With a long-established track record as the continent’s largest financial platform and one of the world’s biggest mining producers, South Africa has significant economic clout in the region. However, industrial strife and policy uncertainty have become key sources of investor concern of late. Recent years of slowing growth have failed to make much of a dent in structurally high unemployment and inequality, although a new government-endorsed development plan seeks to broaden inclusion and establish the foundations for higher-value-added growth. The economy benefits from an internationally competitive private sector, which accounts for roughly 70% of GDP, according to the Treasury, 18% of which constitutes an informal sector, while the public sector makes up the remaining 30% of GDP.
South Africa ranks as the largest economy in Africa and the 28th largest globally, with gross GDP of roughly R3.2trn ($390bn) at year-end 2012, according to the South African Reserve Bank (SARB). In 2011 it joined the association of emerging national economies comprising Brazil, Russia, India and China (BRICS), of which it is the smallest member, making up 2.5% of BRICS’s GDP, according to Standard Bank.
The correlation of South African growth to global conditions has increased in the two decades since the end of apartheid, according to the IMF, but expansion averaging 3.3% annually has lagged at roughly half the rate of emerging market peers in that 20-year period. Addressing structural challenges, including high unemployment, which reaches as high as 40% for workers under 25, a weak education system, strong and divisive unions, and ageing infrastructure, will help the economy reach optimum growth levels.
Growth slowed from 3.5% year-on-year (y-o-y) in 2011 to 2.5% in 2012 due to adverse conditions in key export markets like the EU, subdued global commodity prices and unrest in the domestic mining sector. The economy slowed markedly in the third quarter of 2012 with y-o-y growth of 1.2%, down from 3.4% in the second quarter and the slowest pace since the nadir of the global financial crisis in 2009, following incidences of violence as part of a wildcat strike at the Lonmin-operated Marikana mine in August 2012 (see analysis). While the mining sector’s share of GDP has fallen from 21% in 1970 to roughly 5% in 2012, it remains the country’s key foreign-exchange earner, accounting for close to 60% of exports.
Manufacturing output, which accounts for around 15% of GDP, recorded 2.4% y-o-y growth, while agriculture grew 2.3% in 2012, according to Statistics South Africa, despite a set of farmer strikes in the final quarter of the year. Indeed, the economic rebound seen in the fourth quarter of 2012 was largely driven by a 10% y-o-y rise in agricultural output and a 5% increase in manufacturing production. The economy thus experienced growth of 2.1% y-o-y in the last three months of 2012. Recovery remained unsteady, however, with the purchasing managers’ index, which tracks manufacturers’ sentiment and on which 50 indicates expansion rather than contraction, dropping back from 49.5 in November to 47.4 in December 2012.
Some still express concerns. “The South African market remains volatile and tough. With the exception of a few of the large banking, insurance and retail groups opening up branches elsewhere in the continent, most corporates are not in expansionary mode,” Adam Craker, CEO of IQ Business Group, told OBG.
In its 2013 budget, released in February 2013, the Treasury revised growth forecasts down from 3% to 2.7% for 2013, 3.8% for 2014 and 4.1% in 2015 (to R4.26trn, $519.3bn). Commercial banks like Nedbank project a slightly lower rate of 2.6% for 2013. This is reflected in slower growth in the country’s three largest provinces of Gauteng, Western Cape and KwaZulu-Natal, which together account for close to 60% of GDP. While economic expansion will rise towards what both commercial banks and the IMF see as the natural growth trend of 3.5% to 4%, it remains short of the 5-7% annual GDP growth required to support the government’s goal of creating some 5m new jobs by 2020.
Household consumption plays a key role in the South African growth story, accounting for some 60% of GDP in 2012, according to the Treasury, and worked to offset sluggish exports in 2012. Credit to households grew faster, at 9.9% in 2012 – up from 6.3% in 2011, but well below the heady days of 26% credit growth in 2006 – driven by record low prime lending rates, moderate inflation and a rapid expansion in unsecured lending. Higher wages also played a role: Statistics South Africa figures reveal that wages in the formal sector rose some 37% in nominal terms (17% in real terms) between 2008 and the start of 2012, to a monthly figure of R13,000 ($1584).
