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South Africa’s GDP growth could surpass expectations but unemployment still persists

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The South African economy has been off to a good start in 2018. Statistics South Africa, the country’s national statistical service, released national accounts figures with revisions that pointed to more positive momentum in the economy than previously thought.

South Africa grew by 1.3% in 2017, beating the consensus estimate of economists, and the revised numbers no longer record a technical recession early in the year.

I n the six-monthly Monetary Policy Review that was held in April, The Reserve Bank of South Africa opined that “South Africa’s economic growth could pick up faster than forecasted if the right structural reforms are implemented”.

That means the economy could expand faster than the 2% for 2020 the central bank projected in the previous month, a rate it hasn’t exceeded since 2013. Since the turn of 2018, confidence has been up as the new political leadership under President Cyril Ramaphosa has demonstrated a strong commitment to strengthening institutional integrity—especially in stateowned enterprises—reaching out both to business and labor, and pronouncing his intention to build a new social compact in the country.

Cyril Ramaphosa replacing Jacob Zuma as head of the ruling African National Congress in December and as president two months later boosted sentiment and the currency on hopes of structural reforms in Africa’s mostindustrialized economy.

While Ramaphosa has since changed the cabinet to remove some Zuma appointees who were seen as compromised, overhauled the board of the state power utility and pledged to root out corruption, confidence indexes show business and investors now want to start seeing real reforms.

“The pickup in growth is not especially strong,” the central bank said. “This is mainly because, at this early stage, there is little clarity around the reform agenda and without specifics it is difficult to quantify growth responses.”

Ratings agencies similarly highlighted South Africa’s slow economic growth as a major concern. The National Development Plan affirms that South Africa’s economy needs to grow at an average of 5.4% annually in order to address the country’s high unemployment rate, which is at 27%.

However, there is a growing optimism around the country, which is shared by some of the major credit ratings agencies, that under President Cyril Ramaphosa’s leadership, SA’s gross domestic product (GDP) growth could surpass expectations.

In March 2018 Standard & Poorʼs global ratings revised South Africa’s GDP growth forecast for 2018 upwards, from 1% to 2%, citing a strengthening domestic and foreign investor sentiment following a change in the countryʼs leadership and ensuing policy announcements.

An ongoing global upturn is also boosting demand for both commodities and manufactured goods, the ratings agency said. It warned, however, that this was not enough to address the country’s unemployment crisis. Ratings agency Moody’s also gave South Africa a reprieve when it maintained the country’s sovereign rating at Baa3, one notch above junk status, with a stable outlook.

It cited, among other reasons for the decision to keep South Africa at investment grade, the change in the political leadership and the recovery of the country’s institutions. A downgrade would have been devastating for South Africa as it would have meant that all the three major ratings agencies had the country’s foreign currency and rand-denominated debt at sub-investment grade.

The country’s debt service costs, which are currently at R180 billion, would have increased by between R20 billion to R30 billion overnight, triggering South Africa’s expulsion from the Citi world government bond index and projected capital outflows of R100 billion. “We had to defend the [credit] rating with our lives,” said the National Treasury DirectorGeneral, Dondo Mogajane.

“Some investors that we spoke to were already saying, ‘If ever Moody’s downgrades you, we have been instructed by our credit committees to reduce our exposure by 90%,’ so holding guard on Moody’s was quite critical this time around.”

The currency on the other hand has also gained 9% since Ramaphosa was elected ANC leader, helping to lower price pressures. Inflation slowed to an almost three-year low of 4% in February. The central bank forecast it will remain in the 3% to 6% target band until at least the end of 2020, stabilising at just more than 5%. While current inflation is unusually low, recent developments in services prices and inflation expectations “provide some evidence that positive price shocks, if properly managed, can engender permanently lower inflation,” the central bank said.

The Reserve Bank assumes electricity prices will rise 7.3% in 2019 and 8% in 2020. The central bank’s approach is to wait for an announcement from the energy regulator before adjusting inflation projections, Governor Lesetja Kganyago told a forum on the Monetary Policy Review. “We hope sanity will prevail in terms of the increases granted,” he said. The Monetary Policy Committee cut its benchmark repurchase rate to 6.5% in March. The possibility of higher global interest rates, and its effect on inflation through the exchange rate, means the MPC is “not committing to a rate-cutting cycle.”

Finally, the 2018 budget returned to the government’s long-standing commitment to fiscal consolidation, which appeared to have been temporarily abandoned in the 2017 Medium-Term Budget Policy Statement. Business and consumer confidence is up, and market appetite for South African securities strengthened.

The rand strengthened by about 12% since the African National Congress (ANC) elective conference and 10-year government bond yields are down to levels last seen in 2015, reducing borrowing costs.

Fueled by the confidence boost—and much more benign inflation—South African growth is expected to accelerate. Many economists, including those at the World Bank, have revised their growth forecasts upwards. In its latest publication, the 11th edition of the South Africa Economic Update, the Bank predicts growth of 1.4% in 2018 and 1.8% in 2019 (previous estimates were 1.1% and 1.7% respectively).

The estimates are on the conservative side. This is largely owed to the fact that confidence still needs to translate into consumer spending, which may be weighed down by the revenue measures of the 2018 budget, and into investment. There are several reasons that may keep investors cautious.

Mining is still held back by uncertainty over legislation, even though the government has reached out to resolve disputes over the country’s third Mining Charter. In addition, World Bank projections suggest that prices for South Africa’s raw materials will remain modest or decline (as in the case of coal).

Following the vote in parliament in early 2018 to review the Constitution to potentially make it easier to expropriate without compensation is likely to weigh on investment in commercial agriculture. The manufacturing sector has been struggling to increase global competitiveness and its weak integration into global value chains limits its opportunities to grow with the world economy.

Indeed, the January and February lift in the Purchasing Managers Index, which indicates the economic health of the manufacturing sector, was not sustained, falling back into contractionary territory in March. Whether growth picks up beyond a modest cyclical rebound will depend on the government’s ability to deliver against high expectations to reduce policy uncertainty and accelerate structural policies that can raise the growth potential of the South African economy more meaningfully.

The most recent economic update simulates various reform scenarios and their impact on jobs, poverty, and inequality. It holds some potential good news for South Africa, as inequality is likely to decrease from current levels (South Africa is the most unequal country in the world, according to the Bank’s recent Poverty and Inequality Assessment).

Growth and jobs creation will play an important role in making South Africa less unequal, which will help the government’s efforts to strengthen the social compact.

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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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