Post February prospect for South Africa

After delivering a difficult budget for 2020, Minister Mboweni and the Executive Office still face an uphill battle to reassure the business community that policies announced during February’s State of the Nation Address and Budget Speech will be implemented while also attempting to douse the fires ignited in the tripartite camp through proposed wage cuts.

Many consider the budget statement the opening gambit for a long overdue confrontation between government and labour. It’s not yet clear if government will push through plans to renegotiate wage agreements with ANC alliance members. But, if wage negotiations happen, how business fits into this budding confrontation remains to be seen.

As always, the risks are high, with the cost of political confrontation being front and centre. The new track set out in the SONA and budget speech brings some relief that the solution this time does not rely solely on policy responses. This time, it includes a pinch of fiscal stimulus for the private sector and consumers.

2020 Budget

Considered a private sector and consumer-friendly budget, the minister pleasantly surprised commentators and observers as the budget brought above-inflation increase in personal income tax brackets and rebates for FY 2020/21, meaning taxpayers will pay 5.2% less income tax[1]; surprisingly against admission that tax revenue targets for the financial year were missed.

To try and arrest debt accumulation and close the budget gap the minister announced proposed cuts in the public-sector wage bill[2] and a reduction on main budget non-interest expenditure (i.e. lowering programme baselines). These are ‘proposed’ cuts in the wage bill since government and labour would have to agree to renegotiate the terms of the wage agreements, something which organised labour has been vehemently resisting. Admittedly, some of the savings from these cuts will be offset by additions and reallocations of R111 billion, with more than half going towards failing State-Owned Entity (SOEs), notably Eskom and South African Airways (SAA).

Saving the SOE, Eskom, remains a priority and is probably best for any medium-term economic stability. Government is committing R230 billion over ten years to achieve the restructuring of the electricity sector, but within this remains a lot of space to ‘kick the can down the road’. Ten years is a long time over which to measure and implement changes and political marches from opposition parties have already taken place to resist any restructuring that might result in privatisation of SOEs.

Seen as a key driver of economic growth and employment, SMMEs too can celebrate the announcement of a review of the preferential small business tax regime, the VAT registration threshold and the turnover tax. Government is also looking to reduce the corporate tax rate while broadening the base.

Despite the celebrated announcements, a consolidated budget deficit of R370.5 billion, or 6.8% of GDP, is expected for the financial year 2020/21 with gross national debt projected to be R3.56 trillion, or 65.6% of GDP, by the end of 2020/21. Total consolidated government spending is expected to grow at an average annual rate of 5.1%.

An increasing debt burden aside, the budget was well received. The main vote of confidence is yet to come from Moody’s at the end of March as they may – or may not – announce an update on the Government of South Africa’s credit ratings. However, post-budget discussions, workshops and roundtables revealed that there remains a healthy level of scepticism in government’s capacity to implement policy, echoing Moody’s concerns. Deeper still is scepticism over the state’s intention to reduce its influence over the economy and allow for more private sector participation, given the governing party’s alliance with COSATU and the SACP.

Setting the stage for a confrontation

South Africa’s growth prospects over the medium term continues to look grim with high frequency data indicating that the country ended 2019 in recession. Furthermore, most estimates show that South Africa’s growth prospects for 2020 are now under 1%.

What these estimates don’t show is that they were made before the outbreak of COVID-19 (the Corona virus), which means even the National Treasury’s adjusted 0.9% GDP growth might be ambitious given its impact on the global growth outlook, as well as the effect on South Africa’s tourism sector with travel cancellations. Several cases of COVID-19 has been announced over the past week in South Africa, but the Department of Health’s capacity to effectively deal with positive cases and track the spread seems to be intact. The department’s capacity and processes, developed in anticipation for the spread of Ebola, are likely paying off as they are directed towards the new threat.

However, should there be a full blown COVID-19 outbreak in South Africa, tertiary services-based industries – like trade, tourism, personal services and community and social services– are likely to bear the brunt of the effects. Unfortunately, these are also South Africa’s largest industries by employment. Thus the resulting adjustments could further deteriorate household spending and as large gatherings are cancelled, and consumers avoid crowded places like shopping centres and markets, many SMMEs that rely on foot traffic and provide auxiliary business services would suffers the worst consequences since these operations are not geared towards weathering a protracted slump in demand.

The primary and secondary sectors -mining, manufacturing and agriculture etc.- would suffer from the same constraints on personal movement but the breakdown in global supply chains is likely to deal a much bigger blow to South Africa’s already ailing secondary industries. Domestic manufacturing output could come under pressure as shortages in imported input stocks increase and global demand weakens further. This would result in an increase in prices of manufactured goods for domestic sale while average household income shrinks. There could be an increase in the cost competitiveness of South Africa’s exports, assuming the Rand depreciates as currencies move towards safe havens, but gains would be offset by the slump in demand.

