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South African Economy Outlook Q2 2017



Incoming data for H2.17 is evidencing that while sub -Saharan Africa continues to experience subdued growth on the commodity price effect, globally economic activity is picking up, but structural impediments in many sub-Saharan countries, South Africa included, will limit the lift gained from the (modest) global upswing.

While commodity prices have recovered to some extent, many commodity exporters are reported to be finding commodity price levels still insufficient and government debt levels have been rising, particularly in sub-Saharan countries where this has increased uncertainty and so negatively impacted investment.

S outh Africa suffered from a contraction in investment last year (2016), and government gross debt has escalated from 22% of GDP in 2008/09 to 45.7% of GDP in 2016/17. Uncertainty has risen too on the political and economic policy front with South Africa currently seeing its key credit ratings split between investment grade (IG) and sub-investment grade (SG).

Moody’s and S&P have South Africa local currency (LC) long-term sovereign debt (LSD) on investment grade, while Fitch has it on sub-investment grade. South Africa’s foreign currency (FC) long-term sovereign debt is investment grade from only Moody’s, while Fitch and S&P have it on sub-investment grade.

This three/three split will likely persist after Moody’s country review of South Africa, as the agency is expected to move its local currency and foreign currency long-term sovereign debt ratings down by only one notch (still investment grade). South Africa bonds would then not fall out of the World Government Bond Index (WGBI), with likely little further impact on the rand from this source this year.

However, with country reviews from Fitch and S&P twice a year at least, and the possibility of ratings changes between scheduled reviews, the possibility of further downgrades cannot be excluded, which has heightened uncertainty.

A 35% weighting is ascribed to this down case of further credit rating downgrades and a 35% weighting to the expected case. With the World Government Bond Index holding a large amount of South Africa’s LC (local currency) LSD (long-term sovereign debt) the rand could weaken substantially if this Citibank fund has to sell its South African bonds (local currency long-term sovereign debt), given the large size of its holdings.

The rand and bond yields were to a significant extent shielded from April’s credit rating downgrades by the strong risk on financial markets as foreign investors were heavy purchasers of Emerging Market debt globally.

Looking forward for the rand much will depend on the global cycle, with the domestic currency at high risk of volatility, and weakness in particular from further credit rating downgrades and/or a risk-off global environment.

Expansionary fiscal policy in the US is still expected to drive growth, while the European recovery continues, with manufacturing activity and trade improvements of 2016 still noted globally, and indications that this persisted into H2.17. The feed through into investment and imports is expected to persist, strengthening global economic activity.

Figure 4: Commodity and oil markets and advanced economies PMI’s

Source: IMF WEO April 2017 and Bloomberg / Economist

However the slowdown in China and moderation in commodity prices has impacted emerging market growth, with only a modest pick-up expected. In sub-Saharan Africa a lift in growth is expected as well (see figure 2), with South Africa’s pick-up in growth more modest. Commodity prices are generally expected to rise this year and next, but only modestly, and not reaching the heights of 2011 (see figure 4).

In this modest global growth environment, with only a gentle upward trend in commodity prices, commodity exporters cannot expect a substantial boost to economic growth from this source. Rising government debt levels will need to be reined in, with South Africa receiving a credit rating downgrade this year on its escalation in debt to GDP since 2009 in a declining growth environment (with substantial contingent liabilities on its balance sheet from the guarantees to its state owned entities).

The credit rating downgrade is not expected to precipitate an interest rate hike this year, with the impact on the rand and bonds proving limited in the global risk-on period. The Forward Rate Agreement curve is flat to down this year while the US is expected to hike by two to three 25bp increments in 2017.

CPI inflation is expected to moderate in South Africa this year, and next year as food prices moderate and demand pressures remain weak in the economy as economic growth remains below trend until 2022. The fall in fixed investment (Gross fixed capital formation) in South Africa in 2016 (see figure 9) was driven by state owned entities and the private sector, with growth in government investment slowing down sharply.

The IMF says “rising public sector debt is becoming a cause for concern in sub-Saharan Africa …the ratio of public debt to GDP has increased …to an average of 42 percent of GDP in 2016 (and a median of 51 percent). This is the highest value since many countries received debt relief in the 2000s under the Heavily Indebted Poor Countries/Multilateral Debt Relief Initiative.”

