South Africa: In a commodities trough Global Economic Outlook, Q4 2015
With stubbornly high unemployment and falling labor force productivity, South Africa’s economy desperately needs a boost. The question is whether the government can overcome both internal problems and external pressures from Chinese and US policies.
South Africa’s economic recovery has been sluggish: GDP growth in 2014 was weak, and growth in 2015 is unlikely to be significantly better. A slowdown in China, a strong US dollar, and weak global commodity prices are likely to keep overall economic performance subdued; China’s recent devaluation of the yuan and the impending hike in interest rates in the United States are also likely to exert pressure on South Africa’s economy. A fall in the South African rand’s value and the recent tightening of monetary policy to contain price pressures will likely add to the burden on indebted consumers, limiting economic growth. Further cause for concern stems from internal challenges such as electricity shortages and labor disputes as well as high unemployment, declining labor-force productivity, and a high degree of income inequality.
A shaky first half to 2015
In the first half of 2015, the South African economy grew 1.6 percent relative to the same period a year ago. But a weak base year (2014) for calculating year-over-year growth clouds a realistic picture.
In Q1 2015, the economy grew 1.3 percent on a quarter-over-quarter seasonally adjusted annualized basis, but Q2 saw those gains reversed as the economy shrank 1.3 percent. The poor economic performance stems from contractions in key sectors such as manufacturing, mining and quarrying, and agriculture and related sectors.
On a quarter-over-quarter seasonally adjusted annualized basis, the manufacturing sector declined 2.4 percent in Q1 and 6.3 percent in Q2, while mining and quarrying surged 10.2 percent in Q1, only to decline 6.8 percent in Q2. Both sectors have been struck by a combination of internal and external headwinds, including internal obstacles such as electricity shortages and external challenges in the form of weak commodity prices. Agriculture and related sectors such as forestry and fishing plummeted 16.6 percent in Q1 and 17.4 percent in Q2 due to widespread drought conditions. The tertiary sector partially compensated for sluggish economic performance elsewhere: Finance, real estate, and business services grew 3.8 percent in Q1 and 2.7 percent in Q2, with increased activity in banking and financial intermediation driving growth.
Prices for some of South Africa’s key exports such as gold, platinum, coal, and iron ore are currently at multiyear lows. It is not surprising, then, that South Africa’s exports in terms of US dollars have taken a tumble.
From an expenditure component angle, private consumption slowed to an annualized growth rate of 1.2 percent in Q2 from 2.4 percent in Q1 (figure 1). Consumption has been stifled by factors such as rising prices (in Q2), household indebtedness, and stagnant consumer confidence. Public consumption grew a meager 0.4 percent in Q2 after shrinking 1.9 percent in Q1 as the South African government committed to fiscal consolidation in the face of growing debt. Gross domestic fixed investment—hampered by weak business confidence—slowed to a growth rate of 1.0 percent in Q2 from 1.8 percent in Q1.1
Slowing China and strong US dollar likely to hurt the economy
China’s slowing GDP growth, coupled with the strength of the US dollar, has weakened global commodity prices. On the one hand, slackening demand from China has depressed prices; on the other hand, a strong US dollar means that commodities, which are priced in dollars, now cost fewer dollars than before. This is significant to the South African economy, as commodities constitute a significant portion of the country’s total export basket. Prices for some of South Africa’s key exports such as gold, platinum, coal, and iron ore are currently at multiyear lows. It is not surprising, then, that South Africa’s exports in terms of US dollars have taken a tumble. Goods exports in dollar terms have declined year over year for the last three years (8.2 percent in 2012, 4.0 percent in 2013, and 4.9 percent in 2014), and the trend is likely to continue this year.2 In fact, on a year-over-year basis, the US dollar value of goods exports declined for six of the first seven months in 2015. However, in terms of volume, South Africa’s exports continued to experience growth: The volume index for exports (including gold) increased 5.6 percent in Q1 and 13.9 percent in Q2, albeit from a low base in 2014 (figure 2).3
Another factor likely to work against the South African economy is the devaluation of the Chinese yuan. A weaker yuan is likely to reduce the purchasing power of Chinese businesses, which translates into weaker demand for commodities. Further pressure will stem from a promised forthcoming hike in US interest rates, as repatriation of capital will further strengthen the US dollar. A weaker yuan and a stronger dollar could keep commodity prices depressed for an extended period, with commodity-exporting countries such as South Africa likely bearing the brunt. In fact, certain international mining companies, such as Lonmin and Anglo American, have already announced plans to close mines and reduce their workforce. Even though mining and quarrying activity in South Africa has picked up pace (relative to a year ago) after months of labor dispute in 2014, the initial momentum will likely be overshadowed by a bearish global commodity market. The mining sector is of significance to South Africa’s economy. While directly accounting for only 5.0 percent of GDP in real terms (as of 2013), the sector accounts for a third of the country’s total merchandise exports (30.5 percent as of 2013) and a fourth of South Africa’s total exports (25.0 percent as of 2013). Furthermore, the mining sector engages more than half a million people in direct employment (510,000 as of 2013) and accounts for 8.0 percent of total private nonagricultural employment (2013).4
