Both economic and financial fundamentals have been gradually deteriorating following years of stagnation and protracted uncertainties. Ever since the global financial crisis the rainbow nation got stuck in an impasse with no immediate outlook for high growth momentum to return in the near future. Structural domestic tensions combined with incoherent policies and mismanagement under President Zuma further depressed (investor) confidence. The collapse in international commodity prices and curtailed Chinese demand added to the blow, while agricultural output has been hit hard by El Niño-related droughts. Capital inflows also became more volatile while global investment appetite for emerging markets is sinking. Henceforth, South Africa became more vulnerable since it depends on portfolio and other investment inflows for financing its structural current account deficit. Still, external indebtedness remains sustainable although ratios have been following a rising trend over the past decade.
Up until today, South Africa is struggling to deal with the impact of these lingering shocks, already being challenged by home-grown structural weaknesses. The introduction of credible and effective fiscal reforms will be crucial for rebuilding confidence and unfolding the giant’s potential. Yet, in case of political apathy or another major shock, the country’s solvency might deteriorate faster than currently anticipated for.
This context has seen the classification for MLT political risk further downgraded to category 4 (from 3) in August 2016. Commercial risk in South Africa has evidently deteriorated as well. Ongoing slow growth performance and currency depreciation imply that commercial risk classification is in the highest category. Yet, whereas commercial and solvency risks have clearly risen, the adequate buffer of international reserves and a deep local capital market entail a more steady liquidity risk. As such, Credendo Group’s classification for the ST political risk has remained stable in category 3.
- Large natural resource potential
- Mature institutions
- Strong services sector
- High unemployment and inequality
- Infrastructure bottlenecks (especially energy-related)
- Reliant on volatile capital inflows
Head of State and Government
- Jacob Zuma (2009/2014)
Description of electoral system
- Presidential elections: 5-year term; next in 2019
- Legislative elections: 5-year term; next in 2019
- 55 M
Per capita Income
- USD 6,050
- Upper middle income
Main export products
- Travel (7.9% of current account receipts), iron ore (6.6%), gold (5.6%), vegetables (3.4%)
Dissatisfaction with Zuma’s approach
A series of political battles and numerous corruption scandals linked to President Zuma significantly damaged the African National Congress (ANC) and the country’s reputation. Tensions escalated in December 2015 following Zuma’s dismissal of two finance ministers in four days, sending a shockwave through the capital markets. Zuma even survived an impeachment procedure in April 2016 for breaching the constitution after ignoring recommendations of the graft watchdog to pay back public funds used to renovate his private residence. What’s more, his growing anti-Western rhetoric and policy initiatives like for example the unilateral revocation of bilateral investment treaties with European countries, are complicating relations with the West. Consequently, the ANC is expected to continue to prioritise relations with BRICS despite their weakened economies and large trade imbalances (especially with China).
Yet mostly, many people are fed up with their dead-end socioeconomic position. In fact, ever since the ANC took office following the end of apartheid, progression in structural reforms has been too slow to raise average living standards and target the gaping inequality in society. South Africa’s unemployment rate is excessive compared to other emerging markets and rose to a staggering 26.7% of the labour force in Q1 2016. A huge part of the population is therefore left outside, especially young people, due to great deficiencies in the educational system and skill mismatches on the labour market. Another cause is the wage bargaining system, serving the interests of established businesses and the employed, while it raises the barrier for the unemployed and for small and medium-sized enterprises that typically employ the most people. Also, industrial strike actions in pursuit of pay raises are very common in South Africa. In recent years multiple prolonged labour strikes turned violent causing outsized economic damage; think of the Marikana massacre in 2012 and the six-month platinum strike in 2014.
Besides outsized unemployment, inequality is another major problem. Around 80% of the population is black, with the remainder including minority groups (mixed-race or Indian origins). Yet, white men and women continue to dominate top positions in the private sector. To address racial inequalities inherited from the apartheid era, the Black Economic Empowerment (BEE) policy was introduced and became one of the ANC’s major flagships. As part of the BEE, a land expropriation bill was passed in early 2016, enabling the state to buy land (even without the owners’ consent) at an officially determined value after which it is expropriated to raise the level of black land ownership. Still, it is nothing like the violent land grabs that took place in neighbouring Zimbabwe. In fact, it is politically popular and proved essential for directing a greater share of wealth to the black majority. Although in practice the BEE also facilitates new patronage systems and corruption while it is costly for enterprises to comply.
