Omicronomics: what the new variant could mean for SA’s economy

Like all other Covid-19 variants before the current Omicron variant, one must be mindful of the many estimates and potential impacts it may have on local economic activity and financial markets. The past 18 months have taught us that economic conditions can change rapidly in either direction. However, what we do know is several countries have implemented travel restrictions on SA, and we believe many of these restrictions will remain in place until the end of January 2022. 

For SA, the Omicron variant comes at a time when the seasonal hospitality sector was hoping to finally benefit from an uptick in local and international travel, tourism and hospitality in general.

Up until the second quarter of 2021, the trade, accommodation and catering industry was the second-worst performing industry in the domestic economy, with overall economic activity in this industry almost 20% below the levels seen in the fourth quarter of 2019. Only the construction industry in the domestic economy fared worse. Unfortunately, the trade, accommodation and catering industry is now likely to see another weak quarter and may well not recover to pre-Covid levels before December 2023

At an aggregate level, should the travel restrictions remain in place until the end of January 2022, our estimates suggest the negative impact on GDP could be about 20 bps, split between the fourth quarter of 2021 and first quarter of 2022. This, of course, is subject to local travel restrictions not becoming stricter too.  

Before the Omicron variant, we expected growth to average 5.1% y/y in 2021 and 2.0% y/y in 2022; this may now be marginally lower. Arguably the impact on employment could be greater than the impact on growth because of the seasonal timing and the industries worst affected by this. From a fiscal perspective, this may also necessitate the extension of the Covid-19 social grant beyond the current deadline of March 2022.

For the rand, the new variant and travel restrictions come at a time when the US is less likely to put the same Covid-19 restrictions in place as we are seeing in other parts of the world. Given that the US Fed chair Jerome Powell indicated last week that elevated inflation may become less transitory, the Fed is also unlikely to slow its asset tapering and will remain on a general monetary tightening path. This favours the US dollar.

That said, at this stage we do see the rand’s sharp depreciation as an overshoot of our fair value range of R14.80-R15.50 against the dollar, as opposed to a fundamental shift in the local currency’s fair value. As a result, the latest developments are unlikely to change our view of the currency. Ultimately, once there is more certainty about the new variant, we believe the rand will regain some of its lost value and move back towards levels we deem fair. 

But as pointed out, it may not be until the end of January that we see some return to normality as far as travel restrictions are concerned.

Where does this leave inflation and the Reserve Bank? Global supply chains may well be affected by the new variant and price pressures are likely to intensify. As a result, SA’s import prices could rise further. At the same time the rand is weaker, which adds to upside risks for domestic inflation.

Fortunately, our estimates suggest that the exchange rate pass through of currency weakness into domestic prices remains low and below 10% due to weak domestic demand. This suggests that firms that face higher import prices and a weaker currency may struggle to pass on price increases to domestic consumers, which will ultimately result in a smaller impact on local headline inflation than what may otherwise be the case.

Goods inflation has already risen this year (at 7.1% y/y in September), capturing some of the higher input costs that producers did manage to pass through. Furthermore, locally, services inflation has been muted for most of 2021 and more travel restrictions are likely to keep some elements of services inflation muted.

With the little information we have right now on the Omicron variant, the net effect of its impact on inflation could be largely neutral, leaving our inflation outlook unchanged at 4.5% for 2022. That said, if we must choose a bias, we suggest that upside risks rather than downside risks are likely to prevail. Despite the variant’s negative impact on growth, we continue to favour another 25 bps hike by the SARB in Q1:22 as the central seeks to manage actual inflation and inflation expectations about the midpoint of the target band. 

Walter de Wet is a senior strategy analyst at Nedbank Corporate and Investment Banking.