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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

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

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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.

Dawie-Roodt-Chief-Economist-at-Efficient-Group

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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