Structural policy moves are needed to boost SA economy

Politics, economics and investment rarely intersect as incisively as they did halfway through 2016. If we had, the day prior to the Brexit referendum, asked a group of economists to predict the likely level of the rand, Brazilian real or the Mexican peso, should the British vote for Brexit, they would have said that a weakening of 10% to 15% from those levels was likely. Instead, most emerging-market currencies have appreciated – in some cases by around 5% to 10%.

In hindsight, the reason is clear. Fears around the impact of Brexit on global growth raised expectations of weak global monetary conditions, pushing bond yields negative in the UK, and lower in all the developed markets. Together with a slow, but notable improvement in emerging-market fundamentals over the past two years, this was enough to push global investors back into emerging markets in search of yield.

Politics clearly matters for investors, but this insight must be balanced by the understanding that politics drives short-term volatility, while economics drives long-term returns. 

A mix of local politics and global economics dampen South African growth 

A combination of global and local factors will determine the fate of the South African economy over the next two years. Unfortunately, there is little clarity on either front. Will the global economy continue producing mediocre growth, which keeps a lid on commodity prices, thus dampening South African growth? And will money continue to flow into emerging markets in a search for higher yields than the negative rates being offered in many developed markets?    

There is little South Africa can do about Chinese growth rates, the impact of Brexit or the US elections. All have the potential to significantly impact SA’s growth rate.  However, the downgrade in estimates of the country’s potential GDP growth from between 4% and 4.5% in 2010 to 1.5% currently is due to both the sluggish global environment and self-inflicted wounds, including political and policy uncertainty.  

One symptom of this uncertainty is private sector fixed investment, which has not grown since 2009. Unless confidence is restored, fixed investment (and thus potential growth) will remain low.    

Unfortunately, the combination of local and global issues means that SA GDP growth is likely to be around 0% to 0.5% in 2016 – barely positive. There should be a rebound in 2017, but to around 1.3%. Policy uncertainty, as epitomised by the shock removal of finance minister Nene on 9 December 2015, shoulders much of the blame.  

Business confidence at record lows   

Electricity constraints due to the mismanagement of Eskom over the last decade (though there has been some improvement of late), labour unrest as a result of the poor relationship between labour and business, and the increasing regulatory burden on business are all factors that result in lower fixed investment. Together these local factors account for at least two percentage points of decline in SA’s potential GDP growth rate.  

Aside from the decline in growth, there are other lingering consequences related to Nene’s dismissal. While both the rand and the cost of insuring SA’s debt (measured by the cost of credit default swaps) are back to pre-9 December levels, rand-denominated bond yields in SA have not fully recovered. The spread between the SA 10-year bond yield and the JP Morgan emerging-market investment-grade index averaged 140 basis points (bps) between 2011 and late 2015. On 10 December 2015, it spiked to 310bps. Since then, it retraced somewhat to around 255bps.   

This means there has been an increase of 100bps to 150bps in SA borrowing costs due to the uncertainty caused by Nenegate, immediately reducing the amount available for investment by government in infrastructure and services. This reduces the country’s potential growth rate, and hence the potential returns available to local investors.    

Can SA avoid a ratings downgrade?

In June, Standard & Poor’s (S&P) cautioned that a downgrade would be inevitable in December 2016 if GDP growth did not improve in line with its expectations, if institutions became weaker on the back of political interference and if net general government debt combined with government guarantees to financially weak government-related entities surpassed 60% of GDP.  

Fortunately, there are some positive signs. We’ve seen an improvement in SA’s terms of trade. A continued trade surplus should ultimately reflect in a smaller current account deficit, lessening our vulnerability to external shocks.    

Finance minister Gordhan announced a significant fiscal consolidation in the February 2016 Budget. So far, the revenue and expenditure targets are broadly on track. Unfortunately, there are no signs yet of any structural policy moves that are needed to boost SA’s growth rate, create jobs and shore up the country’s investment-grade rating for the long term.  

That notwithstanding, while the country is facing growth and fiscal concerns, the economic problems are not quite as dire as we feared earlier in the year. If the recent political turmoil quickly quietens down, SA could potentially avoid a downgrade from S&P in December. In the meantime, a cautious approach and a well-diversified portfolio, both in asset allocation and geographic allocation, would be prudent.