South Africa: Dawn of a New Era?

27 May 2018

Financial markets have celebrated the selection of Cyril Ramaphosa as leader of the ANC in December 2017, and his subsequent election as the Republic’s president.  The beleaguered Rand (ZAR), for example, has rallied over 20% in the past four months.  Even the rating agencies have jumped on the band wagon.  Both Fitch and S&P (as recently as in November) had downgraded South Africa (RSA) to junk status, but in the past few days Moody’s maintained their investment grade rating, and upgraded their outlook from negative to stable.  Has a new era begun in South Africa?  A comprehensive answer to this question is beyond the scope of this short blog.  But, with key elections upcoming in 2019, I will use a collection of my favourite charts — saving you time reading too much! — to shed light on the issues that will shape policy decisions prior to polling day .  And, I will outline strategic implications for financial markets.

Good Luck Cyril!: The Legacy of the Zuma Administration

In the wake of the Global Financial Crisis, the past decade has been difficult for all nations, but South Africa’s economy  has under-performed. Chart 1 (at the top of the blog), for example, illustrates that during Thabo Mbeki’s 10-year presidency, RSA’s per capita GDP converged consistently towards the OECD average.  During the subsequent decade, however, South Africa’s economic performance has diverged sharply compared to the rest of the OECD.

Remarkably, much of this under-performance has taken place since President Zuma announced the National Development Plan in 2012.  This program’s key objectives were to eliminate poverty and dramatically reduce inequality  by 2030.  Poverty had been successfully reduced between 2006 and 2011:  declining from 51% of the population to a still sky-high 39%).  Chart 2, however,  shows that poverty has risen since 2011!  Moreover, poverty has increased for virtually all demographic groups — male, female, blacks, and coloureds.  Only amongst the White and Indian/Asian populations did destitution decline (from already low levels).

Chart 3 illustrate that the degree of income inequality is amongst the highest in the world. And despite the NDP’s ambition to address this social ill, the Chart indicates inequality also has risen during the past decade. (Gini indices range from 0 to 100 with high numbers indicating greater inequality).

South Africa’s high level of unemployment is a major factor behind both poverty and inequality. Joblessness now stands at 27% compared to an already scandalous 24% in 2010.  Stunningly, youth unemployment tops 50%.  There are many reasons for such high levels of joblessness, but two will likely dominate pre-election policy debates, and  I will deal with the role of wages later. However, there is broad consensus that the education system is failing.  Indeed, the following Chart illustrates that RSA’s rate of school completion is the lowest in the OECD.  Not only are students not graduating, but even those finishing do not have the skills currently sought: as revealed by a growing skills mismatch in the labour market.

The next Chart identifies one of the reasons for the these poor results —  the level of spending on education is 50% below the OECD average.

The NDP also aims to boosts RSA’s potential GDP growth rate towards 4% from 1.5% presently, largely through improving the business climate.  In the 2018 WEF Competitiveness Report, South Africa ranks 61st out of the 137 countries participating. And, RSA’s ranking slipped from 52nd in 2012, and 49th as recently as 2015.  The following Chart reveals that South Africa’s rating on many  institutional factors approaches developed countries levels: good marks for investors’ rights, IP protection, business sophistication, judiciary, etc. (granted, there is still room for improvement). On health care, education, labour markets, infrastructure, and crime, however, RSA truly remains a developing and divided economy.

Despite this mixed picture, South Africa’s corporate sector is one of the more profitable in the EM universe.  To be sure, as is true world-wide, RSA’s firms have increased debt in recent years. However, the following Chart indicates that corporate debt levels are more manageable than in many EM nations.

Fiscal policy is a key concern for both financial markets and credit agencies.  During the Mbeki era, South Africa had a reputation for fiscal probity, and government debt was low and declining.  During the past decade, however, fiscal slippage has led to a sharp increase in government liabilities (next Chart).  While it is worth noting that the level of public sector debt is in line with (or lower) many other EM and OECD nations, the trend is worrisome indeed.