The outlook for household consumption is mixed in 2013, given job creation rates and the rising debt burdens of lower-income households in particular (see Banking chapter). The average share of debt to disposable income has increased from 53.7% in 2001 to 75.9% in the first half of 2012, according to the South African Savings Institute, while gross savings have remained relatively flat between 2001 and the first half of 2012, when the rates stood at 15.6% and 16.3%, respectively. Growth in household spending has generally trended downward since 2011; annual growth slipped from 4.8% in 2011 to an estimated 3.4% in 2012, and is only forecast to rebound gradually after hitting a low of 3.1% in 2013, rising to 3.7% in 2014 and 3.9% in 2015. Retail sales peaked in August 2012, at R47.33bn ($5.8bn) on a seasonally adjusted basis, according to investment bank Absa Capital, while the rebound in sales in November 2012 to R46.73bn ($5.7bn) did not match the performance in the third quarter of that year.
Meanwhile, credit to the corporate sector grew by 10.3% in 2012, up from 6.1% in 2011, according to Treasury data, despite the cash-rich status of leading firms and their hesitance to invest domestically given uncertain economic prospects. “Fixed investment activity in 2013 is likely to be fairly muted as demand conditions, both locally and globally, remain uncertain, whilst excess production capacity still exists in many sectors, thereby curtailing private sector fixed investment,” the Industrial Development Corporation, a national development finance institution, noted in its February 2013 economic update. While growth in public investment is already double that of private sector fixed-capital investment, which rose at 4.3% in the first three quarters of 2012, compared to the 8.6% rise in public investment, the relatively conservative 2013 budget includes significant investments in infrastructure by state-owned enterprises and the three tiers of government (see analysis).
Inequality has remained a persistent and growing challenge in South Africa, especially given the economy’s reliance on household consumption. While GDP in 2012 had more than doubled from the R1.39trn ($169.4bn) recorded in 2002 and average annual per-capita income has grown from R27,866 ($3396) to R38,734 ($4721) in real terms (adjusted for inflation) between 1994 and 2012. South Africa’s Gini coefficient (a measure of inequality, with 0 as the highest income equality) has deteriorated from 0.596 to 0.631 between 1994 and 2012, making it the world’s most unequal society, ahead of Colombia at 0.559 and the US at 0.408, according to World Bank data. With the highest unemployment rate of all major emerging economies, at 25.5% in 2012, the main source of job creation over the past decade has been the government, which accounted for 85% of new jobs since 2002, according to Statistics South Africa data.
The most affluent 20% of South Africans, half of whom are black, controlled 72% of GDP while the poorest 40% accounted for just 6% in 2012, according to Statistics South Africa data. Although a majority of South Africans have been connected to basic services – the 2011 census reported that 85% of the population had access to electricity and 78% lived in formal housing – affordability remains a significant challenge. The number of citizens receiving social grants from the government grew from 2.9m in 2000 to 16m in 2013, according to local investment manager Stanlib.
Amid slowing global growth in 2012 and in line with many other OECD countries, South Africa faced a series of ratings downgrades from Population by Living Standards Measure categories, 2012 all major credit rating agencies from September 2012 onwards. The cost of credit-default swaps (CDS) on five-year government debt had already jumped 21 basis points to 151 in the two months from late July 2012, with this adding to the growing risks associated with labour unrest in the aftermath of the strikes and related clashes in Marikana in August of that year.
Moody’s was the first agency to downgrade South Africa by one rank to Baa1, a medium grade, in late September 2012, followed by Standard & Poor’s (S&P) cut to BBB in October of that year. According to Moody’s, the main driver of these downgrades was the “decline in the government’s institutional strength and diminished capacity to manage the growth and competitiveness risks”. Konrad Reuss, managing director for South Africa and sub-Saharan Africa at S&P, told OBG, “The lack of coordination across various government departments was one of the key factors influencing our sovereign rating downgrade of South Africa in 2012.” Fitch, the last of the big three agencies to act, downgraded its rating to BBB in January 2013, citing the same issues, but maintained South Africa’s outlook as stable rather than negative.
While rating downgrades affected the rates at which both government and corporations could raise funding on public debt markets (CDS on the same debt jumped further to 171 by March 2013), the differences in outlook between the rating agencies reflects a lack of consensus on South Africa’s growth prospects.
“All three rating agencies have downgraded South Africa in recent months, with Moody’s and S&P currently maintaining a negative outlook on the sovereign rating, whilst Fitch returned the outlook to stable,” Jeff Gable, managing principal and head of Africa non-equity research at Absa Capital, told OBG. “Our sense is that this difference in outlook has more to do with the individual timing of each agency’s announcements rather than an underlying difference of opinion over the longer term. Fitch’s decision came after the African National Congress elective conference was complete, whilst the earlier announcements by S&P and Moody’s came at a time of great labour strife and policy uncertainty.”