Municipal elections emphasised ANC’s eroding grassroots support
President Jacob Zuma is serving his second term in office following the 2014 general elections. The two main opposition parties – centre-right liberal Democratic Alliance (DA) and radical left-wing Economic Freedom Fighters (EFF) of expelled former ANC Youth League leader Malema – did increase their share of votes in 2014, benefiting from unchaining disgruntlement with the ANC. Recent municipal elections held on 3 August displayed even more opposition gains, making it the worst election result for the ANC since the end of apartheid. In Tshwane and Nelson Mandela Bay, which include the capital Pretoria, Cape Town and Port Elizabeth, opposition party DA won convincingly. Henceforth, South Africa’s political landscape was somewhat reshaped by disillusioned urban voters. Still in general, the ANC won most votes as support for Zuma’s party remains pervasive in rural communities. The radical leftist EFF performed best in mining-rich provinces and came in third with 8.2% of the vote.
During the ANC’s 2017 party conference, new leadership and a presidential candidate for 2019 will be appointed. The party is likely to face more internal polarisation and Zuma is expected to be increasingly sidelined given the municipal election result and his crumbling popularity. This will reduce his influence on the selection of a successor and therefore increases the chances of business-friendly Deputy President Ramaphosa to become head of the ANC, stirring today’s political patronage structures. This year’s historic municipal elections could become a herald for the 2019 national elections. In any case, South Africans need policymakers with a new approach to address its structural socioeconomic issues. Fundamental reforms and political courage to move against vested interests will be vital to create opportunities and tackle unemployment, inequality and economic exclusion.
Growth stagnation lingers on…
The continent’s most advanced and industrialised nation used to be the favourite of international investors thanks to strong institutions and a booming mining and services sector. Yet, ever since the global financial crisis erupted in 2009, the rainbow nation hasn’t managed to revamp economic growth, held back by serious structural domestic strains and a depressed global environment. After saddening 2014 and 2015 GDP growth achievements (1.6% and 1.3%), the 2016 growth projection of 0.1% is the lowest level since the 2009 recession. A minimal growth recovery of 1.1% is envisaged for 2017 which would nonetheless connote a third consecutive year of falling per-capita income. Medium- to long-term growth projections are brighter around 2.4%, although this remains low compared to population growth (1.6% per year).
The South African rand has been falling since 2012 and lost another third of its value against the US dollar in 2015 due to worsening terms of trade (in spite of being an oil importer) and foreign investor anxiety fuelling the rand sell-off. However, the sharp depreciation of the rand will not provide much of a competitive advantage as most other emerging markets also saw their currencies weaken. Aggravated by drought-induced food price hikes and power shortages, inflation is expected to reach 6.7% by year end, trespassing the upper end of the SARB’s (South African Reserve Bank) target range of 3-6%. In early 2016, SARB hiked interest rates (repo rate, with 25 bps to 7%) for the 4th time since the end of 2014 in a bid to stabilise inflation expectations in spite of the growth-decelerating impact. Low national savings rates and a slowdown in household consumption, which used to be the principle growth driver, furthermore attribute to sustained underperformance. There is no outlook for high growth momentum to return in the near future as the global environment remains difficult and persistent weakness of the rand is likely to keep pressure on interest rates elevated.
Tarnished confidence due to domestic woes and external shockwaves
South Africa has a greatly diversified economy (mining, agriculture, financial services, tourism, manufacturing, etc.) and companies with a regional and even global footprint. Nonetheless, over the past years South Africa’s manufacturing and mining sectors have been damaged by degraded investor confidence caused by domestic vulnerabilities like regulatory uncertainty, inflexible labour markets and infrastructure bottlenecks together with recurrent violent strikes and a severe electricity crisis. Since mid-2014 two major external shocks added to the setback, namely depressed mineral export demand from China (most important export destination) and the collapse in international commodity prices. As a result of global oversupply and China’s shifted orientation towards its internal market, mineral and metal prices are expected to remain well below their peak levels over the coming years.
