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Prospects of the South African Economy in 2018

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The South African economy in 2017 experienced a fluctuating growth quarter-onquarter basis. The economy grew 2.0% in the third quarter of 2017 (seasonally adjusted and annualised), down from a revised 2.8% in the second quarter

Agriculture, mining and manufacturing were the main drivers of the expansion, while there was a contraction in general government services resulting from low employment numbers in the public sector. After recording an increase of 38.7% in the second quarter, the agriculture industry continued to power ahead, expanding by 44.2% in the third quarter.

This is the largest quarterly jump in agriculture production since the second quarter of 1996. Increased production of field crops and horticultural products were the main contributors to growth, with notable increases in the production of maize and vegetable products. That season’s maize crop is expected to be the largest on record.

The Crop Estimates Committee pegged commercial maize production for that season at 16.74 million tonnes, more than double the 7.78 million tonnes produced last year (2015/16), and higher than the current record of 14.66 million tonnes harvested in 1980/81.

Mining and manufacturing were the other major contributors to economic growth in the third quarter. Increased gold and platinum production saw the mining industry grow by 6.6%, while the 4.3% rise in manufacturing was spurred on by increased production of both petroleum and metal products.

Finance and business grew by 1.2%, helped along by increased activity in financial mediation, insurance and auxiliary services. There was also positive growth in personal services (0.9%) and transport and communication (0.6%).

Four industries, however, saw a decline in economic activity in the third quarter. Falling employment numbers in the public sector saw general government services posting its third consecutive quarter of negative growth, contracting by 0.7%. Other notable industries that saw a decline were trade and electricity, water and gas.

Despite a rebound in retail trade sales, falling wholesale trade sales pulled the trade industry down by 0.4%. The electricity, water and gas industry experienced a 5.5% contraction, a result of falling electricity generation and demand.

Other highlights from the third quarter 2017 GDP release:

  • Unadjusted real GDP was up by 0.8% yearon-year in the third quarter of 2017.
  • The South African economy grew by 1.0% in the first nine months of 2017 compared with the first nine months of 2016.
  • Nominal GDP in the third quarter was estimated at R1.17 trillion.
  • Expenditure on GDP grew by 2.1% in the third quarter, spurred on by a rise in household consumption spending and fixed investment. There was, however, a fall in government consumption spending. Exports were down, but imports were down more, resulting in an improvement in net exports (i.e. exports less imports) and, consequently, a positive contribution to total growth from the external sector.

Economic growth is projected to pick up moderately in 2018-19, as stronger activity in trading partners boosts exports. Investment will support growth in 2019 on the assumption that business confidence increases and policy uncertainty fades.

Despite persistently high unemployment, private consumption will expand as wages increase moderately and food prices stabilize. Falling inflation leaves room for a moderately expansionary monetary policy to support activity. Unexpected slippage of the budget deficit is contributing to growth in the short term, but is also creating more pressure to contain rising public debt and is raising the risk of a further credit downgrade.

Improving the efficiency of public spending and better controlling the deficits of stateowned enterprises are necessary to raise fiscal credibility and create room for public investment to foster growth and reduce social inequality.

The high dependence on external financing is the main source of financial vulnerability. Low investor confidence and credit rating downgrades in 2017 have contributed to a net outflow of foreign investment.

To cushion the transmission of external shocks to the financial system, implementation of the financial sector regulatory reform should be accelerated and foreign-currency-denominated debt issued by private entities further monitored.

Growth is weak as policy uncertainty persists

Economic growth is slowly improving following the drought in recent years, driven by a recovery in agriculture and favorable commodity prices. However, political uncertainty has eroded business and consumer confidence. The deterioration of the fiscal stance will not help to bring back confidence.

Unemployment remains high, reflecting skill shortages and weak investment, and weighs on household consumption. Inequalities in opportunities and incomes remain high.

