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South African Economy in a tight spot in 2017

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South Africa’s economy continues to be stifled by weak growth on one side and the need for fiscal consolidation on the other. Weak growth links back to tepid external demand, subdued private investment, low business confidence, labor market challenges such as high unemployment and skills shortages, and political uncertainty. While spending on infrastructure and skill development is necessary for long-term economic growth, South Africa needs to exercise fiscal prudence to retain its investment-grade sovereign credit rating.

South Africa’s monetary policy might also tighten in 2017 in response to US monetary tightening. A rating downgrade of South Africa’s sovereign debt, though not that likely in the coming quarters due to a commitment to fiscal consolidation, will imply higher borrowing costs that will put upward pressure on domestic interest rates. Weak growth and tight economic policy make for a difficult economic scenario.

South Africa’s economy continues to be stifled by weak growth on one side and the need for fiscal consolidation on the other. Weak growth links back to tepid external demand, subdued private investment, low business confidence, labor market challenges such as high unemployment and skills shortages, and political uncertainty.

While spending on infrastructure and skill development is necessary for long-term economic growth, South Africa needs to exercise fiscal prudence to retain its investment-grade sovereign credit rating. South Africa’s monetary policy might also tighten in 2017 in response to US monetary tightening.

A rating downgrade of South Africa’s sovereign debt, though not that likely in the coming quarters due to a commitment to fiscal consolidation, will imply higher borrowing costs that will put upward pressure on domestic interest rates. Weak growth and tight economic policy make for a difficult economic scenario.

A slowdown in 2016

The International Monetary Fund (IMF), in its October 2016 outlook, projected a global growth rate of 3.1 percent, slightly slower than 3.2 percent in 2015 and 3.4 percent in 2014. IMF estimates show that the economy of sub-Saharan Africa, one of the fastestgrowing economic regions of the world since 2000, is likely to grow just 1.4 percent in 2016, down sharply from 3.4 percent in the previous year.

A major reason behind the region’s decelerating growth is the slowdown in its two largest economies: Nigeria and South Africa. Both Nigeria and South Africa have come under pressure from slowing global demand and weak commodity prices. According to the IMF, South Africa’s economy is projected to record growth of just 0.1 percent in 2016. In 2016 until the end of Q3, the South African economy grew 0.3 percent: The primary sector (agriculture and mining) shrank 4.8 percent; the secondary sector (manufacturing, construction, and utilities) expanded 0.3 percent; the tertiary sector (wholesale, retail, transport, finance, and government services) expanded 1.2 percent; and taxes (less subsidies) contracted 0.8 percent.

Latest data indicate that on a quarter-overquarter seasonally adjusted annualized basis, economic growth (measured by production) slowed to 0.2 percent in Q3 from 3.5 percent in the previous quarter (figure 1).

Mining was a major contributor to overall growth due to an increase in iron ore production in response to the rising iron ore prices. A recovery in mineral prices could boost future mining activity in the country. General government, finance, real estate, and business services also contributed to overall GDP growth in Q3.

However, agriculture, manufacturing, utilities (electricity, gas, and water), and trade subtracted from overall growth. Agriculture contracted for the seventh straight quarter, as a direct consequence of drought conditions across the country.

Manufacturing contracted after a strong showing in the previous quarters, due to slowing domestic demand and weak trade. A contraction in manufacturing and weak domestic demand is reflected in declining utilities production. Measured by expenditure on GDP, growth in Q3 was 0.5 percent, down from 3.7 percent in the previous quarter. Gross fixed capital formation subtracted 0.2 percent from overall growth in Q3, while exports subtracted 9.0 percent.

Fiscal policy is likely to remain tight in 2017

The most prominent threat to the South African economy in 2016 was a sovereign credit rating downgrade to below investment grade, primarily due to fiscal imbalance (figure 2).

agencies have pegged South Africa’s sovereign credit rating at the lowest investment grade (or just above) with a negative outlook, due to structural imbalances, political instability, and weak business confidence. South Africa is likely to come under the scrutiny of the ratings agencies once again in mid-2017.

