INVESTORS in South Africa have always had a difficult time reconciling a bearish long-run picture with at times short-run bullish dynamics.
We are in just such a situation at the moment. On the positive side we have an economy that is feeling the effects of the eurozone crisis and slowing but retaining enough momentum to prevent a recession, a fiscal consolidation path that is broadly credible, and a financial system that is sound and sheltered from the troubles of its global peers, plus a credible central bank.
But underneath is a long-run potential growth rate at 3.75% – far too low to reduce the endemic structural unemployment issues ("real" joblessness is around 38%) and being kept that low by a mixture of policy and politics.
The potential for long-run social instability is therefore a key issue, and one that the rating agencies have been paying close attention to.
A certain minority of investors and local commentators are exaggerating sovereign risk around South Africa – with cries of "Zimbabwe"– but such a view is misguided.
The political risk is that the status quo continues and the country moves further down the road of state intervention and tight labour laws which erode competitiveness – not that there is some cataclysmic blowup.
We therefore see South Africa’s medium-run story as one of underachieving its "potential potential" – ie growth that could be so much higher when the right policies are in place.
There have been grinding net outflows month by month in equities by foreign investors despite record flows into global emerging market equity funds. We have also seen the underperformance of foreign direct investment its peers. Bonds, however, have not been able to trade the long-run story and have seen record inflows of over $25bn since the end of 2008.
This flow was thanks to central banks abroad undertaking quantitative easing, a steep yield curve and high yields locally combined with positive (if low) growth outlook and fiscal policy that investors were broadly content with. Such flows have increased due to South Africa’s inclusion into the World Government Bond Index.
However, a number of shocks have brought the long-term picture into much closer focus. The Marikana mining tragedy showed the underlying dissatisfaction with ANC-aligned unions and the inequality of both income and living standards.
This seems to have led to a desire for more aggressive, illegal and violent forms of wage settlement. The tragedy was not caused by politics ahead of the ANC’s elective conference in Mangaung in December, but was catalysed by it in our view.
Investors are now closely watching for contagion which seems to be occurring in other mining areas and onwards to other sectors of the economy.
We then had the downgrade from Moody’s last week which hinged not on fiscal policy and debt levels but instead on the government’s reduced capacity to respond to the country’s socioeconomic challenges. This came from the inability of the government to bring the Marikana situation under control, or prevent contagion.
The downgrade also highlighted the possibility of the ANC December conference implementing policies as a result of the tragedy that are detrimental to competitiveness and boosting growth.
The final recent jolt has been a shockingly large current account deficit of -6.4% of gross domestic product (GDP) in the second quarter of this year. A current account of this level is not sustainably fundable with bond inflows and other credit flows alone.
Once again, the difficulty in trading this picture is that there are not necessarily major potential shocks on the horizon. The October budget is likely to still paint a broadly credible picture, for instance.
Equally, we see two outcomes to the ANC’s Mangaung conference: (1) the status quo with President Jacob Zuma re-elected and the same slow grind on the policy front as described above, or (2) the election of current Deputy President Motlanthe which could be more positive as regards investor-friendly policy.
However, given Zuma’s ability to shift his policy position we think he is still marginally more likely to get elected than Motlanthe.
Unfortunately, we doubt South Africa will wake up to the consequences of its chosen policy direction until there is a meaningful market funding or domestic shock. It seems Marikana was not enough of a shock.
The government already knows all the answers to the country’s problems – they are contained in the recently published National Development Plan written by Trevor Manuel’s Planning Commission – but we would agree with Moody’s assessment that much of the NDP is never likely to see the light of day in this environment.
Currently, the local politicoeconomic debate is much more like a fraught ideological battle one would have been more accustomed to in 1960s Britain.
For now, investors must watch and wait for December and the prospect of more downgrades to come, even as growth performs well enough and inflation remains under control. Recent shocks have given us glimpses of this bearish longer-run picture, but we are not there yet.
*Peter Attard Montalto is emerging markets economist at Nomura. This article first appeared as a blog
in Financial Times.
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