The changes in ratings have already have made an impact, according to some. “The ratings agency downgrades are having the dual impact of lowering the pool of capital as well as increasing the cost of capital,” Martin Kingston, CEO of Rothschild South Africa, told OBG.
Bolstered by a deep foreign exchange market where turnover reached $17bn a day in 2012, the rand has historically traded as a gauge for global investor appetite for emerging markets – particularly useful for hedging global risk-on, risk-off swings following the recent global financial crisis. Yet from early 2012 the currency’s trading gradually decoupled from global factors, driven by domestic economic and political developments. The broadening current account deficit was the initial trigger for a sell-off in the currency at that time, but the spread of labour unrest in the mining and agricultural sectors, and subsequent downgrades from all major credit rating agencies from late September, sustained downward pressure on the currency. The rand dropped by some 15% against the dollar and the Mexican peso in the year to March 2013, reaching four-year lows of R9.36 to $1, R12.25 to €1 and R13.79 to £1, according to Bloomberg data.
“The rand acts as a safety valve; its drop in 2012 was caused by a confluence of factors, which included both local and international factors, such as a widening current account deficit and labour unrest, as well as volatile global portfolio investment flows linked to monetary easing globally,” Reuss told OBG (see analysis).
During the rand’s appreciation to early 2012 the reserve bank’s foreign-currency reserves grew from $34.1bn in 2008 to $48.9bn, levelling off to $50.8bn by November 2012. While these reserves were still deemed low, the SARB announced its intention to continue to build reserves beyond those levels, which covered roughly 4.5 months of imports in early 2013.
While the SARB seemed comfortable with the rand’s slide through January 2013, both the Treasury and the bank have expressed concerns over the growing volatility that is associated with short-term capital flows. “We do not target a level and try to move it; the rand is too much of an open-market currency,” Gill Marcus, governor of the SARB, told OBG. “It is the volatility that concerns us.” The key for investors will come when the foreign exchange market will have hit its trough. “At some point the market will conclude that the rand has become too cheap, helping to stabilise the currency, but the near-term outlook still looks choppy,” Swiss bank UBS noted in a January 2013 update note.
The upward inflationary pressure in 2012, to the top of the 3-6% target range, constrains the SARB’s monetary policymaking space. The rand’s devaluation of nearly to 10% against the dollar in 2012 played some part in the rise seen in domestic prices – with Standard Bank estimating that for every 1% drop in the value of the rand, inflation jumps 0.2 percentage points. Meanwhile commodity-linked consumer prices turned against South Africa’s favour as the government raised its fuel levy by 12% while key staples like corn increased 22% globally. The consumer price index (CPI) accelerated particularly steeply in 2012, seeing a rise from 4.9% y-o-y in August to 5.6% by November and further still to 5.7% in December, a seven-month high. New CPI figures, re-weighted for the first time since 2009, using 2012 as a base with higher weights for the likes of clothing, housing, education and transport, revealed a drop in inflation to 5.4% in January 2013.
Yet upwards pressure remains in 2013, driven by an 8% annual rise in electricity prices and an increase of R0.32 ($0.04) per litre of petrol and R0.33 ($0.04) for diesel alongside the impact of a weaker currency and pressure of rising labour costs. Higher global food prices due to poor harvests in the US and Europe are also likely to play a role in inflationary pressures going forward.
The SARB forecasts a temporary breach of its 6% inflation ceiling in late 2013, although the average annual inflation is expected to wane gradually from 5.8% in 2013 to 5.2% and 5% in the two years thereafter. While high inflation is a concern in itself, the SARB has decidedly downplayed the significance of temporary breaches of its target band, especially as the drivers of inflation have been exogenous.
“Imported inflation, brought about by rising global oil and food prices, remains a strong concern,” Donna Oosthusye, managing director of Citi (South Africa) and chairperson of the American Chamber of Commerce in South Africa, told OBG. “We are in the unenviable position of facing a combination of low growth and inflationary environment, which is not something that can be easily resolved, as measures to mitigate one issue can harm progress of the other.”
The IMF has highlighted the impact of the over 1% output gap – the gap between actual and potential economic growth – on moderating demand-side inflation. The key, however, will be to curb the rise in long-term inflation expectations as well as the transition towards demand-push inflation.
