External factors challenge South Africa's record of strong economic growth

South Africa’s economy has experienced relatively slow growth in recent years, and GDP has not risen by the rates seen prior to the global financial crisis of 2008-09. The country is suffering from the same global trends as many other developing markets, with falling commodity prices and the threat of rising interest rates taking their toll. However, South Africa benefits from a number of comparative advantages, such as a robust financial services industry and a strong private sector. It is Africa’s second-biggest economy, its most globally integrated in terms of capital and trade flows, and it has sound fundamentals. Indeed, while South Africa’s growth rate has not fully recovered, it is still in positive territory and doing better than many other similar markets.

Despite its strengths, local issues have also weighed on growth. Labour disputes, power supply problems (see analysis), high levels of household debt, inflation, and low business and consumer confidence are all exercising downward pressure on the economy.

History

The story of the South African economy in many ways reflects the country’s recent history. After growing rapidly in the 1960s, with GDP growth hitting 7.9% in 1964, it suffered due to the isolation of the apartheid era. The economy experienced five years of contraction between 1982 and 1993. After the end of apartheid in 1994 it recovered quickly, with GDP growth peaks of 4.3% in 1996 and 5.6% in 2006, according to the World Bank. This was a reflection of the rapid liberalisation of the market, the opening up of the economy and rising commodity prices.

After the onset of the global financial crisis the economy contracted by 1.5% in 2009. Growth has been flat since, and was 1.5% in 2014. GDP was $328bn in 2014, according to Statistics South Africa. The leading contributor is the finance, real estate and business services sector, with a share of 18.4%. Other key sectors are government services (15.2%), wholesale, retail, motor trade and accommodation (13.3%), manufacturing (11.9%), transport, storage and communication (9%), and mining and quarrying (7.5%).

Government Goals 

The government’s economic development strategy has been articulated through initiatives laid out by the National Planning Commission, which was set up in 2010. In 2011 it released the 2030 National Development Plan (NDP). Reduction of inequality, job creation and the promotion of inclusive growth are central to the NDP. Among its economic targets are minimum annual GDP growth of 5%, creating 5m jobs by 2020 and 11m jobs by 2030, and bringing unemployment down to 6%. Socio-economic goals by 2030 include reducing the poverty rate from around 40% to zero, improving the Gini coefficient from 0.7 to 0.6, doubling per capita incomes and improving electricity access from 70% to 95%.

Meeting those targets will be difficult, given the exogenous pressures South Africa faces and domestic constraints on manufacturing inputs. The Medium-Term Strategic Framework breaks the NDP down into a five-year span from 2014 to 2019, with targets, roles and timeframes. There are 14 outcomes that focus on aspects such as rural development, land reform, job creation, inclusive growth and social services. Goals for 2019 include reducing unemployment to 14%, increasing investment to 25% of GDP and adding 10,000 MW of power generation capacity. In 2014 the government announced Operation Phakisa, an economic development programme designed to fast-track NDP implementation. The first phase will target maritime activity, which includes fisheries, marine transport, and offshore oil and gas exploration.

SMES

As with many emerging markets, small and medium-sized enterprises (SMEs) make up a large proportion of South Africa’s private sector. According to the NDP, 90% of planned new jobs will be created by SMEs by 2030. To enable this, the government has rolled out a new department charged with aiding SME activity, the Ministry of Small Business Development.

SMEs are being hit by the broader headwinds facing the economy. They are at risk because they lack capital buffers to ride out short-term downturns in activity, and because they largely operate in the informal sector. Some 1.5m people ran informal businesses in 2013, according to Statistics South Africa, and the informal sector is estimated to account for 5% of GDP. The new authority will work on cutting red tape, improving the business environment for SMEs and expanding the incentives available to them. Addressing financing challenges is also a high priority. Most universal banks are not set up for SME lending, given the lower returns and elevated risk the segment brings, and the need for higher levels of transparency.

Forecasts

 While the forecasts vary, none foresee dramatic growth in the short term. The IMF predicted in October 2015 that South Africa would experience full-year growth of 1.4% – and 1.3% in 2016 – while the World Bank expected 2% in 2015 and 2.1% in 2016. The South African Reserve Bank (SARB) – the central bank – estimated in September 2015 that full-year growth would come in at 1.5%.

