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Weak Economic Growth Knocks ‘Ramaphoria

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South Africa’s economy contracted in annualized terms in the first quarter, pointing to the end of the so-called “Ramaphoria” that followed the new president’s appointment in January, and highlighting the ongoing challenges facing the economy. Data released by Statistics South Africa showed the economy shrank 2.2% on a quarter-on-quarter basis and in seasonally-adjusted annualized (SAAR) terms, reversing the strong outturn recorded in the fourth quarter of last year (Q4 2017: +3.1% SAAR). Driving the broad-based moderation—the worst since the depths of the financial crisis—were contractions in the mining and manufacturing sectors, as well as in the agricultural sector.

Note: Year-on-year changes of GDP in %
Source: Statistics South Africa (Stat SA)

After Jacob Zuma was forced out as leader by the ruling party in February, Ramaphosa pledged to clean up governance, deal with high unemployment and improve basic services, igniting a wave of optimism dubbed “Ramaphoria”.

South Africa’s economy has barely grown in the past decade with fiscal missteps and corruption contributing to weak business and consumer confidence.

However, the poor gross domestic output (GDP) in the first three months of 2018 will erode some of the enthusiasm in Africa’s most industrialized economy. The rand weakened by almost one percent against the dollar in response. The rand lost ground against the major currencies as well in midday trade on 5th June 2018:

  • Dollar/Rand: R12.64 (0.60%)
  • Pound/Rand: R16.90 (1.00%)
  • Euro/Rand: R14.78 (0.59%)

GDP contraction was led by a slowdown in agriculture and mining, after its strong growth in the final quarter of last year, Statistics South Africa said with the electricity, construction and trade industries also recording negative growth, the group revealed.

The 2.2% fall is the largest quarter-on-quarter decline since the first quarter of 2009. In that quarter, the economy contracted by 6.1%.

After recording four consecutive quarters of robust growth in 2017, the agriculture industry lost ground in the first quarter of 2018, contracting by 24.2%, the largest quarter-on-quarter fall since the second quarter of 2006.

Agriculture’s relatively strong performance in 2017 is one of the positive factors that helped keep the economy afloat in 2017. This momentum failed to carry through to 2018, with decreased production in field crops and horticultural products contributing to the decline in the first quarter.

Mining entered into recession with its second consecutive quarter of economic decline. According to Stats SA’s data, production was down 9.9% in the first quarter of 2018, following on from a decrease of 4.4% in the fourth quarter of 2017. Lower production in gold, platinum group metals and iron ore were the main contributors to falling performance.

“Manufacturing also failed to make a positive contribution to economic growth, falling by 6.4%. The decline was driven largely by a fall in production of petroleum and chemical products, as well as basic iron and steel,” Stats SA said.

“The trade, construction and electricity industries also recorded negative growth in the first quarter of 2018 compared with the fourth quarter of 2017. Trade activity fell by 3.1%, on the back of weaker wholesale, retail and motor trade sales and lower activity in catering and accommodation.

“The construction industry continued to contract, experiencing its fifth consecutive quarter of decline. The industry has lost R1.7 billion in value since the fourth quarter of 2016, falling from R110 billion to R108 billion in the first quarter of 2018 (constant 2010 prices, annualized),” the group said.

Economic activity in transport, finance, personal services and government increased in the first quarter of 2018. The 1.8% rise in general government was mostly related to increased employment numbers in the public sector, it said.

The first-quarter reading upset analysts, who had expected a more moderate 0.5% SAAR contraction. In a survey conducted by Reuters, some economists had expected a quarter-on-quarter GDP contraction of 0.5 percent. “Today’s downbeat figure will dampen some of the enthusiasm surrounding President Cyril Ramaphosa,” Capital Economics senior emerging markets economist John Ashbourne said.

“South Africans themselves were also optimistic; consumer confidence jumped to an all-time high in first quarter. But this ‘Ramaphoria’ does not seem to have translated into stronger spending,” he said, adding a swift turn-around was unlikely.

Furthermore, on an annual basis, growth slipped to 0.8% (Q4 2017: +1.5% year-on-year). “GDP rose 0.8 percent on an unadjusted year-on-year basis in the first quarter, compared with a 1.5 percent expansion in the previous three months,” the agency said.

Adding to evidence that economic growth remained fragile, a survey showed South African private-sector activity was at a standstill in May, with an increase in new orders and rising employment offset by a contraction in output.

“A contraction in GDP for the first quarter of 2018 was expected, but it won’t completely derail growth forecasts for 2018,” according to another economist.

In a market report FNB Chief Economist Mamello Matikinca said that the contraction is usually expected in consumption-driven economies, especially off the back of a high base set in the previous year.

“GDP growth for 2017 was 1.7%, as growth in the fourth quarter was 3.1%. As we have communicated in previous weekly publications, we expect a Q1 ’18 GDP contraction of approximately –1% q/q,” she said.

“We expect much of the weakness to stem from the mining and manufacturing sectors, while a disappointing retail trade number has the potential to drag our forecast number lower.”

Growth in the agriculture sector is viewed as a “wild card” and the double-digit growth recorded in previous quarters may not be sustained, Matikinca warned.

“Our calculations suggest that a small contraction in GDP will not derail the 2018 growth forecast of 1.9% as the quarterly year-on-year number will remain positive.

“We would have to see a contraction of more than –3% q/q for us to consider revising our full year number lower,” she explained.

Manufacturing data for April will be released soon. Matikinca expects a better report than the -1.3% year-on-year contraction recorded for March. “A positive print will be a good start for the sector which is still trying to gain traction as domestic economic growth begins to accelerate.”

Domestic demand eased markedly, held back by across-the-board slowdowns. Growth in household spending more than halved, slowing to 1.5% SAAR (Q4 2017: +3.6% SAAR) as consumers were pinched despite moderating inflation and a stronger rand. Growth in government spending, likewise, slowed to 1.2% SAAR (Q4 2017: +1.6% SAAR), which nonetheless reflected an increase in state-paid employees. Fixed investment contracted 3.2% SAAR in the quarter (Q4 2017: +7.4% SAAR) on a nearly broad-based decline in activity—including residential and machinery outlays, as well as construction activity. Non-residential investment, on the other hand, was the only subcategory to record growth. Modest buildups of inventories, which contributed 0.1 percentage points to the headline reading, were recorded in the manufacturing and utility industries.

The external sector also posted a disappointing outturn, with exports of goods and services falling 16.5% SAAR (Q4 2017: +12.3% SAAR) on falling trade in base metals and mineral products—coinciding with the contraction in mining output. Meanwhile, imports of goods and services fell 6.5% SAAR as machinery and vehicle imports plummeted. Taken together, the external sector subtracted 3.1 percentage points from the headline reading—a modest improvement from the 4.0 percentage points subtracted in the fourth quarter last year.

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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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