Policy reforms are needed to boost growth The fall of inflation into the target range (3% to 6%) has opened up space to adjust policy rates to provide stimulus for investment. The central bank already reduced its repurchase

rate from 7% to 6.75% in July 2017. A further adjustment is projected in 2018 as inflation remains within the target range.

The government budget deficit is overshooting due to significant shortfalls in tax revenue and high spending, particularly in the areas of debt-servicing costs, education and defense. The government will have to prioritize expenditure.

Although the widening deficit will support short-term growth by partially sustaining household consumption through social grants, the rising debt makes consolidation imperative to maintain market confidence. Increasing the efficiency of public investment in infrastructure is much needed to boost productivity.

Reforms to ease the cost of doing business, boost entrepreneurship, lift competition barriers in many sectors and facilitate the expansion of firms in the neighboring region would boost productivity and help create jobs. Growth is projected to increase Favorable terms of trade are projected to continue to drive export growth. The introduction of the proposed minimum wage can boost consumption slightly and reduce income inequality.

However, investment will remain weak in 2018 as political uncertainty remains high. Inflation is expected to remain in the upper half of the target range, driven by a stabilization of food prices and a moderate oil price development that counter balances a potential rise in electricity tariffs. The main risks to growth are policy uncertainty and external factors.

Foreign-owned debt is relatively high compared to other emerging market economies; indeed, the majority of the external debt of state-owned enterprises, banks and corporations is in foreign currency.

Further credit rating downgrades could increase the cost of hedging or raise collateral requirements for foreign currency risk. Uncertainty surrounding Brexit may affect exports and financial flows with one of South Africa’s largest European trading partners.

On the upside, the growth outlook could be better if higher-than-assumed commodity prices or capital inflows would provide further impetus to domestic demand. A stronger-thanexpected recovery of business confidence could provide a boost in investment.

 

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South Africa

The key economic and political risk events to haunt South Africa’s economy in 2019

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South Africa’s much anticipated economic rebound in 2018 did not occur. While substantial efforts by the authorities to strengthen governance of public resources and stabilize the fiscal situation helped the economy to not contract further, economic growth remained tepid with a technical recession (two successive quarters of negative economic growth) in the first half of 2018. GDP growth is expected at below 1% in 2018, down from an already low 1.3% in 2017.

A number of exogenous factors contributed to this poor growth performance. Domestically, climate variations such as a prolonged drought in the Western Cape where harvests were delayed exerted a huge toll on agricultural production. Externally, mounting trade tensions between the United States and China, and tightening global financial conditions contributed to slowing the pace of foreign financial inflows to South Africa while lessening the demand for its exports. Rising world oil prices also exerted strong pressure on the balance of payments and domestic prices, depressing private consumption.

These negative developments, however, do not conceal the fact that South Africa’s growth challenge is deep-seated and largely structural. To grow faster and sustainably, the economy will need to be more inclusive, requiring the participation of a greater share of the population mainly through job creation.

Furthermore, persistent inequality of income and of opportunity will continue to raise pressures for redistribution of limited resources that are drawn from a small tax base. Radical policy demands are more likely in a stagnant economy, fuel policy uncertainty and deter private investment. At the Presidential Jobs Summit and the South African Investment Conference held in October 2018 agreements were made on actions that are expected to enable job creation and to attract higher levels of investment, including inter alia, education and skills interventions, and initiatives to reduce policy uncertainty on land reform, mining and black economic empowerment.

The financing of structural reforms and projects to promote greater economic and social inclusion is nonetheless rendered difficult by South Africa’s tight fiscal and debt situation, itself mainly the consequence of slow growth and strong spending pressures.

As in most previous budget speeches, the commitment to public debt stabilization was reaffirmed in the October 2018 Medium Term Budget Policy Statement (MTBPS), but the target date for debt stabilization was shifted yet again, this time to 2023/24, and at a higher level, to 59.6% of GDP against 56.1% in the 2018 Budget Review.

