’s economic growth target coming in at less than expected, coal and iron ore prices drove global commodity markets lower, fuelling fears across financial markets of an uneven recovery.

As the world’s biggest commodities consumer, China drives prices for raw materials ranging from zinc to copper and crude oil to corn. As a major player in the global economy, what China does matters.

South Africans continue to roll in the economic doldrums

Coming in lower than expectations, SA’s latest GDP print printed at 0.9% YoY for Q4 2022 (2022’s fourth quarter). Overall, the weakness was broad-based, with seven of the ten sectors measured contracting to negative territory. This bout of weakness is unsurprising, given the number of headwinds that weighed on the economy in Q4, including the Transnet strike that disrupted exports, load shedding, high interest rates, and elevated inflation. As usual, the agricultural sector was the wild card for the Q4 print, contracting 3.3% after a stellar performance in Q3. In addition, consumer demand remained weak for the quarter, which filtered through to the broader services sector. GDP came in at 2% for the full 2022 year, with the mining sector the biggest drag on growth.

Growth is expected to slow in 2023 to below 1%. Overall, the domestic economy faces a range of risks in the form of continued high levels of load shedding and the deterioration of port and rail infrastructure. Furthermore, the slow implementation of structural reforms is lowering business confidence and deterring new investment. While economic growth has been volatile for some time, prospects for growth appear more uncertain than usual.

Statistics SA’s latest unemployment statistics show employment [is at 15.934 million] jobs, down from the pre-COVID-19 high of 16.5 million jobs in Q4 2018. SA’s unemployment rate remains uncomfortably high at 32.7% and above pre-COVID-19 levels. Whilst the expanded definition of unemployment (including those discouraged from seeking work) declined to 42.6% (from 43.1% in Q3), it’s a marked 13.9 percentage points higher than that in the same period in 2008, demonstrating the extent of SA’s unemployment crisis.

Of greater concern is the youth category – those aged 15-24 years – the most afflicted segment of the economy. Unemployment in this group rose to an unacceptably high 61% in Q4 after easing slightly in Q3. This indicates the greater structural issues present in SA’s economy – thus, improving the quality of and access to education remains essential.

Overall, the risks currently present to the employment outlook in SA cover all those currently stymying the greater growth outlook for SA – for instance, increased frequency and intensity of load shedding, which will weigh on business prospects, confidence, investment, economic growth and in turn, employment. A slowdown in domestic demand and global growth in response to higher interest rates also pose a risk to job creation.

The bottom line

Typically, in the local economy, material job creation has only occurred when GDP growth approaches 3% pa. Thus, the SA economy is simply not growing at an adequate rate to sustainably boost long-term employment prospects for South Africans. SA’s economic growth is forecast to slow below a meagre 1% YoY.

In 2023, load shedding is expected to continue at a relatively high intensity throughout the year. Household consumption is expected to weaken, given the high-interest rate environment. Additionally, the economic slowdown in developed markets will likely reduce export demand (even as imports grow).

However, this could be countered to some extent by demand from China. Electricity supply and other structural constraints prevent the domestic economy from taking off in any real, meaningful way. Without power, the cogs of our economy cannot turn.

Casey Delport is investment analyst – fixed income at Anchor Capital