South Africa’s fiscal constraints have led to lower investment growth for government and State Owned Enterprises, with the bulk of state expenditure focused on social services and civil servant remuneration, while the country continues to run a primary deficit.

At 46% of GDP South Africa’s debt to GDP ratio is similar to the debt to GDP ratio inherited by the ANC tripartite alliance in 1994 with the advent of democracy, when the fiscal deficit for national government was close to 7% of GDP. At that time South Africa’s credit ratings were sub-investment grade. The IMF notes “prudent fiscal policies play a special role in sustaining growth.

spells in sub-Saharan Africa: a better fiscal balance significantly increases the chance that a growth spell will continue, while conversely, a higher debt burden can accelerate its end. …in particular …a lower debt-to-GDP ratio tend to prolong growth spells in the (sub-Saharan African) region.”

The IMF adds currently that “weakening commodity exports, the ensuing sharp slowdown in economic activity, and the build-up of government payment arrears to contractors are all restricting private firms’ capacity to service their loans to various degrees across the region.” Business confidence has essentially remained at depressed levels since 2009, with an average of 59% of business dissatisfied with business conditions.

The close link to fixed investment has shown a contraction in private sector investment over the period. Heightened uncertainty, reflected in poor confidence levels leads to lack of investor appetite, as does anaemic domestic demand. Industrial production is expected to be weak, but positive over the forecast period of 2017 to 2021.

Consumer confidence has been very weak over the period, with gross national income per capita falling in real terms in 2016, both of which have subdued real household consumption expenditure (HCE), and so GDP growth.

With Moody’s still to review South Africa’s country credit local currency and foreign currency ratings, but likely to keep them investment grade, it will be December’s country reviews which could have a ratings impact on the rand, unless further political disturbances this year promote another round of downgrades.

A more gradual trajectory than previously is likely in the return to PPP, given the recent downward trend in credit ratings. The rand could therefore reach PPP in 2020, where PPP valuation will then be closer to R11.50/USD. Loss of another investment grade local currency long-term sovereign credit rating would delay the return to PPP further, while loss of all investment grade local currency long-term sovereign credit ratings would mean the rand would be unlikely to return to PPP.

Unless otherwise stated all views in this narrative are of the baseline case. South Africa has lost growth momentum, with the economy in a downward growth trend over the past several years. Economic growth of around 1.0% y/y is insufficient to prevent further credit rating downgrades, particularly if government debt to GDP ratios does not fall and there is insufficient State Owned Enterprise reform.

The agencies also point to concerns on GDP per capita and the possibility of future government policies undermining economic or fiscal strength -the latter weakening business confidence.

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South Africa

Eskom Crisis and Rising Unemployment– Woes of the South African Economy



South Africa’s outlook has been dealt several heavy blows in recent times following Eskom’s financial results, and the latest unemployment data, which has raised the question: where to from here? South Africa’s unemployment rate climbed substantially in Q2 2019, StatsSA said on Tuesday, 30th July 2019.

The Quarterly Labor Force Survey for Q2 2019 showed that the unemployment rate increased by 1.4 percentage points from 27.6% in the first quarter of 2019 to 29% in the second quarter of 2019.

Eskom, meanwhile, reported a record loss for the year ended March 2019, of R20.7 billion, following years of corruption that has seen the power utility’s debt spiral out of control, fueling rumors that international ratings agency Moody’s could downgrade South Africa’s sovereign debt to junk status.

Analysts had hoped for a turnaround in fortunes following the election of president Cyril Ramaphosa, and post general elections in May. However, the country has been dealt one bloody blow after another, raising serious questions about its turnaround prospects and timeframe, which seems to get further away as both global and local financial institutions narrow economic growth.


The reason why the state’s finances finds itself in such a death-defying spiral, according to chief economist at Efficient Group, Dawie Roodt, is because, especially since 2009, state spending has increased relentlessly at a time when tax collections collapsed– mostly because of a faltering economy.

“At this rate of debt increase, it is very clear things will turn out very unhappy, very soon,” he said.

Roodt said “note that to fix the problem of collapsing fiscal accounts, a combination of three things needs to happen to stabilise the debt to GDP ratio.

“The first thing is that the economy should preferably start growing at a rate of 6%, at which rate the debt to GDP ratio will stabilise.

“Unfortunately, the ruling elite seems to be hell-bent on doing even more damage to the economy with all sorts of silly socialist ideas, like the suggested creation of yet another state bank, a new mandate for the SARB and the unaffordable NHI. Because of this, economic growth, believe me, will not save us from this fiscal cliff,” he said.

