South Africa’s Economic Woes: Growth Slides, Fiscal Space Shrinks

South Africa’s economic woes are increasingly looking more terminal than structural, raising concerns about the government’s ability to keep a lid on social tensions as unemployment and poverty escalate.

Like most other commodity-exporting emerging markets, South Africa faces the triple challenge of a volatile currency, slumping demand from China and an ever-increasing strain on the National Treasury.

The budget presented by Finance Minister Pravin Gordhan this week made it abundantly clear that South Africa needed to urgently find ways to lure investment, reignite growth and stave off a looming sovereign rating downgrade.

Although Gordhan tried to reassure credit rating agencies, vowing to continue fiscal consolidation by curbing spending, analysts were generally not convinced that his budget acrobatics will be enough to prevent the country’s slide into “junk” (non-investment grade) status.

That outcome will hammer the rand, push borrowing costs up, stifle bank lending and hinder the implementation of the government’s ambitious economic blueprint, the National Development Plan. Ironically, on the very same day that Gordhan was presenting his budget, Moody’s cut Brazil to junk status.

Brazil, along with South Africa, is in the BRICS group of emerging markets. The other members are Russia, China and India.

“Commodity exporters in particular have been downgraded, and we see no reason why South Africa should be an exception. We do not think Gordhan did enough to prevent a downgrade but in all fairness, his hands were tied,” said the global currency strategy team at Brown Brothers Harriman in a briefing note after the budget speech.

“Our own ratings model has South Africa at BB/Ba2/BB and so downgrades are warranted,” the briefing note continued. “This compares to a BBB- rating from both S&P and Fitch, but Fitch has a stable outlook. South Africa also has an inexplicable Baa2 (equivalent to BBB) rating from Moody’s with a negative outlook.”

VULNERABILITY

In its reaction, Standard & Poor’s said that Gordhan’s fiscal consolidation was vulnerable to lower-than-expected GDP growth and shortfalls in revenues.

“We also consider that the fiscal trajectory continues to be exposed to contingent liabilities emanating from state-owned entities with weak balance sheets, which may require more support than what the government has currently provided,” the agency said in a statement.

It also noted that debt-servicing costs were vulnerable to the domestic interest rate environment and, to a lesser extent, to exchange rate weakness.

The rand, which has racked up losses of 10% per annum over the last decade, fell 3% against the U.S. dollar as Gordhan spoke before Parliament last Wednesday.

South Africa is the second biggest economy on the African continent, behind Nigeria. Its sophisticated infrastructure, advanced financial system and sound legal framework wins the country plaudits every time.

But ever since the advent of democracy in 1994, the country has struggled to generate meaningful growth, ending up with one of the most unequal societies in the world and one of the highest unemployment rates.

Although the country was somewhat shielded from the ravages of the 2008-2009 financial crisis, it failed to capitalize on the global recovery that followed, as labor strife, policy uncertainty and corruption stifled confidence.

The effects of economic stagnation are evident from the wave after wave of protests over service delivery snags. The protests have now spread to the universities, where black students, many of them from poor backgrounds, are demanding free tuition as part of the so-called #FeesMustFall movement.

Last October, the students extracted a major but very costly concession from President Jacob Zuma when he agreed with university authorities to freeze tuition hikes for this year. It now falls on Gordhan to juggle things in order to come up with billions to fund the gap.

The obstacles to meaningful growth in South Africa have both a historical and contemporary context. Apartheid left millions of black South Africans languishing in poverty, with little or no education. Today, the very same black majority swells the ranks of the unemployed, as structural constraints persist. In the run-up to Gordhan’s budget speech the mood was already negative, mainly because of the damage to investor confidence.

BLOW TO SENTIMENT

The biggest blow to market sentiment resulted from the surprise firing of Nhlanhla Nene, a capable finance minister, by Zuma in December. The fallout from that episode sparked a broad sell-off in South African financial markets and wiped off more than R500 billion ($30.94 billion) in asset values as investors reacted with shock.

Zuma, who faces mounting calls from the opposition to resign, has also been focusing on fending off damaging criticism over the use of public funds for security upgrades at his private homestead.

Pressures from the business community and from within his own party forced Zuma to abruptly reverse course, and he reappointed Gordhan to the National Treasury after Nene’s initial replacement was slammed as inexperienced.

In this year’s budget, Gordhan, as expected, cut the Treasury’s economic growth forecast for 2016 to a dismal 0.9%, a level at which the economy cannot create enough jobs to absorb new entrants into the workforce, boost investment or shore up tax revenues.

So in the intermediate term a continued lack of confidence, especially among investors, is set to exacerbate the challenges facing Zuma’s administration and his party, the African National Congress (ANC). The official unemployment rate is 25%, but by some estimates it could be as high as 40% if the millions that have given up looking for jobs are counted.

“Low growth, high unemployment, extreme inequality and hurtful fractures in our society — these are unacceptable to all of us,” Gordhan told the Parliament. “All of us want jobs, thriving businesses, engaged professionals, narrowing inequality, fewer in poverty.”

In articulating these sentiments, Gordhan effectively echoed what he had said in the past, though to little or no effect.

 

Once again he pleaded for the government to live within its means, saying that one of the pillars of fiscal consolidation would be a reduction in the size of the public service. But in a country where one in five people work in government, slashing the public service might not endear the ANC to its labor allies, who say that austerity will make the working poor much worse off.

Gordhan proposed increases in a series of indirect taxes, including the fuel levy, property taxes and the capital gains tax. He was obviously too afraid to raise the value-added tax (VAT) and personal income tax, as had been speculated before the speech, due to the impact these would have on the poor, especially during the run up to this year’s local government elections.

“Personal income taxes were not raised, as cognizance was taken of the collapse in the economic growth outlook for 2016, a slow-growth year where the consumer is financially vulnerable,” said Annabel Bishop, chief economist at Investec.

Ultimately, investors will need nerves of steel over the next two to three years, as South Africa searches for what is proving to be an elusive economic miracle.

Photo credit: iStockphoto.com/lcswart

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