Is South Africa set for a tough economic year?

May 7, 2014

Despite South Africa's anti-corruption watchdog publishing a damning report on 'security' upgrades to President Zuma's home, opinion polls continue to point to victory for the ruling African National Congress (ANC) party in elections on 7 May.

The state paid $21 million (£12.37 million) to equip Zuma's home with, amongst other things, a chicken run, amphitheatre and swimming pool, but voters seem unfazed; a poll on 4 April said the ANC was likely to win 65.5 per cent of the vote. This is close to the two-thirds majority needed to alter the constitution and is down only slightly from the 65.9 per cent share of the vote they received in the 2009 elections.

The main opposition party, the reformist and more market friendly Democratic Alliance (DA) has run a fairly negative campaign, focusing on Zuma. Though they have gained in the polls it appears not to be at the expense of the ANC. The only other party to have made gains is the new Economic Freedom Fighters (EFF) party, a left-wing populist group under ANC breakaway Julius Malema - though they have plateaued in recent months. Again, this gain appears to be the loss of other opposition parties rather than the ANC.

change in policies

The election seems set to deliver a strong majority for the ANC if polls are to be believed. If the ANC were to see its share of the vote eroded, it would likely alter its policies, though the direction would depend on who was responsible.

Should the DA take votes away the ANC could be driven to pursue labour reforms, and more rapid implementation of the National Development Plan. A more negative outcome would be one where the ANC loses vote share to the EFF, which has been pushing for nationalisation of the mines and uncompensated land seizures. At present though, the polls suggest no particular political push is likely; so the base case is for more of the same.

The only positive we can offer on this front is that we should see more movement on reform post-elections, when there is more political capital to spend.

Can the country survive another round of 'business as usual'? The 'Fragile Five' concept is increasingly redundant as India and Indonesia continue to make macroeconomic adjustments, while Brazil and now even Turkey have moved in the right policy direction. South Africa, though, remains firmly ensconced in the realms of fragility. Yet if we look at measures like credit growth, wage growth and real effective exchange rate adjustment, South Africa actually fares very well in a comparison with the other Fragile Five countries, and versus most other current account deficit emerging market (EM) economies too.

South Africa's fragility stems instead almost entirely from its poor export performance. Exports have fallen sharply in dollar terms in recent years (see chart below), unlike any other EM economy. Driving this is a fall in local production and global prices for the country's commodity exports. Weaker growth in China, discussed briefly at the end of this article, is one factor behind this fall in prices, and looks set to continue.

There has been a recent improvement in the merchandise trade and current account data, but it may only be temporary. Two monthly surpluses were posted in the last quarter of 2013, which reduced the current account deficit for the quarter to 5.1 per cent from 6.4 per cent the previous quarter. While this is a positive development, the recent platinum strike will show up in the data from March onwards, and has also accelerated (if not triggered) the closure of platinum mines which will structurally reduce export volumes.

Recovery in the current account looks likely to be increasingly reliant on import compression. Recent purchasing managers' indices, GDP and other activity data has all been unimpressive - domestic demand is crawling along. Negative from a growth and earnings perspective, of course, but it does mean there's little adjustment needed on this score.

Instead, the main adjustment is to be made in the external sector, and the best channel, is probably the currency. A large scale depreciation would make imports more expensive and exports cheaper, rebalancing trade without constricting growth further. The currency has in fact already depreciated 18 per cent from a year ago, and while export performance has improved marginally there is clearly much further to go given the deterioration in the terms of trade.

weak commodity prices

Weakness in commodity prices means the country must ship out even more of the stuff it digs out of the ground for a given trade balance improvement. Further, though depreciation helps, it also causes inflation. If this inflation feeds through into wages and ultimately export prices, it will undermine competiveness. There would appear to be relatively little the government can do, whatever the election outcome, to resolve this.

However, while South Africa is powerless to affect global commodity prices, it could at least do something to address its local production problems. Labour disputes are frequent and costly; the platinum miners' strike has been running for three months now, reportedly costing $1.4 billion in lost revenue.

Reforms to labour institutions and the market as a whole would help address this issue, and encourage new investment in industries capable of generating export revenues. The government recognises this as an issue, but whether it will feel capable of tackling it will depend on whether voter sentiment tends towards populism or pragmatism in May.

Growth since 2009 has been dependent upon public consumption and public infrastructure investment, which between them have accounted for nearly 40 per cent of growth in that period. Households enjoyed income growth and rising unsecured credit, boosting private consumption. Private investment, though, has been weak. Now consumption is faltering in the face of tighter credit conditions and high inflation. Inflation is currently just below its 6 per cent target, at 5.9 per cent, but further pass-through from currency weakness seems likely.

The central bank typically assumes a 20 per cent pass-through coefficient, though this can be lower at times of very weak demand. Barclays estimates that the rate of pass-through has dropped to 13 per cent since 2007. Still, inflation looks set to face upward pressure from this channel and also domestic food price pressures, and further policy tightening is warranted.

Obviously, further hikes will act as additional hurdles to consumption. On the public expenditure side, the National Treasury has committed to keep expenditure growth to just 2 per cent per annum in real terms (excluding interest payments). Though this is to be welcomed given that the country's credit rating is on negative outlook with two of the three ratings agencies, it will limit fiscal support for growth. All in all this looks set to be a tough year for South Africa, whatever happens in May.

Craig Botham is emerging markets economist at Schroders

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