South Africa’s low levels of growth and investment are a consequence of an inhibiting policy environment, and it is up to President Cyril Ramaphosa to drive the reforms necessary to remove obstacles to growth.
In his recent State of the Nation Address, the president called for a "relentless focus on economic growth". This was certainly welcome, as was the recognition of the need to "unleash private investment" and to address the costs of doing business. But, as we at the Centre for Risk Analysis (CRA) argue, the real problem is an inhibiting policy environment.
In 2018, South Africa’s real annual economic growth slumped to 0.8% and continued to deteriorate in the first quarter of 2019, recording 0% year on year, and -3.2% quarter on quarter. This was driven by declines across key industries in Q1 2019, including agriculture (-13.2%), and manufacturing (-8.8%). The economy has evolved away from its past reliance on the primary and secondary sectors towards tertiary industries such as finance, retail and other services. This is due to a combination of hostile domestic policy and other global forces.
President Ramaphosa wishes for economic growth rates over the next decade to exceed the population growth rate, which suggests an all-too-modest long-term growth target of 1.6%+. But in order to support a growing population, growth levels need to reach at least 2.5%. National Treasury is more optimistic, anticipating economic growth up to 2.1% by 2021. However, Treasury forecasts have overestimated growth by a 50%+ margin over the past decade. Moreover, these forecasts are contingent on policy changes that are unlikely to materialise.
Given the constraints of electricity supply and labour market inflexibility, the CRA’s working assumption is that a growth rate between 1.5% and 2% is probably the maximum that could be achieved over the short-to-medium term. But even this modest figure faces significant downside risks.
Following its June mission to SA, the International Monetary Fund (IMF) called for structural reforms to the labour market and interventions to reduce the cost and difficulty of doing business. The IMF also warned that "without fundamental reforms in Eskom’s finances and operations, continued budget transfers or assumption of its debt by the government will not resolve the company’s issues".
If there is a silver lining, it is that the current account deficit has reduced from -3.5% of GDP in 2018 to -2.9% in Q1 2019. Weak domestic economic performance (and hence reduced consumer spending appetite) may dampen an expansion of the current account deficit. However, a contraction in mining, agriculture and manufacturing production, combined with energy shortages, will inhibit exports. Although current account deficits are normal in emerging economies, these deficits are usually due to higher fixed capital investment. In SA’s case, the deficit is primarily due to consumption. The CRA expects the current account deficit to maintain its present level, in line with Treasury projections.
The South African Reserve Bank (SARB) is under great policy pressure to cut interest rates. Given the understanding that rate cuts will do little to bolster growth, that such cuts would reduce the interest rate differential, and given the inflationary effect inherent in a weakening currency, the CRA expects the SARB to make token cuts at best. But there is no guarantee that the Bank's future decision makers will take the same pragmatic approach to monetary policy.
The economic outlook indicates that the currency is expected to continue weakening towards R20/US$ over the medium term. This analysis is complicated by the fact that the Rand is already trading at a considerable discount to fair value. Should the Ramaphosa administration impose structural reform under pressure, the currency could bounce back to fair value levels estimated at anywhere between R10/US$-R13/US$. Failure to implement these reforms will weaken it further, notwithstanding other unknown variables like the US dollar and the state of the global economy.
The global context is uncertain. The World Bank predicted last month that global growth will weaken to 2.6% in 2019. The Bank also noted that growth among emerging markets is projected to fall to a four-year low of 4% in 2019. Even on this reduced measure, SA continues to underperform its EM peers by a significant margin.
There is also little prospect of a ratings agency upgrade, one of the hopes of the Ramaphosa administration. The CRA’s working assumption is that Moody’s will downgrade South Africa in November (or early 2020 at the latest) – a decision that is long overdue. The likelihood of this decision should be largely priced into the country by November.
Although Mr Ramaphosa is constrained by internal party politics, he has the power to drive through the necessary policy reforms should he choose to do so. The economic consequences of inaction are dire.
David Ansara is the Chief Operating Officer of the Centre for Risk Analysis (CRA). Views expressed are his own. This article was written with Katherine Brown, an intern at the CRA.