Country Report South Africa
South Africa is the largest, most modern and most diversified economy of Sub Saharan Africa. Despite the high per capita income, inequality and unemployment levels are particularly high. The latter is mainly caused by a dysfunctional labor market and education system. These disparities, as well as the failure of the ruling ANC to deliver a more equitable society, have led to persistent labor unrest in 2012, and strife is expected to continue in 2013. Economic growth was subdued at 2.5% in 2012 as the main driver, domestic demand, moderated. The public wage bill drove the fiscal deficit to 5.2% of GDP. Public debt remains manageable, but further fiscal slippage will pose a concern and deter investor confidence. Fiscal consolidation is a priority for the government, but is probably difficult to realize in light of the 2014 elections. Against this backdrop, the government grasped at populist measures and increased policy uncertainty, further damaging investor confidence. Given South Africa susceptibility to external factors and its reliance on economic growth for solving its structural problems, restoring market sentiment is crucial.
Economic structure and growth
South Africa is one of the biggest, most diversified and most developed economies of Sub Saharan Africa. Services are the country’s largest sector, accounting for 67% of GDP in 2012 and providing for around three quarters of all employment. Industry is the second largest sector, accounting for 30% of GDP. It contains the mining and quarrying industry which accounts for more than 10% of GDP and produces South Africa’s main export products (the three largest export categories are platinum, gold and coal, which together represented 31% of exports in 2012). Actually, South Africa is the world’s largest platinum producer and one of the world’s largest gold producers (the largest in Africa). As a consequence, export revenues are highly susceptible to the volatile commodity prices. In terms of employment, mining and quarrying covers 6% of employment. However, due to close links with manufacturing in terms of both input and output, it is estimated that 16% of all employment is related to mining. The largest export partners of South Africa are China, the United States and Japan, while the European Union countries account for almost a quarter of export revenues. The latter makes South Africa vulnerable to the economic distress in the Eurozone.
The first recession after the transition to a democratic system hit South Africa in 2009, reflecting its vulnerability to external demand shocks. Recovery followed, but at a moderate pace that reflects the European economic downturn and the slower growth pace in China. 2012 was marked by persistent industrial unrest in the mining sector, leading to lower sector output and contributing to a moderation of growth to 2.6% in 2012. However, the key driver behind economic growth in South Africa is private consumption (see figure 1), which accounts for around 60% of GDP. Unfortunately, consumer spending is also moderating amid diminishing real income, weak job perspectives, low levels of confidence and high levels of debt (see figure 2), despite some deleveraging after the crisis (figure 3). Actually, gross demand dropped in the fourth quarter of 2012 for the first time since the recession in 2009, which is in line with the evolution of confidence indices for both consumers and business and the Purchasing Managers Index (figure 4).
The drop in confidence in the second half of 2012 seems to be related to the social upheaval which spread throughout the country in this period. Though the latest information on business activity indicate a recovery in 2013 (the PMI of February 2013 exceeded 50 for the first time since August 2012), recent wildcat strikes in the coal industry indicate the social unrest might continue this year (see next section). This poses a downside risk to economic growth, which is expected to be constrained to around 3% in 2013 amid a weak global outlook. The following four years should show an improvement amid ameliorated world economic perspectives and fiscal stimulus.
Though South Africa provides one of the most attractive business climates in Sub Saharan Africa (figure 5), the economy is also confronted with structural problems which constrain growth at a suboptimal level. Infrastructural bottlenecks with respect to energy and transportation have hampered growth and will continue to do so. Energy shortages could pose problems in 2013 as the reserve margins have fallen to 2% and little improvement is expected until the beginning of 2014, when the Medupi coal plant should come into operation.
However, a dysfunctional and rigid labor market is the most important hindrance to growth. South Africa has a participation rate of around 54% (compared to around 75% in the OECD countries) and an unemployment rate of 25% (has been above 20% for 16 years now). The problem is highest amongst youths (51% unemployment rate in 4Q2012). Moreover, unemployment is higher amongst the black population (28.5% compared to 5.5% amongst the white). One of the main reasons behind wide-spread unemployment is skills mismatch caused by an inefficient education system (38% of South African businesses report skills shortage to be a constraint on growth). The education system is plagued by poor quality and efficiency, being confronted by structural problems such as teacher absenteeism, lack of accountability and poor quality of facilities, education materials and staff. Unemployment is aggravated by a suboptimal labor demand, since a combination of highly concentrated industries and collective bargaining keeps the labor costs high , posing a barrier to the entry of small enterprises. The high labor cost also drives productivity down and pushes investment into foreign territories (gross fixed investment is only 21.1% of GDP).