The strain is being felt particularly strongly in specific sectors. For example, the GDP of primary industries contracted by 9.3% in the second quarter of 2015, according to Statistics South Africa. Secondary industries were down 1.4% in the first quarter of 2015 and 4.7% in the second quarter. As a result, the country experienced a manufacturing recession in the first half of 2015. By contrast, tertiary industries have added relative buoyancy, growing by 1.1% in the second quarter. However, the economy is doing better than some other BRICS countries. Brazil, for example, grew by only 0.1% in 2014 and fell into recession in 2015, contracting 1.9% in the second quarter and 0.7% in the first quarter, according to the OECD.

South Africa’s repo rate – at which the central bank lends to commercial banks – hit a record low of 5% in July 2012 but began to rise at the beginning of 2014, and was lifted to 6.25% in 2015. The rate, which has been as high as 21.86%, averaged 9.25% between 1998 and 2015. SARB has decided to tighten policy, and shifted from an expansionary position to a more cautious approach in a bid to prevent imbalances in the market, avoid bubbles and encourage savings. However, it seems that as forces largely outside of SARB’s control are affecting the currency, and that the weaker rand is not having a major impact on inflation, the bank is reluctant to take aggressive action.

Inflation

In 2015 the consumer price index went from a low of 3.9% in February to 5% in July. Yet the trend was not sustained and has since reversed, leaving some questioning whether concerns over inflation are being overplayed. In September 2015 the rate stood at 4.6%. Like many developing markets, South Africa is no stranger to major inflationary hikes. Indeed, the rate broke 20% in the late 1980s and the average rate was 9.33% between 1968 and 2015. Relatively speaking, inflation is now largely under control.

Commodities

From January to June 2015, South Africa’s biggest export was iron ore. Gold was second, palladium third and platinum seventh, with various other ores and alloys also in the top 10. The fact that nearly all of these commodities have fallen in price, with some crashing, has had a strong impact on revenues and therefore the economy. Platinum, which was trading at almost $2200 an ounce in late 2007, has dropped to around $860, while gold, which reached $1900 per troy ounce in September 2011, is now at around $1070. In August 2015 exports of base metals were 20% down year-on-year, while exports of mineral products were down by the same percentage.

As South Africa is a net importer of oil, the economy could have benefitted more from the much-reduced price of crude, but any advantage has been cancelled out by the broader commodities crash. “Being an oil importer, you would expect a boost, but the country is also an exporter of commodities,” said Patrick Raleigh, associate director of sovereign and international public finance ratings at Standard & Poor’s.

Industrial Action

South Africa has also been hit by industrial action. In 2014 it experienced at least 88 strikes. Although such action is not uncommon in the country, these lasted far longer than normal and the demands were greater. For example, platinum workers walked out for five months, the longest downing of tools in South Africa’s history, and demanded a doubling of wages. The Department of Labour calculated that the strikes in 2014 cost the economy R6.1bn ($527m). “The mining strike was a blow to sentiment,” Jorge Maia, head of research at the Industrial Development Corporation, a state-owned development finance institution, told OBG.

Given its dependency on commodities, the slowdown of the Chinese economy – and therefore demand – is a concern, as the country has been South Africa’s largest trading partner since 2009. It has also been a major investor, most notably in the minerals sector. While China remains engaged in the region and reports suggest that it remains committed to the country and the wider continent, the figures suggest that the concerns are not without good reason. In the first half of 2015 China’s investment in Africa fell by 84%. Chinese investment in the continent peaked at $11.7bn in 2008 and is now around $1.5bn a year, according to The Financial Times.

Fiscal Deficit

Since the global financial crisis the books have not balanced and the situation is much as it was in the 1990s, with the deficit hitting 6.3% in the 2009/10 fiscal year. While the ratio is now down to around 4% of GDP, it is proving stubborn.

