Tightening in global financial conditions, triggered by a rise in U.S. interest rates and a strong dollar, put South Africa under pressure. The Rainbow nation, once a darling of international investors, seems to degrade into a perennial basket case. After the end of apartheid in 1994 until the financial crisis of 2008, South Africa’s economy grew annually by 3.6% in real terms, but since the financial crisis growth dropped to 1.5% per annum. Worse, this has been accompanied by a rise in indebtedness. Public debt rose from 22% in 2008 to 50% this year. The deterioration occurred under the watch of Jacob Zuma, an incompetent and corrupt ANC bigwig and South Africa’s president from 2009 to 2018 (see our blog “Under the Rainbow”, April 2017). The mood changed following the resignation of Mr. Zuma and the appointment of Cyril Ramaphosa as president of the country in February of this year. Markets believed that Mr. Ramaphosa would aptly deal with the country’s many problems and put South Africa back on the path of growth.
Saving the nation? Moi…?
It hasn’t happened yet. A severe drought impacted the agricultural sector but also other parts of the economy are sputtering due to low business and consumer confidence, resulting in two consecutive quarters of negative growth this year. Real growth for the whole of 2018 probably will not be higher than 0.7%. The global sell-off in Emerging Markets obviously also doesn’t help (the rand depreciated by 12.5% this year) and the weakness in rand is partly responsible for upward pressure on inflation (4.7% this year, expected to rise to 5.2% next year). Unemployment officially is about 27% but in reality much higher (35% or so as many people have given up to look for work), whereas the poverty rate is rising (a staggering 37% of the population has to get by on less than US$ 3.20 per day). Inequality is one of the highest in the world with a Gini of 63. Population growth is estimated (by Stats SA) at 1.55% per annum, which means that average economic growth of 1.5% over the last 10 years is not enough to address South Africa’s dire situation. The current account deficit this year is forecasted at -3.5% and is financed nearly entirely by international portfolio flows as opposed to more sticky foreign direct investments. Combined with rising inflation, the space for monetary easing will be limited. Actually, a rate hike is more likely, in our view, in order to offer investors an acceptable real interest rate to stick around (40% of local currency public debt is held by non-residents).
Clearly, drastic structural reforms are required to turn the tide. But, first of all, South Africa should live within its means to avoid to be at the mercy of global financial markets. Like Argentina and Turkey, South Africa has a twin deficit. This year, the country runs a fiscal deficit of -3.6% (source: Bloomberg consensus forecast) which is largely caused by interest payments on debt, translating into accumulation of public debt given that GDP growth is low. Public debt will rise towards 60% in 5 years’ time if current policies are continued. Fiscal space, therefore, has become constrained. In order to live within its means, South Africa should cut back on government spending. Government expenditures are equal to about 33% of GDP, which is elevated compared to countries like Chile, Mexico and Indonesia although not completely out of range. However, civil servant wages make up about 35% of spending, which is substantially higher than OECD average (and even higher than generous Brazil). The government should radically cut wage spending by 5% and use the savings to create a primary surplus of 1.0% (now -0.5%) to reduce the burden of debt servicing over time.
Structural reforms are long overdue. Education quality should be improved (better teachers) and school completion rates increased (making educational spending more efficient). Labour markets should be deregulated. Specifically, the current practice of collective bargain agreements should be abandoned as they tend to be too expensive for SMEs. The new minimum wage level should be reconsidered as we think it will leave many (unskilled) people out of work and it should be easier and cheaper to fire workers (thereby reducing the hurdle to hire them in the first place). Bureaucracy and red tape should be curtailed (as should be done in other Emerging Markets as well). Finally, the national airline (SAA), an eternal money loser, should be sold or shut down and Eskom, the national electricity company, should be unbundled and privatized in order to improve governance and bring down electricity prices. Also, corruption should be addressed. “State capture”, which refers to the influence that well-connected individuals (e.g. the Gupta brothers) have on government policies and regulations with the aim to benefit from public resources (e.g. reduced taxes, favourable contracts), should be tackled fiercely. State capture costs a lot of money (the Auditor General estimates irregular expenditures at 1% of GDP) and discourages (foreign) investment.
Will he follow in his footsteps…?
On September 21st, Ramaphosa announced a set of measures to revive economic activity, including approval of a new charter for the mining sector, infrastructure projects (if he can find private money) and farmer subsidies (bad idea). He said more or less what the market wants to hear but the plans lack detail, especially on how they should be paid for, and are not going far enough. We question whether Ramaphosa will be the savior of the nation. He was uncomfortably close to Mr. Zuma, serving as his deputy from 2014 to 2018. Ramaphosa only took distance from Zuma after it became clear that Zuma would not lend him support to secure the highest post. Further, he exploited his political ties to amass a fortune of some US$ 450 million (according to Forbes) on the back of black economic empowerment policies which he helped draft (state capture avant la lettre). Maybe not the same as corruption but not fair either. Mr. Ramaphosa is a good negotiator. He was an effective trade union leader (he founded the National Union of Mineworkers) and helped Nelson Mandela negotiate a peaceful transition to democracy. He was also a moderating force during Zuma’s reign. But a good negotiator is not necessarily a good leader: he needs to draw up comprehensive plans how he wants to shape South Africa’s future and subsequently implement them diligently. Instead, he is playing into populist themes like proposing to amend the constitution with the aim to clarify when land can be expropriated without paying compensation. Of course, when property rights are possibly infringed upon investors get worried. Although Mr. Ramaphosa says redistribution of land will be fair, it seems clear that this whole exercise is to appease the leftwing of the ANC as well as the radical EFF in the run-up to the presidential elections between May and August next year. The idea to nationalize the Reserve Bank also sends a wrong signal. The central bank is one of the institutions that actually works fine; why tamper with it at this moment in time? Mr. Ramaphosa has to choose what type of leader he wants to be: an orthodox economic reformer that brings prosperity to the South African people or someone who panders to bad leftwing ideas. He can’t have it both ways as it is not inconceivable that South Africa will follow Argentina and Turkey with its own balance of payments crisis if reforms are not pushed through quickly enough. As Dolly Parton once philosophically mused, “if you want the rainbow, you gotta put up with the rain”.