The high unemployment is, in turn, one of the main causes for a tremendously high inequality level in South Africa (figure 6). Though one of the wealthiest countries in Sub Saharan Africa, South Africa has one of the highest Gini coefficients in the world (only Namibia and Comoros score worse). The ANC managed to create a black elite, but failed to deliver on the promise of economic justice (the richest 20% receive 72% of national income and half of them are black, while the poorest 40% receive 6%). In many emerging markets, the informal sector plays an important role in elevating people out of poverty, but in South Africa this accounts for only 20% of employment.
The banking sector of South Africa is well capitalized and has solid liquidity buffers, having passed the crisis of 2009 relatively unaffected. The four largest banks, Absa (owned by Barclays), First National Bank, Nedbank and Standard Bank, account for 84.1% of the total banking- sector assets. Following the recession, banks tightened their credit criteria, but credit growth gradually picked up in the following years. Profitability metrics have improved in 2012 (Return on Equity and Return on Assets were 17% and 1.19%, respectively, in August 2012 from 15.3% and 1.07% a year earlier), though it is expected that the subdued economic growth will soften them in the near future. The main vulnerabilities of the banking sector are: the high share of sovereign bonds in bank assets amid the deterioration of sovereign rating, liquidity risk given the dependence on short-term domestic wholesale funding and high exposure to highly leveraged households amid the subdued economic environment which could increase the number of impaired loans and affect the value of collaterals.
Political and social situation
South Africa is a democracy characterized by a robust separation of powers between the executive, the legislative and the judiciary, and independent institutions such as the Supreme Court and the South African Reserve Bank. The president is Jacob Zuma of the the African National Congress (ANC). The party has dominated the political scene since the abolition of apartheid in 1994 and is ruling in an alliance with the Congress of South African Trade Unions (COSATU) and the Communist Party (CP). The “liberation dividend”, which has legitimized ANC’s power in the past 18 years, is starting to wear off as the party has failed to deliver on its promises, especially on the delivery of services, social benefits and a more equitable society. As a result, South Africa is now characterized by an economic and spatial divide.
Zuma’s term in office has been plagued by repeated allegations of corruption (such as the expensive renovation of his private residence with public money) and cronyism, and by inadequate reactions to critical situations such as the Marikana strikes and the failure to distribute textbooks in Limpopo. These issues have set doubt on his leadership skills and have led to ample discontent and criticism from both his own party and the population as a whole. The opposition called a motion of no-confidence in November 2012, but the ANC managed to block it. Disagreement on policy direction have led to conflicts with previous partners such as the ANC Youth League (ANCYL), COSATU and the CP and to infighting within the party. One of the leadership challengers was ANCYL leader Julius Malema, eventually expelled from the party and currently stoking against Zuma from the outside. Kgalema Motlanthe challenged Zuma’s leadership at ANC’s five-yearly party summit in December 2012. However, despite his track record, scandal- plagued Zuma was re-elected as ANC leader. Half of the ANC’s leadership was replaced as a result of the leadership challenge by Molanthe, which could bode well for the future of the ANC. One of the newly elected is Cyril Ramaphosa, a former unionist and a prominent business man, elected deputy president. He is expected to have a dominant role within the ANC as a de facto PM until elections, which will reassure the business community policies will be pragmatic, as he represents the moderates in the party. However, discontent with Zuma within the ANC and infighting is expected to continue this year, leading to policy paralysis, inclination towards populist measures and increasing uncertainty until presidential and parliamentary elections in 2014. The ANC is expected to win the polls, but the intensifying discontent is likely to take its toll on the results. An eventual decease of Nelson Mandela might temporarily boost ANC popularity as it would give a new momentum to its liberation credentials.
In the second half of 2012, South Africa was troubled by a series of wildcat strikes which impaired the mining sector and even expanded to the transport sector, having a major effect on export revenues. Police intervention at Lonmin's Marikana platinum mines led to violent clashes and the death of 34 protesters, shocking the country with the violence used by the police. The unrest is a reflection of the population’s discontent with the ANC, as well as the failure of representing organizations (the recognized unions) to voice the grievances of the poor. In South Africa, the dominant unions are recognized by the business and receive a chair at the negotiation table. However, the agreements made apply to the industry as a whole. The affiliation of most of the dominant unions with the ANC (through COSATU, one of the three main union federations) led to their politicization, the leaders being more preoccupied with defending their positions than with representing the working poor in negotiations. As a consequence, working conditions and pay are inadequate. Support amongst the poor and lower ranks has diminished, as they either affiliate with new unions not related to ANC or take a militant stance to express their dissatisfaction. In the platinum industry, discontent with the ANC affiliated NUM has led to a shift in dominance towards AMCU. As the latter became more militant to assume its new role, protests intensified culminating in the Marikana clashes in August. The outcome of these clashes led to a high frequency of unauthorized strikes in the rest of the year. Though calm seemed to prevail in December, actions started again in February, now in the coal sector. Considering upcoming wage negotiations in the coal and gold industry and restructuring plans of Anglo American Platinum (Amplats) in the platinum industry, unrest is likely to continue in 2013. Unfortunately, the industrial rife brings attention to entrenched socio-economic problems and deters investor confidence.