The SARB’s monetary policy committee cut benchmark interest rates by 50 basis points to 5% in July 2012, the lowest rate for 30 years and the first move since the similar-sized cut in November 2010. With inflation consistently above 5% since July, real interest rates have remained negative. While this stimulated a recovery in credit growth to the private sector, it also stoked fears of resurgent inflation in 2013. Amid uncertain growth prospects both globally and domestically, the bank has adopted a dovish tone on inflation while also paying attention to real productivity growth. “If actual infla-Macroeconomic performance & projections, 2010-16* tion hovers around 5% and stays within that range, we do not see it as runaway inflation,” Marcus told OBG. “What would concern us is the state of wage demands, particularly in relation to productivity.”
Although inflationary pressure remains on the upside according to the SARB’s March 2013 meeting, which kept rates on hold, Marcus explained that, “the relatively subdued growth outlook and the negative output gap have meant that we have been more tolerant of inflation at the upper end of the target range.”
While South Africa remains in the top tier of African economies in terms of the World Bank’s “Doing Business” rankings of investment climates – taking 39th spot overall in 2013 compared to a sub-Saharan African average of 140th, but still behind the continent’s leader Mauritius at 19th place – its standing has deteriorated in recent years. The most significant drops since 2012 have occurred in the ease of getting electricity (down two places to 150th), ease and cost of registering property (a drop of one place to 79th), starting a business (falling 10 places to 53rd) and dealing with construction permits (down one place to 39th). Meanwhile, the economy was ranked 74th in the 2013 Heritage Foundation’s Index of Economic Freedom, well behind Mauritius’ place among the top 10.
While infrastructure investments by the likes of electricity generator Eskom will improve certain rankings once extra capacity comes on-line by 2015, the pace of reform in other soft infrastructure has slowed since the passing of a new Company Law in 2008. While the rest of the South African Development Community (SADC) remains committed to a Single Window system for Customs, South African authorities have moved towards a National Window on a different IT platform. Yet the government has established a new institutional infrastructure to support the development of smaller firms, including micro-enterprises.
Of greater concern for many investors in 2012 were the proposed changes to the country’s local affirmative action policies to require a greater share of black ownership in the economy. Proposed revisions to the country’s Broad-Based Black Economic Empowerment (B-BBEE) initiative, circulated since SepGDP breakdown by industry, 2012 tember 2012 for public comment and passed by the National Assembly in June 2013, have drawn public concerns. “International investors require policy certainty,” Oosthusye told OBG. “As long as you know and understand the rules, even if they are imperfect, you are happy to play – uncertain and continually changing policies become problematic.”
Redressing historic racial inequities has been integral to economic planning since the 1996 constitution and the subsequent 1998 Employment Equity Act, which established a system of affirmative action to remove barriers to employment and representation for all races. While the 2000 Preferential Procurement Policy Framework established a preference for bidders for government contracts who scored points under Black Economic Empowerment (BEE) criteria, the impact of such BEE scorecards remained muted. Indeed while the aim had been to create a new class of leading black businessmen to support smaller black-owned firms, this trickle-down effect was limited. A dominant tier of larger BEE groups, like Shanduka Group and Hosken Consolidated, were awarded the lion’s share of deals while the fragmented market of black-owned small and medium-sized enterprises (SMEs) remained marginalised.
Some industry leaders cite other faults of the implementation of BEE. “BEE incentivises and influences a company's employee mix, but it does not encourage companies to hire new employees. So, it is in essence changing, rather than expanding the pie,” Laurent Langellier, CEO of Air Liquide, told OBG. “The country’s biggest challenge is job creation, and BEE would also improve were it to focus more on skill development.”
The government broadened the criteria examined for BEE under 2003 B-BBEE legislation that added factors like skills training, sub-contracting and business development, criteria that were then enshrined in the 2007 Codes of Good Practice. A number of sectors have industry charters that draw on these codes, including in the mining and financial sectors, which set minimum criteria for gaining a concession or a licence. The mining sector, for instance, has set 2014 as the date by which all active mining companies will need to have a quarter of their equity held by blacks.
While compliance with these charters remains voluntary, bidders for government tenders are assessed using a system of points for seven key criteria. Two of these included “direct empowerment” including black-owned equity stakes (with 20.1% and above categorised as black-empowered, and 50.1% or more as black-owned) and the number of black management positions. The two next criteria were internal employment equity and skills development, while the three final factors comprised “indirect empowerment” such as preferential procurement (sub-contracting), enterprise development and socioeconomic development, including a company’s contributions to the local community. While the first set of criteria are attributed the highest weight in the assessment – of up to 20% for ownership and procurement criteria – management control and socioeconomic development are rated less significantly, at 10% and 5%, respectively.