South Africa’s economic recovery is further threatened by other global risks including:

  • A further softening in global demand if trade tensions between the US, China and the EU endure;
  • Increasing debt burdens in Emerging Markets if commodity price and currency volatility increases, further exposing undelaying market weaknesses.
  • A rapid increase in energy prices if tensions in the strait of Hormuz escalates.

At the start of March, the impact of COVID-19 seems to be countering fears of a price hike in Brent Crude as global demand for fuel, especially in quarantined areas (like Wuhan and potentially Northern Italy), are decreasing. The OPEC group had also failed to negotiate a cut in production and competition among members is forcing the price down even further. This will keep a lid on energy price push inflation but how central banks respond to this particular dampener will have a massive impact on global financial markets.

While global conditions are ripe for fiscal stimulus and budget consolidation, through which SARB’s MPC and Treasury seem to be aligning with by softening monetary policy and fiscal stimulus, a weak economic performance will be most notable for South Africa’s low-income households.

In the short to medium term, anticipated low economic growth will put additional pressure on the country’s social safety nets as more workers are likely to face retrenchment and low-income earners, for whom organised labour has been campaigning for above-inflation wage increases over the last decade, are at risk of falling back into a poverty trap.

Both challenges could demand their ‘pound of flesh’ from the budget to provide relief. As more citizens claim from the adequately wide, but relatively shallow, social security programmes further adjustments to the budget and more loans might be on the cards. On the other hand, labour unions could demand further increases to counter tougher economic conditions, or at the very least a status quo of wages, meaning the proposed public sector budget cuts will not materialise threatening South Africa’s medium-term budget consolidation objectives.

As markets adjust to the new global risks, South Africa’s government, at all levels, would be expected to provide further relief to households and industries, while opposition parties are not likely to let the opportunity slip to protest continued governance failure under the ANC’s watch. Protracted labour action and service delivery strikes will put the executive under more pressure but is unlikely to deter the president and National Treasury from their slow and steady, back-to-basics strategy. Government’s current approach is pragmatic but not likely to excite investors who are looking towards government for further signs that private enterprise is welcome to wider participation in controlled sectors like bulk transport and energy.

In the short term, what remains critical is the state’s ability to raise capital through the sale of bonds at affordable rates, which means keeping Moody’s happy. The credit ratings agency is looking for a credible medium-term vision for the country including a plan to narrow the budget deficit and stimulate economic activity.

Since Moody’s outlook turned negative in November 2019, due to “the continued deterioration in South Africa’s trend in growth and public debt burden, despite ongoing policy responses”[3], the state has had two critical policy windows to address these concerns. It is believed that both the State of the Nation Address and the Budget Speech might have been enough to stave off an immediate ratings downgrade but the continued deterioration in South Africa’s economic growth and greater risks realised in the global economy would likely see the other shoe drop with a downgrade announcement at the end of March.

At this point Moody’s is running a reputational risk by being the only ratings agency to keep South Africa above junk. In the interest of optimism, it’s important to consider the benefits to the ratings agency of delaying an announcement to later this year. Taking more time to make an announcement will give Moody’s some space to make an longer term assessment on the risks posed by COVID-19 to the global economy, and the potential opportunities of a hitherto limited exposure of COVID-19 in Southern Africa compared to the spread in the rest of the world. Moody’s will also have more time to see if South Africa’s government delivers on its policy announcements made in February and if they deliver results.

Currently, inflation is expected to remain within the target range (3%-6% range), albeit on the lower end (≤4.5%), which is great for consumers, and allows for further adjustment to the policy rate if needed. Unlike most developed countries, South Africa and other emerging markets still have some monetary policy space to compensate for the slowdown in global demand. However, as investors weigh the costs and benefits of investing in developed country indices to emerging market bonds and stocks, an emerging market risk-off sentiment could prevail along with avoidance of emerging market currency volatility.

However, according to local portfolio managers, global markets have already priced in the risk of a Moody’s credit ratings downgrade for South Africa. Nevertheless, a downgrade could trigger a further exodus and make it more expensive to attract finance to South Africa in future.

Returning home

While international investors have several choices when making investment decisions, most South Africans are limited and choose to engage domestically. However, domestic investments have been made despite governance, policy and institutional failures with the hopes that the country’s fortunes would turn around. This has resulted in a continued deterioration in business and investor confidence as businesses with even mooted expectations suffer disappointing returns.