Consequently, South African mining production contracted by a substantial 18% (year on year in March 2016), with iron ore and platinum metals taking the largest blow. In addition, agricultural output has been hit hard by droughts cause by El Niño, which raged through southern Africa over the past year. Henceforth, corporates became less profitable, especially in the agricultural and mining sector. Also equity prices of financial institutions declined this year while high interest rates and inflation together with a weak labour market are pressuring the highly indebted households. Consequently, credit growth to households has slowed, although growth in credit to the private sector remained resilient. Even so, banks’ buffers are deemed adequate to endure a possible jump in NPLs (non-performing loans) on household credit and corporate books.
Notwithstanding the diversified export base, South Africa’s current account deficit is structural and projected to balance around 12% of the current account receipts over the coming two years before gradually narrowing. This deficit used to be easily financed as Africa’s most liquid market attracted large capital investment flows (Johannesburg stock exchange and domestic bond market) and considerable foreign direct investments. Yet capital flows became volatile following the 2014 US Fed’s tapering, which curbed global investor appetite for emerging markets. Tighter global financial conditions resulting from the normalisation of the US monetary policy and more recently the Brexit will continue to expose South Africa, being highly dependent on portfolio and other investment inflows (bonds and equities held by foreigners). Moreover, numerous corruption scandals together with a combination of incoherent policies and mismanagement aggravated the loss of investor confidence. Therefore, after years of large surpluses, the 2015 balance of payments displayed a financing shortfall of 0.25% of GDP while a tiny deficit is anticipated for 2016 and 2017 as well. Fortunately, South Africa’s foreign exchange reserves are at adequate levels and domestic financial markets are deemed deep and sophisticated enough to absorb the external financial gaps.
The road to recovery hinges first and foremost on budgetary credibility
Fiscal space for growth-enhancing public investment spending remains limited with a budget deficit that reached an average of 4% of GDP over the past five years and is projected to reach 3.9% and 3.6% in 2016 and 2017. High unemployment burdens the government with a soaring welfare bill that absorbs more than 35% of total public expenditure. Moreover, several large state-owned enterprises (SOEs) – such as roads agency Sanral and state power utility Eskom – represent sizable contingent liabilities reliant on government guarantees and weak financial balance sheets that could pose a risk to fiscal stability. Despite previous consolidation efforts since the 2013 budget, rising interest costs and low growth gave rise to persistent budgetary pressure.
A comprehensive package of structural reforms is supposed to turn the primary fiscal balance (excluding interest payments) into equilibrium (0%) as of 2017 and put government debt back on a sustainable path. Public debt accumulated to 50.1% of GDP in 2015 coming from 40.9% in 2012, although it is anticipated to stabilise around an average of 52.7% over the next four years. Either way, about 70% of public debt is held domestically and almost 90% of total indebtedness is denominated in South African rand, which seriously eases (exchange rate) risks. Fiscal policy ought to focus more on governance, spending efficiency and private sector participation in SOEs, while a combination of cost-cutting measures and expenditure reprioritisation should be introduced. In fact, the recovery of budgetary credibility through implementing meaningful fiscal consolidation will help stabilise debt projections and will therefore be essential for dodging an impending downgrade to ‘junk status’ by the three main credit agencies. Hence in case of policy inertia, future public debt ratios could be higher than currently anticipated for.
External debt ratios are climbing… but expected to remain sustainable
External indebtedness has been following an upward trend over the past decade, moving from 72.3% of current account receipts in 2006 (23.1% of GDP) towards a projected 133% in 2016 (51% of GDP). Growing private and public sector debt together with persistent economic headwinds since 2008 have driven up these ratios. Over the coming five years, external debt ratios are estimated to somewhat stabilise around 135% of current account receipts or 53% of GDP, still sustainable levels. Traditionally, South Africa is rather reliant on short-term external debt which has also grown over the past decade, from 25% of current account receipts in 2006 to 32% in 2016, raising the rollover risk to some degree in case of a shock.
Foreign international reserves have lost about 6.6% since the end of 2013. Yet, South Africa still enjoys a relatively solid liquidity buffer that covered the equivalent of 4.4 months of goods and services imports in June 2016, the standard threshold being 3. Reserves cover more than 1.5 times the annual external debt services that peaked at 25.4% of current account receipts in 2015, although they are expected to remain above 20% of current account receipts in the forthcoming years.