While the new codes published for public consultation in September 2012 and passed in mid-2013 in theory simplify the B-BBEE scorecards, they also include stiffer penalties for “fronting” – in which black-owned firms pose as a front for the ultimate beneficiary – and will become mandatory. Although the labour movement has welcomed these penalties, the main unions have objected to the voluntary nature of other B-BBEE provisions, such as subcontracting to black-empowered companies, or investing in training and education for black staff. “We are in favour of the heavy punishment of fronting in the amended B-BBEE legislation being presented to parliament,” Jonas Mosia, industrial policy coordinator at Congress of South African Trade Unions, told OBG. “Our objection concerns the abuse of the BEE system and inadequate rules to mandate procurement from local manufacturers.”
Firms with less than R10m ($1.2m) are to be exempt, from the new rules, while those with turnover of between R10m ($1.2m) and R50m ($6.2) will be considered “qualifying SMEs”. The generic scorecard is to be simplified from seven criteria to five, which set minimum requirements for areas including ownership, skills training and enterprise, and supplier development.
Investors have raised concerns over the requirement for divesting from significant stakes (of over 20%) in their businesses in coming years. Yet the experience of Microsoft, which in 2011 established a R500m ($60.1m) “equity equivalent programme” to develop black-owned software companies over a seven-year period, demonstrated the willingness of firms to seek mutually beneficial ways of complying with new rules. In another example, Dutch-based oil tank storage provider Royal Vopak’s sold a 30% stake in its Durban terminal to a BEE firm in July 2012 to dilute its stakes.
Foreign & Direct
A number of large inward foreign direct investment (FDI) deals have raised the level of FDI nearly five-fold from $1.2bn in 2010 to $6.4bn in 2012, according to UN Conference on Trade and Development (UNCTAD) data. However, this figure still fell short of the pre-crisis level of $9bn in 2008. The 10.3% y-o-y growth in inward FDI in 2012 was over twice the growth in FDI into Africa, which reached 4.8%, although South Africa trailed Nigeria’s $8.4bn in FDI in 2011. The bulk of larger FDI deals are equity participations in established firms with dominant market positions, rather than the greenfield investments more commonly seen in the rest of the continent. Highly liquid capital markets, allowing for significant capital-raising domestically, along with a top tier of firms with extensive international operations have supported this trend.
Despite its challenges, South Africa has broadly preserved its mantel as one of the lowest-risk investment destinations in Africa. Examples of such acquisitions include US-based Walmart’s acquisition of a 51% stake in retailer Massmart and the $1.3bn buy-out by China’s Jinchuan Group of copper miner Metorex in 2011. UK-based Barclays Bank’s acquisition of an additional 6.8% in Absa Bank for roughly $2bn also contributed to higher FDI figures, although the all-share nature of the buy-out represents no additional capital inflows.
The year 2012 saw a larger number of smaller deals, including Dutch-based Damen Shipyards’ expansion of its Cape Town operations and Unilever’s launch of a fifth factory at a value of $81.7m. In January 2013 the AngloDutch fast-moving-consumer-goods giant announced plans to invest $97.5m in a sixth factory and $24.4m in upgrading and expanding existing facilities. Mining continued to attract attention with Canada’s Platinum Group Metals announcing a $260m investment in a new platinum mine to open by 2014. But while a few larger deals have boosted aggregate FDI figures, analysts highlight the inconsistency of FDI volumes.
“We have seen a number of FDI deals in recent years, but the pipeline has not been consistent,” Reuss told OBG. While mining continues to attract significant interest, especially given attractive valuations in a commodity down-cycle, FDI has increasingly targeted sectors catering to the country’s emerging consumer class, such as retail, financial services and pharmaceuticals, among others. Investment in manufacturing, particularly of original equipment manufacturing and automotive assembly, has also attracted some of the world’s leading carmakers, including GM and BMW. However, “So long as foreign ownership battles and debates take place, it will be hard to convince global headquarters to support capital-intensive investments,” Andy Baker, the regional president for Africa at G4S, told OBG.
Despite significant downside risks ranging from a continued global slowdown to sustained civil and labour unrest, the development agenda laid out in the 2013 budget and other government policies are designed to steer both its economic planning and private sector investment for the next two decades. While its fiscal space is narrow, long-term investments in infrastructure, education and health will be key to attaining its growth potential. Striking a sustainable new social contract between labour, business and government is also set to be crucial (see analysis). The economy’s strong fundamentals and position as a gateway for investment should support these long-term aims.
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