Though in a significant departure from previous statements, there was clear recognition of the greater role the private sector, development finance institutions, and multilateral development banks could play in complementing scarce public finances for infrastructure. Regulatory reforms, lowering the risk of financial instruments to facilitate private sector investment, and a clearer delineation between commercially viable and socially desirable interventions were identified as instrumental to breaking a vicious cycle of low inclusiveness coupled with limited public resources to speedily address the challenge.

South Africa’s economy after experiencing a recession last year may be even bumpier in this 2019. Here’s a look at the key economic and political risk factors to watch out for in 2019:

The budget

After Finance Minister Tito Mboweni painted a bleak picture for finances in October 2018, attention will turn to his plans to boost growth and prevent debt from spiralling out of control at the budget presentation in February. The national budget is a “key pressure point,” Intellidex’s head of capital markets research, Peter Attard Montalto, said in a note. The absence of concrete plans to boost economic growth could trigger a change to negative in the outlook on South Africa’s credit ratings.

Credit rating

A downgrade to junk by Moody’s Investors Service would trigger forced selling of bonds by investors tracking investment-grade indexes, including Citigroup’s World Government Bond Index. That’s “very likely,” according to David Hauner, Bank of America Merrill Lynch’s head of cross-asset strategy for Eastern Europe, the Middle East and Africa. Moody’s didn’t publish a review as scheduled in October 2018, while S&P Global Ratings and Fitch Ratings have kept their sub-investment grade assessments. Ratings companies may be waiting for the budget data before making another call.

State companies’ debts

Troubled state-owned companies will continue to weigh on the country’s finances, with their combined debt of R1.6 trillion. Almost half that is guaranteed by the government, the Treasury said in October 2018. Power utility Eskom needs R20.1 billion to meet its obligations in 2019, national carrier South African Airways needs to repay R14.2 billion by March 2019 and the state broadcaster has warned it won’t be able to pay staff unless it gets R3 billion from the government by February 2019. George Herman, chief investment officer at Citadel Investment Services, predicts a “worst-case scenario” for the companies: “the state will have to step in to bail them out,” he says.

Expropriation

Lawmakers will report to parliament on March 31, 2019 on changes to the constitution to make it easier to expropriate land without compensation. While these steps form part of the ruling African National Congress’s plan to accelerate wealth redistribution, commercial banks that hold farm debt could be hit. Lobby groups are gearing up to fight the process in court and the possible protracted legal wrangling could lead to a period of prolonged uncertainty.

May elections

South African elections have been mostly peaceful and accepted as free and fair since the first all-race ballot in 1994, but the run-up to this year’s vote may see an increase in populist rhetoric and constrain the ANC’s room for maneuver. Polls show the ANC maintaining its majority, but the party needs 55% to 60% of the vote to put President Cyril Ramaphosa in a position to implement reforms aimed at reviving economic growth, said Old Mutual Investment Group economist Johann Els. Ramaphosa could overhaul — and shrink — his cabinet after the election.

Reserve Bank

The current terms of two of the Reserve Bank’s most senior officials run out this year. While both could be reappointed, the possibility of changes in leadership will add to uncertainty amid a drive by the ANC to make the central bank state-owned. Deputy Governor Daniel Mminele’s second term ends in June 2019 and Governor Lesetja Kganyago’s first five years at the helm ends in November 2019. The governor and his three deputies are appointed by the president: Kganyago has said he’d be available to serve another term if asked; Mminele hasn’t commented.

What an economist says …

“The increase in foreign participation in the domestic government bond market to 40% from 23% in 2011 is a key risk for South Africa. It makes the rand highly vulnerable to negative domestic events as well as changes in sentiment to emerging markets. With interest payments to foreign bondholders accounting for most of the current-account deficit, South Africa is essentially borrowing more from abroad to service its higher debt load.” – Mark Bohlund, Bloomberg Economics.

 

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