The ruling administration has made a commitment to fiscal consolidation. The medium-term budget policy statement (MTBPS), delivered in October 2016, indicates that South Africa’s Ministry of Finance expects the budget deficit for the fiscal year 2016–17 to be 3.4 percent of GDP, slightly lower than 4.2 percent in the previous year. The budget for the next fiscal year (2017–18), presented in February 2017, will likely reinforce a commitment to fiscal discipline in order to negate the threat of a ratings downgrade.

However, political instability and weak economic growth continue to pose risks. On the external front, what might work to South Africa’s advantage (and to the advantage of sub-Saharan Africa) is an uptick in global commodity prices, strengthening economic growth in the United States and Europe and allaying fears of a China hard landing. Internally, boosting domestic investment remains critical to overall growth: Gross fixed capital formation declined 5.2 percent in Q3 on a year-over-year basis, the third straight quarter of decline (figure 3).

Investment in machinery also declined in Q3 for the fourth straight quarter. Business confidence remains low and is likely to weigh on investment decisions. According to the South African Chamber of Commerce and Industry, the average of the business confidence index in 2016 was 93.5, far lower than 100 in 2015 (the base year for the index). Furthermore, monetary policy might also tighten in the near term.

Interest rates could edge up in 2017

The South African Reserve Bank (SARB) might come under pressure to raise the policy interest rate in 2017 in response to the domestic price rise and US Federal Reserve’s tightening monetary policy. The policy repo rate has been held steady at 7.0 percent since a hike in April 2016.

Even though the real effective exchange rate of the South African rand has been on an upward trend since the beginning of 2016, higher interest rates and improved economic performance in the United States are likely to keep the US dollar strong and exert downward pressure on the rand’s recovery.

Other factors likely to contribute to a weaker rand are a widening current account deficit in South Africa and a high inflation differential between the two countries (United States and South Africa). A weaker rand will likely add to inflationary pressure. Another factor likely to contribute to inflation is the higher price of crude oil. Inflation data in each month of 2016 (November 2016 being the latest available data point) was above the SARB’s target inflation range of 3–6 percent (figure 4).

Drought fuelled inflation, resulting in a sharp rise in food prices. If drought conditions abate, resulting in lower overall prices, and if the rand does not weaken considerably, then the SARB might hold the policy repo rate steady in the short term.

However, if interest rates are hiked, they are likely to weigh heavily on alreadyweak business investment and indebted consumers. Household debt in South Africa is roughly 75 percent of disposable income. Despite a decline from the highs of 2008, the level of household debt coupled with tighter monetary policy will likely keep consumer expenditure under pressure.

If South Africa stumbles in its fiscal consolidation plan or falls far short of its GDP growth potential (as it had in 2016), then a ratings downgrade in mid-2017 could result in a steep increase in interest rates and borrowing costs.

South Africa’s woes: More of the same

Apart from trying to maneuver between weak growth and tight fiscal (and monetary) policy, South Africa’s economy will have to continue to address certain persistent problems in 2017. Unemployment is likely to remain high: The official unemployment rate rose to 27.1 percent in Q3 2016, the highest level since early 2004 (figure 5).

High unemployment means that South Africa’s tax-paying population will remain relatively low, making balancing the fiscal budget difficult. Another problem is a shortage of skilled labour. This problem is rooted in a weak education system.

According to the Organization for Economic Cooperation and Development’s 2015 ranking of education systems, South Africa ranks 75 out of a list of 76. Furthermore, inequality in South Africa continues to remain stark, as indicated by the country’s Gini coefficient score of 0.66–0.69, one of the highest readings in the world. Infrastructure shortcomings also continue to plague the country.

The South African minister of finance, in his October MTBPS, committed to adding revenue through tax measures; allocating additional government expenditure to post-school education, health services, and social protection; and continuing investment in infrastructure. He also forecasts weak but improved growth of 1.3 percent in 2017. Though this is encouraging, South Africa will have to do a lot more if it is to meet its National Development Plan goals by 2030.

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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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