In term of security, crime is the biggest problem in South Africa. Though there has been improvement, the country has one of the highest rates of murder and rape in the world, which tarnishes the country’s image. Corruption is a persistent phenomenon. Recent law on the protection of state information is regarded as a major setback to freedom of expression and of the press, though the Protection of the State Information Bill still has to pass the National Assembly in 2013, and cost South Africa 10 places in the Press Freedom Index (down to 52 out of 179).
South Africa has been regarded as a stable country for Sub Saharan Africa standards, though recent developments are damaging this reputation. As such the country plays a leading role in security efforts in the region and represents the continent in international forums and summits, such as the World Trade Organization. South Africa is also a member of several regional unions, such as the African Union, the Southern African Customs Union and the Southern African Development Community.
Economic policy is described in two strategy documents, the New Growth Path (NGP) and the New Development Plan (NDP). The latter is more recent (released in August 2012), has a broader scope and a longer term focus, therefore enveloping the NGP.
The main goals of the NDP are eliminating poverty (from an estimated 39% to 0%) and reducing inequality (reduce the Gini coefficient from 0.69 to 0.6) by 2030. Job creation holds a central role in realizing these targets (the main goal is creating an additional 11 million jobs by 2030, out of which 2 million public jobs). The plan relies on inclusive economic growth to achieve its goals, and the inclusiveness is accomplished by enhancing human capital creation and creating a developmental state. Consequently, the three main areas of focus for policy are stimulating higher economic growth to reduce unemployment, supporting the people to have a decent living standard and to develop their capabilities in order to be able to participate in the economy, and restructuring the state in order to enhance its capability to make it all possible. The document is very comprehensive, outlining fifteen topics that reflect the three priorities and stipulating specific objectives and actions for each one of them. The recommendations for economic policy mainly focus on expanding exports, improving competitiveness, investing in infrastructure (focus on transport, energy and water), reforming labor market, stimulating private investments and supporting small enterprises and rural entrepreneurship, while inducing a shift in ownership towards disadvantaged groups. In the short term the focus lies on reforming the labor market to increase employment amongst youth. The realization of the human capital enhancement priority focuses on creating equal opportunities and reducing the economic and spatial divide. The recommendations concentrate on proper public services delivery to everyone. In the short term the focus lies on improving education and health ( especially for young children) and on reducing segregation through housing strategies and investments in the transportation system. The realization of a developmental state relies on a restructuring of the civil servants apparatus by attracting capable individuals, reducing politicization and increasing accountability. The NDP further places high emphasis on active citizenry, defined as mobilizing the population to achieve the envisaged goals and raising awareness of each individual’s responsibility.
The NDP is a comprehensive and pragmatic document, but will have little effect without a proper implementation. It is estimated that its implementation will turn out to be difficult as it runs into vested interests and contradictory policies. The short term implementation of the labor reforms to stimulate youth employment is an illustrative example. The NDP prescribes giving a tax incentive to enterprises that hire market entrants. However, the law is unlikely to be implemented in this form by the ANC cabinet because such an approach conflicts with COSATU’s core principles and COSATU’s support of ANC in the 2014 elections is crucial. Therefore, the implementation of the youth labor reform is seen as an important milestone, which will indicate whether the ANC is capable of turning the current plans into effective policy solutions.
The difficult economic situation pushed the government towards hinting at populist measures such as nationalization in mining and land tenure in the past year. Though some fears were eliminated during the ANC summit in December and the draft on mining legislation in February, uncertainty prevails. It is still unclear which direction policy will go with respect to mining (which taxes?, what will strategic state stake imply?) and land tenure (possible ban on foreign ownership of agricultural land, caps on farm sizes and the shift from a “willing seller” “willing buyer” system to an “equitable ownership” one, which could lead to expropriation cases). However, the election of Ramaphosa as a deputy president of the ANC bodes well for a pragmatic approach, since he led the National Planning Commission in writing the NDP and has the reputation of having a hands-on mentality.
