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15 May 2023 – The South African economy is expected to stagnate in 2023, roughly 2.5-3.0pps below the average growth for Sub-Saharan Africa. The activity rates of the extractive sector will lag behind those of the manufacturing sector. In spite of a favourable price trend for metals brought on by the Chinese reopening and increased demand for safe havens due to geopolitical uncertainty, the production of mining products (particularly coal) may continue to be subdued.
Annual inflation hit 6.9% in 2022, with food costs well in the double digits since Q3 2022 and fuel and transport prices providing some downward pressure from last year’s highs. Food prices have increased by more than 25% on average compared to January 2020. The inflation rate is still above the upper bound of the 3.0-6.0% band set by the central bank, which could trigger another 25–50bps increase in the key policy rate to 7.50–7.75% before a window of opportunity for a pause opens. It is probable that inflation will then stabilize at around 6%, maintaining a differential from long-term global inflation of roughly 3-4% and allowing for a gradual depreciation of the local currency, the rand.
Electricity generation poses the heaviest drag on growth, with the national utility being able to work at only half of its nominal capacity. This lack of reliable electricity supply hinders businesses, industry and households from realizing their potential. Policies to increase the supply of electricity in the private sector were only put into place in 2021–2022, and it is unlikely that the known private commitments to increase generation capacity to be operational in 2023 will be enough to meet demand. The business sector, especially the mining industry, has already expressed interest in generating its own electricity. However, in order to produce the maximum 100 megawatts permitted and sell the remaining energy to the grid, at least 250 private producers are estimated to be needed. While labour unions are likely to mobilize strikes in opposition to loosening local content rules for new generation capacity, it is improbable that sufficient capacity will materialize in the upcoming 12 months.
Protracted electricity load shedding – which is anticipated to last 250 days in 2023 – rising social unrest and violence (recorded cases of intentional murder increased by +10.1% y/y in Q4 2022 to reach 7,555 events) and the need to increase social spending before the 2024 election all pose risks to the outlook.
Interest on debt remains high, but the budget deficit surprises on the positive side
Due to a considerable short-term absorption of revenues to repay for interest on debt and an increase in sovereign bond yields to the present level of 7.5% for two-year maturities, South Africa ranks in the worst quintile in our public debt sustainability risk assessment as of end-2022. Conversely, the present inflationary cycle helped to create the largest budget surplus ever between April and December 2022, supporting the trend towards the predicted decline in the fiscal deficit in FY 2022–23. The total deficit for the time period was only 2.8% of GDP, which is a substantial improvement over the past three fiscal years, during which the deficit averaged 5.2% of GDP. The primary contributors to revenue growth were personal income tax (PIT), corporate income tax, local and import VAT, as well as import customs duties. Salary increases and bonuses led to larger PIT inflows, and greater inflation bolstered VAT revenue streams.
Although the level of government debt is still elevated, the ratio is expected to stabilize at little more than 70% of GDP, including government guarantees on state-owned enterprises’ (SOEs) debt. Interest payments are part of the price of the favourable debt structure, which is primarily denominated in local currency and has a lengthy amortization profile on average (12 years). Fiscal consolidation will continue, with increased tax collection and disciplined salary increases providing some flexibility to meet mounting social demands and moderately support SOEs in case of need. Although the country’s dependence on foreign capital makes it susceptible to “sudden stops” (a sudden change in investor appetite), the external balance has so far been resilient to shocks. Buffers include a flexible exchange rate, limited external debt in foreign currency and substantial external assets that make South Africa the largest net investor on the continent, with a net position of USD59bn (14% of GDP).
Due to its slow-growing and generally volatile export markets, South Africa has a high import propensity of 28% of GDP, which should keep the country’s external accounts in the negative and put pressure on the rand. The rand’s value also depends on price discrepancies with the rest of the world, fluctuations in commodity prices, the current account deficit and the amount of foreign reserves. Rand upside pressures include a persistent increase in foreign investor interest in developing economies and upwardly moving commodity prices as global GDP progressively recovers. These factors should buffer the currency’s longer-term depreciation trend.
Contrasts among political elites and violence weigh on the institutional framework
The country is less competitive than its peers due to its distance from global markets, relatively high labour costs and an extractive economic structure. Increased strike and unrest risks are a result of inter-union conflict, particularly in the precious metal mining industry where there is an ongoing struggle for power. The government intends to coordinate a state-capture investigation with prosecutions, which are likely to name additional businesses in claims of commercial wrongdoing. Yet, the continuing destruction of certain potent patronage networks will likely lessen the dangers of corruption for investors in the near future.
The state’s limited ability to conduct effective policy is compounded by demographic pressures, competition between groups and unions in countering government action and inequality heightened by the crises of recent years and, more recently, by inflation. In addition to load shedding and flooding in 2022, ineffective campaigns against the spread of HIV and a low Covid-19 vaccination rate (around 35% of the population) explain the difficulties of institutions in responding to grassroots needs and preventing social turmoil. Worsening disputes among political elites and the resulting increase in violent uprisings and insurgencies further weigh on state legitimacy, the capability of the ruling ANC party to defuse dissent and the predictability and effectiveness of government action.
Strengths
- Key strategic economic and political player in the region, with a rich natural resource base (gold, platinum, chrome, manganese, vanadium, coal and diamonds) and judicial and business environments ranking above the regional average
- Exchange-rate flexibility helps to cushion external shocks and the central bank has an established track record of proactive and credible policy stances
- Deep financial markets and a sound banking sector (overall ample liquidity, good asset quality, satisfactory capitalization)
- Exchange rate flexibility helps to cushion external shocks and the central bank has an established track record of proactive and credible policy stance
- Deep financial markets and a sound banking sector (overall ample liquidity, good asse
Weaknesses
- Social tensions and insecurity persist amid high poverty, income inequality and endemic unemployment (above 30%)
- Structural issues weigh on potential growth while the electricity crisis has been declared a national state of disaster, with flood damages increasing the losses caused by load shedding
- Elevated dependence on portfolio investment flows and aging infrastructure (energy and transport) limit the development of a diversified industrial base
Source: Allianz Trade