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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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South Africa

The battle ahead for Cyril Ramaphosa to fix Africa’s second largest economy – South Africa

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South Africans (SA) have breathed a collective sigh of relief. After extensive campaigns and infinitely examined possibilities, the election is over and the ruling African National Congress is in power with what most democracies would consider a sizeable majority of the popular vote.

After President Cyril Ramaphosa was elected president unopposed by the National Assembly on 22nd May 2019, he assured all South Africans he will be a president for all.

Ramaphosa said he is “truly honored and humbled to be elected to serve people of South Africa”.

“I will seek to act and be the president of all South Africans, and not just those who voted for the party I lead,” Ramaphosa said.

“I will be a president for all South Africans, and not just for the African National Congress.”

He said the composition of the National Assembly is a reflection of the will of the people.

“Collectively all of us who are here have a mandate to build a nation founded on social justice. They also have a mandate to revive the economy to create jobs to actualise hope so that people’s aspirations are met.

In building the economy, the new administration needs to move speedily to revive an economy that has expanded at an annual pace of less than 1.5% for the past four years and tackled a 27 percent unemployment rate by reducing policy uncertainty and bolstering private investment, according to Raymond Parsons, a professor at the North West University’s School of Business and Governance.

“A key test will include the selection of a credible and streamlined cabinet that also enjoys the confidence of business and the markets,” he said.

Before the election, Ramaphosa’s reticence to carry out a clean sweep may stem from his tenuous hold on the ANC in the aftermath of a hard-fought internal election that’s left the party deeply divided and has resulted in some Zuma allies remaining in top party posts.

The president faces a number of urgent economic priorities, and how he handles these will decide which way Moody’s review of South Africa’s roughly R2-trillion of sovereign debt will go. The next review is scheduled for November 2019, but could happen sooner.

If Moody’s decides that risks have increased and downgrades the country to sub-investment grade, SA will be ejected from the Citi World Government Bond Index, forcing asset managers to sell billions of rands worth of SA bonds.

The consequences of a downgrade will ripple through the economy like falling dominoes. A sell-off of rands will cause the currency to weaken and inflation to rise as a result of more expensive imports. A rising fuel price alone has the potential to drive inflation across the economy. In a bid to manage inflation, the South African Reserve Bank could increase interest rates. At the same time, the cost of government borrowing will increase as investors demand a higher return on their investment in government bonds, leaving less to spend on infrastructure. Whichever way we turn, life in SA will become more expensive.

A downgrade will also deal a blow to Ramaphosa’s goal of attracting $100-billion in new investment to South Africa.

Thus, inspiring the confidence of rating agencies, investors, business, labor and consumers is essential to kick-starting the country’s sluggish economic growth rate. How exactly this will be achieved is, of course, the million-dollar issue and investors will be watching the president closely in the coming weeks and months.

Immediate Obligation

The first big post-election milestone will be the appointment of the new Cabinet, an essential step in the creation of a capable state.

“The market will be watching for competent appointments, particularly in the areas of finance, trade and industry, economic development and telecommunications,” says Nedbank chief economist Dennis Dykes.

Upon his election as the president, Ramaphosa said that his new Cabinet would be pleasing to South Africans as he is under pressure to pick ministers untainted by scandal and to trim it down, with its size hinging on the extent to which government departments will be reconfigured for a leaner, more efficient administration.

Asked if he would downsize on his Cabinet, he said: “I am not yet sort of locked on numbers; I am dealing much more with functionality and efficacy.”

It goes without saying that the market will not respond positively to the appointment of people tainted by State Capture, corruption and patronage. However, the president has limited choice and has to stick to the ANC’s prescribed list of candidates, with the exception of two positions where he has the discretion to appoint from the outside.

All eyes will be on the economics cluster, where change is rumored.

Quick policy wins

Many promises have been made, but not kept.

In February, the president spoke about reducing the cost of doing business in SA. How will this be practically executed? The World Bank’s 2018 Doing Business Report placed South Africa 82nd out of 190 economies (compared to a ranking of 32nd in 2010). Improving on the performance in terms of the criteria used by the World Bank for the score — including ease of starting a business, dealing with permits, getting credit and enforcing contracts —should be a priority.

Ramaphosa also promised to accelerate the licensing of the high demand radio frequency spectrum. While some progress has been made as far as the policy goes, the government’s instinctive urge to control this valuable spectrum is hampering progress.

Similarly, simplifying SA’s visa regime has apparently been prioritised, but appears to have been stalled by the director-general at Home Affairs.

“South Africa is losing ground against the rest of Africa and other emerging tourist destinations, that is evident in the stats,” says Dykes. “Making SA an attractive tourist destination is such low-hanging fruit all you have to do is open your mouth. Where is the progress?”

Ramaphosa also promised to review the configuration, number and size of national government departments.

“Cutting down the size of government would send a powerful signal that the president is determined to implement reforms,” says Dykes.

Fighting Corruption

Investors — both local and foreign — will take heart when there is decisive and visible action against corruption, whether led by the private sector, such as Steinhoff and VBS Bank, or by the public sector. It is clear that leadership issues at the National Prosecuting Authority are being addressed, but questions are being asked about the government’s appetite for prosecution.

“Pushing the National Prosecuting Authority to take action is not fully within Ramaphosa’s ambit, but further capacitation would be good,” Dykes said.

“The president does not have to have a hand in the prosecutions, but he can stress the urgency by reiterating government’s commitment to take action,” said Mondi. “He could also announce the new head of the Public Investment Corporation and provide details on Eskom’s chief re-organization officer. These are all signs that he is acting against State Capture and for capacitation.”

Restructuring the economy

Restructuring the economy to support economic growth. Current ANC economic policy will not deliver the growth rates necessary to reduce unemployment and structural reform of the economy is essential.

“South Africa will never become a self-sustaining, self-help, transformational growth story within existing ANC policy frameworks,” says Madalet Sessions, portfolio manager at Denker Capital.

“Without structural reform, realistically the only thing we should expect from Ramaphosa is bureaucratic reform and reduced corruption. But even if this was the case, a more capable state would at the very least support growth.”

Structural reform means treading where angels fear to go.

Black economic empowerment rules, for instance, are complex and administratively burdensome, particularly for small business.

“The new requirements saw small businesses go from a level 2 to level 7 with the stroke of a pen,” says Dykes. “This system is complex and opaque and causes great uncertainty.”

South Africa’s economic policy is often implemented without proper analysis of the consequences. For instance, Eskom and SAA went ahead with revised procurement policies, driven by vested interests, that required higher levels of local procurement, but which drove cost structures to unsustainable levels.

There is a need for the government to implement a policy that is economically sensitive, and not just politically sensitive.

Investing is all about risk and reward. Investors will be watching the government closely to see whether it has the appetite to get this equation right. If Ramaphosa can achieve this, investors will come.

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