After booking a record budget deficit in 2012 at 5.2% of GDP (close to the deficit incurred during the recession of 2009), the government gives high priority to fiscal consolidation, meant to restore investor confidence. However, the budget for 2013/14 released in February 2013 already cast doubts on the government’s commitment to this priority, since the projection for 2013/2014 was relaxed once more to 4.6% of GDP and the 3% of GDP target was postponed to the medium-long term horizon. Furthermore, it is doubtful whether the targets are attainable. The shortfall in 2012 was mainly driven by current spending, especially the public wage bill, which amid agreements made last year, is only expected to grow in real terms. Moreover, in light of the elections of 2014, tax hikes have been taken off the table, while social services and cash transfers are expected to increase. Lastly, capital investments are not expected to contribute directly to growth due to persistent inefficiencies and corruption, so tax revenues are expected to be disappointing. Government plans to invest in infrastructure only once growth is realized will only aggravate the situation as the growth potential is much lower without such investments.
The high fiscal deficit pushed public debt to 41.1% of GDP (the highest since 2001). Despite the deterioration of the debt metrics, public debt remains manageable amid the low level of external exposure, astute debt management and the domestic appetite for public debt in all maturity categories. Moreover, recent inclusion in the Citibank World Government Bond Index eases access to capital markets, should the local demand change. However, downgrades from all three international rating agencies followed the inclusion and there are concerns about future sovereign downgrades, which would threaten the current position.
The South African Reserve Bank (SARB) follows an inflation targeting framework. The goal is to keep the Consumer Price Index (CPI) within a 3-6% band. The policy rate was last changed from 5.5% to 5% in July 2012 and is expected to be kept at this level until at least the beginning of 2014, as a weak ZAR (South African Rand) coupled with high inflationary pressures leave no room for stimulating the sluggish economy. The inflationary pressures for 2013 (see figure 5) stem from the foreseen wage increases and the recently approved electricity price hikes, amongst others. The weaker ZAR (exchange rate of around 9.3 ZAR/USD in March 2013 – see figure 6) is a consequence of significant damage to investor confidence and to the current account deficit (through lower export) brought about by the civil unrest, and pushes South Africa into a vicious spiral (weaker rand – higher inflation – deteriorating current account deficit.
Balance of Payments
At 6.3% of GDP in 2012, the current account deficit almost doubled in comparison to 2011. The record trade deficit of 1.2% of GDP was mainly caused by the reduced output in the mining sector amid labor protests , though in the first half of 2012 a weak European demand for export products was the main factor causing the shortfall. The income deficit increase was driven by higher dividend payments to foreign portfolio investors in anticipation of the new dividend tax, and the transfer shortfall was mainly caused by more payments to the Southern African Customs Union. Finally, imports also played a role, as more capital goods for infrastructural programs were purchased.
The financial market in South Africa is one of the best regulated in the world and is highly international (40% of bonds and 50% of the stock market is owned by foreign investors). Given the low domestic savings rate, South Africa has relied on non-debt creating inflows for financing its current account deficits and for building up substantial FX reserves, which amounted to USD 47.5bn in 2012. The flexibility of the exchange rate, the liquidity of the equity market and the level of FX reserves safeguard against a drop in such inflows, reducing the country’s vulnerability to external shocks. In terms of investments, South Africa seems to be regarded as the gateway to Africa. Net FDI was constant over 2012 at 1.4% as both outward and inward FDI diminished in absolute terms, though they show a steady level as a percentage of GDP. Recent announcements of purchases and setup of new businesses by foreigners indicate inflows will be robust in 2013. The announced deals also suggest South-South investment flows are increasing in importance. On the other hand, outflows are also expected to pick up as South African companies search for higher productivity and lower operating costs. The new FDI legislation replacing bilateral treaties could also play a role in attracting more flows to the country.
South Africa’s external debt amounts to 30% of GDP, 2 percentage points higher than in 2011. Only 16% of it is short term and is mainly owed to private creditors (who own 79% of foreign debt). Official creditors (IMF) are negligible (2% of foreign debt). The medium and long term debt is mainly owed by the government that holds 53% of it. Debt servicing by the government should not be a problem as long as demand for its paper remains high.
Debt service ratios decreased in 2012 (the debt service ratio and the interest service ratio declined to 21% of XGSIT and 2% of XGSIT from 23% and 3.2 in 2011) because the significant drop in external receipts from exported goods, income and transfers could not be compensated by the lower debt service costs. FX reserves increased by 11% to USD 47.5bn, but not enough to compensate shifts in other accounts, causing the liquidity ratio to slightly deteriorate from 138 in 2011 to 134. The import cover has more or less stabilized at an acceptable 4.5 months as FX reserves increased.