A second option is to increase taxes by the equivalent of 5% of GDP (current market price), which is approximately R250 billion. For example, VAT needs to increase by more than 11 percentage points to get this kind of money, or personal income taxes need to increase on average by nearly 10 percentage points.

This option, Roodt stressed, is irrelevant as a tax increase of this magnitude would have a huge adverse effect on growth, while overburdened taxpayers would likely revolt.

“Preferably, and the only realistic option left, is to cut state spending with a similar amount: R250 billion,” Roodt said.

“Percentage wise that is a real reduction in state spending of approximately 15%, or 20% in nominal terms. Now, show me the politician with the clackers to go and give COSATU the good news. But even if we could implement such austerity measures, the initial impact on the economy will be hugely negative – damned if you do, damned if you don’t,” the economist said.

Roodt also delivered a scathing assessment of president Ramaphosa.

“Judging from president Ramaphosa’s actions so far, he must either be weak, doesn’t appreciate the danger in which the South African economy is, or he simply doesn’t care,” Roodt said.

“I think we have a weak president that simply doesn’t have the political capital to implement unpopular structural changes. All that is left for him to do is to use (gutted) institutions, like the NPA, to do the heavy lifting for him. He is playing the “long-game”, but this economy doesn’t have a long time.

“Even if we can somehow wave a magic wand and get rid of all the corruption and incompetence in the state and SOEs overnight, the perilous condition of the state’s finances will need an extraordinary attempt to save us from further economic collapse,” Roodt said.

Roodt said that none of his three scenarios will likely prevent the inevitable: “Debt will continue to balloon, the economy will falter, poverty and unemployment will keep going up and those that are responsible for all the troubles will keep on blaming “the others” for their absurdities”.

“By then the only remaining alternative will be to inflate your debt away. But for that to happen you need to control the SARB – and with Lesetja Kganyago at the helm, that is not going to be easy. But be assured, as we sink further into this debt chaos the pressure on the SARB will become relentless and eventually also the SARB will buckle under the pressure. And then, inflation.”

“What we must understand,” Roodt said, “is that no structural adjustment, no new dawn, no fresh start can be taken seriously unless it includes an admittance that there are just too many trying to live off too few. Many tens of thousands of civil ‘servants’, including those at SOEs, are simply not needed. They must go.”

Economic growth– from bad to worse.

Early second-quarter indicators signal some respite following a sharper-than-expected contraction in Q1 due to rolling power outages. The retail sector picked up in April; car sales, on average, bounced back from the first quarter in April–May; while manufacturing activity grew at a faster pace, on average, in the same two months. Overall growth prospects remain bleak, however, with uncertainty over the restructuring of Eskom, the heavily indebted state-owned power utility, weighing on economic sentiment. Following slight upturns in April, the manufacturing PMI swung back into negative territory in May–June, and business confidence faltered again. The government is considering other measures to aid Eskom in addition to the ZAR 230 billion pledged, while minimizing the risk to public finances and credit ratings. Options on the table include swapping the firm’s sizeable debt for sovereign bonds or using a special purpose vehicle.

The International Monetary Fund becomes the latest key institution to slash its growth forecast for Africa’s most-industrialized economy, which may have fallen into its second recession in as many years. It now expects the economy to expand by 0.7% in 2019, half of what it estimated in in the beginning of the year, and similar to forecasts by the South African Reserve Bank and Bloomberg Economics.

The economy shrank the most in a decade in the first quarter of this year as the nation suffered the worst power outages since 2008.

The National Treasury, which forecast growth of 1.5% in the February budget, is expected to lower its prediction in the October mid-term budget. While the World Bank’s 1.1% estimate seems to be an outlier, it was published as part of its mid-year Global Economic Prospects outlook on the same day that Statistics South Africa released data showing a much bigger-than-expected contraction for the three months through March. South Africa is stuck in its longest downward business cycle since 1945, data from the central bank showed in June.

In all, growth is seen decelerating this year as persistent power outages continue to weigh on economic sentiment and curb investment and private spending. That said, a pickup in export growth should cushion the slowdown. Downside risks to the outlook stem from policy uncertainty surrounding Eskom’s debt restructuring and President Cyril Ramaphosa’s reform agenda.

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