Previous spending patterns help to explain the current situation. The government had reduced the expenditure-to-GDP ratio from 28% in the late 1990s to 25% in 2003. It also brought revenues from 23% in the 1990s to above 25% in 2006. Yet the ratios did not tell the whole story. The economy was growing quickly and so was expenditure. In rand terms, spending tripled between 2001 and 2009. When the crisis hit, the government had significant existing budgeted obligations, a need to spend money in a countercycli-cal manner and falling revenues, as profits and sales fell and unemployment rose. While the government has been pushing for austerity to bring the figures back into line, it will be difficult, given the need for spending related to economic recovery and welfare for those who have been affected by the slowdown.

Given the drop in commodity prices, it is likely that the government will have to make deeper cuts than expected in the budget, making it hard to reach its targets. The budget is under pressure at a time when spending needs to be targeted at stimulus packages and welfare. “You have real challenges when growth is 1.5-2%. That is not enough to reduce unemployment and inequality. You need 5%,” said Axel Schimmelpfennig, senior resident representative at the IMF.

Government debt to GDP has risen to 41.2% in 2014/15. While that is not high compared to the levels in most developing countries, it is set to rise to an estimated 44.7% by 2017/18. While the IMF expects South Africa to be able to service its debts, it sees this high level of obligations as making it vulnerable to external shocks and rising global interest rates. The ratings agencies are watching closely. In November 2014 Moody’s downgraded the government’s debt to “Baa2” from “Baa1”, and Standard & Poor’s lowered its rating to “BBB-” from “BBB” in June 2014.

Trade Imbalance

South Africa’s balance of payments is causing concern for the authorities and businesses alike. In January 2015 the trade deficit hit a record high of R24.2bn ($2.1bn), when the market had forecast a deficit of under $10bn. The wide gap was the result of a 23.1% fall in exports. The decline was seen across the board, and was the result of falls in every category, from resources to manufactured goods. The next two quarters proved volatile, with the balance veering between deficit and surplus. The current account has been negative since 2003, and has worsened since 2011. As a percentage of GDP, it troughed at -6.2% in the second quarter of 2014, a level not seen since the 1970s. It has since rebounded to -3.1%, and has not been below -4% since 2012.

Currency Concerns

The rand has been moving in sympathy with the deteriorating balances and more generally as a result of global economic conditions. It has lost around half its value since 2011, falling from R6.6 to the dollar in January of that year to a low of R14.1 in September 2015 (it had been as strong as R6 to the dollar in 2006). The weak rand has in some ways come as a relief to the economy, as it is making exports cheaper and has the potential to slow domestic consumption and balance trade. Yet its fall has been offset by the fall in commodity prices and domestic issues weighing on the economy.

FDI

Between 2002 and 2014, total foreign direct investment (FDI) in South Africa rose three-fold, slowing only briefly around the time of global financial crisis. However, as a reflection of the broader decline in emerging markets and commodities since early 2014, FDI inflows have dropped off sharply. According to SARB, total FDI has been stagnant at around R1.6trn ($138.2bn) since early 2014. UN Conference on Trade and Development figures show a 32% year-on-year drop in FDI inflows to $5.7bn in 2014, down from the peak of $9.2bn in 2008, and the number of greenfield investments fell from 161 to 121.

Most analysts feel that this is more of a reflection of global patterns than the specifics of the South African market. The authorities are also aware that the investment coming in is not always the most constructive in terms of sustainable growth. Analysts say that too much is going into the natural resources sector and acquisitions of existing companies, and not enough towards the building of new capacity.

The government has a range of measures in place to encourage more and higher quality FDI. The 121 Investment Scheme, which runs until the end of 2017, targets greenfield and brownfield investment and supports the building of manufacturing facilities and the training of workers. It offers allowances of up to R900m ($77.8m) for greenfield projects.

The country also has the Automotive Investment Scheme, which offers grants and credits for investments in vehicle manufacturing; the Capital Projects Feasibility Programme, which contributes to feasibility studies for projects that might boost exports; and Export Marketing and Investment Assistance, which compensates firms for investments that could increase exports. “FDI has been largely of an acquisition type,” Maia told OBG. “We would prefer to see more greenfield and brownfield investment.”