The deterioration in the public finances largely reflects increased government spending, which rose from below 30% to 33% of GDP during the past 10 years.  Again, it is worth noting that the overall level of spending is not out of line with its peers.  However, alterations in the composition of spending could help combat poverty.  In a poor, unequal nation, it is not too surprising that transfers represent 30% of government spending.  However, the following Chart reveals that public sector pay (as a percent of both GDP and overall government outlays) is well above OECD and EM levels.  As a result, public sector investment ( on infrastructure, etc.) is crowded out, represents only 3% of GDP. Indeed, South Africa’s low-level of gross savings (16% of GDP compared to the 22% EM average) leads to a low-level of investment — a key contributor to RSA’s tepid long-term GDP growth potential.

Ramaphosa Era:  Tentative Steps in the Right Direction

Prior to next year’s elections, President Ramaphosa is likely to focus on stabilising the fiscal situation (reflecting concerns about further credit ratings downgrades) and lowering poverty and inequality.

In February’s budget announcement, the government highlighted some of its fiscal priorities for 2018/19 and the years beyond.  At a minimum, the budget was praised for refraining from the inflammatory, populist rhetoric of previous speeches.  The government  is attempting to cut the budget deficit without choking off the recently improved economic performance.   To this end,  the government has made steps, albeit tentative, in the right direction.  First of all, the 2018/19 deficit will be reduced to 3.6% from 4.3% of GDP last year.  However, the government refrained from implementing the additional 1% of GDP fiscal tightening required to stabilise the public sector debt.  As a result, the central government’s debt/GDP ratio will continue to rise toward 56% in 2020 from 52% of GDP last year.

Reflecting the priority placed on reducing unemployment, poverty, and inequality, the government announced welcome plans to increase educational spending for poor families. This should amount to an additional 1.5% of GDP in the coming years.  Unfortunately, the government did not take the opportunity to curb pay increases for public sector employees, which will rise nearly 8% this year.

The second pillar of effort to reduce poverty and inequality is the implementation of a higher minimum wage.  This plan is likely to be rolled out gradually beginning in the coming months.  The Chart above indicates that the proposed level (Rand 20/hour) is high compared to other countries.  However, this largely reflects the  very low-level of prevailing South African wages.  It is estimated that nearly 50% of the working population will benefit from this program, so it should meaningfully impact poverty  The government and the central bank (SARB) will closely monitor any deleterious effects on inflation, employment, and GDP.

Strategic Implications: inflation and the SARB
  • The SARB forecasts CPI inflation at 4.9% and 5.2% in 2018/19 respectively. With wages already rising 6.8%, the SARB will assess carefully the impact of the minimum wage and public pay deals  on its 3-6% inflation target.  Both the SARB and the market anticipate the repo rate to rise 25bp by year-end, and an additional 50bp in 2019.  Even though GDP growth has accelerated, I believe that considerable slack remains in the economy, and that inflationary pressures will diminish.  Indeed, recent data indicate that the ZAR’s appreciation already has improved the inflation performance.  In the run-up to the election, therefore, the SARB will be under pressure not to raise by the anticipated 75bp.  Rather, monetary policy is likely to remain on hold, and I believe the next move in rates in fact could be lower.

  • Following ZAR’s sharp rebound, the Rand is no longer dramatically undervalued (next Chart). In a pro-growth, pre-election environment, I expect policymakers would prefer lower interest rates rather than a strong currency.

  • In addition, ZAR will face the headwind of rising US interest rates.  The following Chart indicates that South Africa has a large external borrowing requirement caused by the combination of a current account deficit, high short-term external debt, and very low levels of international reserves.  Therefore, South Africa could be vulnerable to a reduction in global investors’ risk appetite.  The final Chart illustrates that South Africa finances its current account deficit through portfolio inflows — note especially that foreign direct investment fled the country during the later Zuma period.  This mix, again, could potential leave the ZAR vulnerable to reduced global risk taking, as the US Federal Reserve normalises policy.