Since President Ramaphosa assumed office in February 2018, the business community has been waiting for a bold decision from the executive that would reignite private sector-led economic growth. However, Ramaphosa has been trying to consolidate his political power within the governing ANC and re-establish the ANC’s position as the party to radically transform the structure of the economy. Over time, the business community grew less patient as Ramaphosa spent the better part of the last two years shoring up his support via committees, summits, envoys and building social compacts with no real results to show for it, yet.

Through announcements in the SONA and the budget speech, a step change was noticed that sparked some excitement in the business community. Either through necessity or bold executive decision, two critical pillars of political support are now in the ‘reform’ crosshairs: public sector wages and government’s grip on the electricity sector.

For many stakeholders, this would mark the start of a new debate about the role of organised labour in South Africa and the rationality of, often overbearing, government control of economic sectors.

Learning to trust

Through direct control (in the case of SOEs), dogmatic policy support of labour sensitive industries or overbearing regulation, South Africa’s government has been at the driving seat of the economy for the better part of the last decade. The reasons for these levels of control are well documented and the agenda for a ‘developmental state’ is widely supported, but government’s inability to adjust its approach to more effectively deliver on its objectives have certainly played its part in further entrenching government control for political support and unfortunately, personal gain.

Through the past two addresses in February, the public has been reassured that the underlying economic strategy as published by the National Treasury[4] remains intact, with the objectives of reaching NDP targets in sight, over the long-term. This is a critical signal as national economic policy has been inconsistent, to say the least, over the last decade.

The Treasury paper is widely supported by the private sector, and a large contingent of the public sector, as a strategy to address targeted challenges that will have an immediate impact on our everyday lives. But some fears remain that government, or more specifically some ideologues in government, are not yet ready to release its grip on economic control. This is noticeable in the differences between the Treasury paper and some sectoral master plans.

As has been noted in several sectoral master plans, and hinted at in the budget speech and SONA, the inclination towards import substitution and full vertical control of value chains remains a hallmark of government’s sectoral support and economic policy. These policies could work if South Africa was a China or USA economy, which already have massive manufacturing bases and enormous domestic markets under a single sovereign jurisdiction. But as a relatively small economy at the southern tip of Africa, it neither has the industrial base nor the level of access to markets with the same purchasing power as the US or China. Instead what South Africa has is the opportunity to become a large services base for a continent with boundless potential, but that gap is closing quickly too.

Over the next three years, a rare opportunity could open for the country if government relinquishes some of its grip on the economy. Private sector could show that it too can deliver economic growth to contribute to a more equitable society; government has the opportunity to prove that it can nudge the country on a path of growth and development rather than dragging it by the nose. And government, in cooperation with organised labour and civil society, can ensure that real structural change takes place.

The most likely outcome for the medium term probably lies somewhere in between broad relaxation of government control and the status quo. For one, the public sector wage bill negotiations could spill over into wage negotiations with the private sector as labour unions seek to regain some ground for their members, which can reduce South Africa’s competitiveness and investor appeal further. And, unfortunately, government is likely to prioritise implementation of several of its sectoral master plans, moving towards vertical integration that suits select industries’ needs, to further cushion them at the expense of upstream and downstream participants and foreign competitors.

Notes on the Statistical Annex

South Africa did enter a technical recession at the end of 2019 per the statistical charts appended. On average only 4 of the aggregated 10 industries reported by Stats SA grew over the last four quarters, with the largest average growth rate for the year reported by the “Finance, real estate and business services” industry (0.59%).

The worst performing industry “Agriculture, forestry and fishing” faced tough conditions in 2019, but contributes a relatively small share to South Africa’s total GDP. Threats to the Agri industry, however, are external; global weather conditions and the spread of pests and disease are likely to continue to put the stakeholders under pressure. Recovery in the rest of the sectors are either dependant on a bounce back in global demand or a resurgence in domestic consumption; unfortunately, both will likely remain under pressure in the short term.

[1] https://businesstech.co.za/news/budget-speech/377225/the-2020-budget-in-a-nutshell/

[2] An agenda item on the management of the public service wage bill at the Public Service Coordinating Bargaining Council has been tabled with a focus to discuss containment of costs in the final phase of implementation of the current wage agreement.

[3] Moody’s changes South Africa’s outlook to negative from stable, affirms Baa3 ratings; https://www.moodys.com/research/Moodys-changes-South-Africas-outlook-to-negative-from-stable-affirms–PR_412385

[4] Towards an Economic Strategy for South Africa; http://www.treasury.gov.za/comm_media/press/2019/Towards%20a%20Growth%20Agenda%20for%20SA.pdf

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