Some notable investments have been announced recently, however, suggesting that South Africa may be able to attract more productive international participation. In August 2015 Volkswagen said it would be investing R4.5bn ($388.8m) up to 2017 in its factory at Uitenhage. The funds will go towards manufacturing facilities (R3bn, $259.2m), local supplier capacity (R1.5bn, $129.6m) and training (R22m, $1.9m). The German car firm said it was making the investment because South Africa is a good site for exports to the rest of Africa, and because the government provided support. The company had demonstrated commitment to the country over the long term, investing R5.9bn ($509.8m) between 2007 and 2014.

Historically Open

South Africa is open to foreign investment and seen as a welcoming economy. The country underwent a major round of liberalisation after the end of apartheid in 1994, including the lowering of tariffs, regulatory reform, the end of most import controls and a series of privatisations. Now it is relatively open and free. Non-nationals can participate in almost all sectors, with government approval required in only a few, such as energy, mining, banking, insurance and defence. No prior approval is otherwise needed and private property is protected.

However, foreign exchange is one challenging area. While non-residents can freely import and export capital, locally incorporated companies, including subsidiaries of foreign firms, are subject to exchange controls, although there has been a substantial relaxation of these controls over the years. In some cases, central bank approval is required for these entities to make payments overseas. Dispute resolution can be slow, the bureaucracy can be complicated and it can be difficult to access basic services.

South Africa ranked 73rd in the World Bank’s “Doing Business 2015” report, down from 69th in 2015. It is fourth in Africa, behind Mauritius, Botswana and Rwanda, but still ranks poorly in some key areas. The country is 120th in terms of starting a business, down from 113th in 2015. The process is relatively cheap but takes 43 days, 20 days longer than the average in sub-Saharan Africa. South Africa is ranked 168th in the report for getting electricity (taking 226 days), 119th for enforcing contracts, 101st for registering property, 90th for getting construction permits and 130th for trading across borders.

Personal Debt

The level of personal debt has been growing in recent years and poses a challenge for policymakers. Indeed, South Africans are some of the most indebted people in the world. According to the World Bank, 86% of the population took out a loan in 2013/14, compared to the global figure of 40%. Of those who are credit-active, around half are in arrears. A consumer-driven economy – household final consumption is over 60% of GDP in South Africa – can only grow so fast if people cannot spend. Those who have borrowed have very little free cashflow, as much of their income is committed to paying down their loans. Other factors – such as the weak rand and inflation – also weigh on the country’s consumers. Consumer confidence has been falling since 2010, and in June 2015 it hit a 14-year low.

Unemployment

One of the most worrying factors in the South African economy is unemployment. The rate had dropped considerably, from above 30% 15 years ago to 21.5% in 2008. However, since the global financial crisis, it has risen again. In the first quarter of 2015 it hit an 11-year high of 26.4%, around the same level as at the end of the apartheid era.

Concerns have also been expressed about the country’s future direction, as it appears to be gradually moving from an open and liberal society to a more nationalistic one. In 2012 South Africa started to terminate bilateral investment treaties with several European countries. Like a number of other developing nations, it felt that the treaties gave investors too much power, and that they potentially conflicted with the country’s laws and constitution. A flurry of new laws and bills are also sending mixed messages to foreign investors. The Private Security Industry Regulation Amendment Bill requires that foreign security firms sell half of their shares to local interests, while the Mineral and Petroleum Resources Development Bill allows the government to decide what percentage of minerals are exported, and to dictate their prices. The Expropriation Bill increases the power of the government to seize property. Questions have also been raised about the Promotion and Protection of Investment Bill, which appears to weaken the rights and protections afforded to foreign investors.

The country’s reputation has also been affected by a spate of attacks on foreigners, mainly towards people from other African countries competing for jobs with local workers. There have also been riots related to other issues, such as a rise in tuition fees.

Outlook  

South Africa has all the makings of a strong economy. It has resources, it is well managed, its institutions are sound and it has a history of liberal policies. Recent weakness is largely the result of events beyond South Africa’s control, although some factors are home-grown, such as power and skills shortages. The country is well placed geographically to benefit from the growth of Africa and well positioned to gain as the world economy recovers. The apparent creeping retreat to protectionism is a concern, as the country needs strong FDI and good trade flows to prosper. However, its politicians are well aware of the dangers of overcompensating and turning inward in times of adversity. It is to be hoped that South Africa will steer a middle course, protecting its rights as a nation without scaring off investors.