Rand declines, inflation creeps up, and monetary policy is tightened
A combination of an impending interest rate hike by the US Federal Reserve (Fed), a slowdown in China, weak commodity prices, and concerns over prolonged economic weakness in South Africa have resulted in a weaker rand (figure 3). Since the beginning of 2015, the rand has depreciated 15.8 percent against the US dollar (as of September 22, 2015), which has in turn stoked inflation: After falling since May 2014, inflation edged up from 3.9 percent in February to 5.0 percent in July. Though this lies within the South African Reserve Bank’s target range of 3–6 percent, the upward trend in prices prompted the central bank to raise the policy interest rate by 25 basis points to 6.0 percent in July. After this hike, inflation declined to 4.6 percent in August. However, if a weakening rand sustains price pressures, then a further increase in the policy rate remains a possibility, especially since South Africa’s meager foreign exchange reserves ($41.2 billion as of August 2015) limit it from defending the currency in the open market. Moreover, higher interest rates are also likely as emerging markets prepare for a Fed hike in interest rates, which will add to the burden on indebted households by driving up the cost of servicing debt. In Q1, household debt in South Africa stood at 78.4 percent of disposable income.5
One positive outcome of a weaker rand is that South Africa registered a trade surplus in Q2, its first surplus in three years. An improved trade balance contributed to a further narrowing of the current account deficit, which stands at 3.1 percent of GDP as of Q2, down from 6.2 percent of GDP a year ago.
The country’s Gini index, indicating inequality in income distribution, stood at 65.02 in 2011 (a higher reading indicates greater inequality), far above other emerging economies such as Brazil, Russia, and India.
South Africa’s internal problems persist
In addition to headwinds from beyond its borders, South Africa has its fair share of internal problems; the most pressing have been electricity shortages and labor disputes.
Eskom, the country’s public power utility, has struggled to meet demand for electricity over the last year, with households and businesses experiencing widespread “load shedding” since November 2014. The shortfall in electricity production is linked to delays in maintenance and several technical glitches in South Africa’s aging power stations; furthermore, new capacity has been slow to come online. The shortfall in electricity production is a major blow for an economy in need of quicker growth. The manufacturing sector in particular has been hit hard, evidenced by the sector’s poor showing in the first half of the year. While the supply of electricity is expected to improve slightly over the near term as the first six units of the newly constructed Medupi coal-fired power plant reach full capacity, electricity shortfalls are expected to continue over the medium term. Shortfalls are likely to result in higher power tariffs (projected to rise 12.7 percent in 2015), contributing to inflation that is likely to dampen consumption spending and rein in economic growth.6
Labor disputes have also held back economic growth: A recent study by the Department of Labor shows that the country experienced at least 88 labor strikes in 2014, resulting in a loss of 10.3 million workdays. The strikes, usually called after business owners refuse to meet trade unions’ wage demands, cost the economy an estimated 6.1 billion rand (nearly $500 million) in 2014, down from 6.7 billion rand in 2013.7 The mining sector in particular has been susceptible to strikes in recent years.
South Africa’s internal problems don’t end there. The country faces an unemployment rate of 25.0 percent (as of Q2 2015) and a contractionary trend in labor force productivity (figure 4). Output per employed person has shrunk year over year for each of the last three years (by 0.3 percent in 2012, 0.8 percent in 2013, and 0.4 percent in 2014), and the trend is likely to continue in 2015. Furthermore, South Africa continues to struggle against inequality: The country’s Gini index, indicating inequality in income distribution, stood at 65.02 in 2011 (a higher reading indicates greater inequality), far above other emerging economies such as Brazil, Russia, and India.
Investment and skill development are the way forward
South Africa’s economy is in desperate need of a boost. Although uncertainty in the global economy and a bearish commodity market will likely keep the economy subdued in the near term, the government needs to plan ahead for the long term. While investment in infrastructure and skill development is critical to the economy’s long-term success, South Africa’s fixed investments as a percentage of GDP have languished in the range of 12.0–20.0 percent for the last quarter of a century. Total fixed investment was 20.7 percent of GDP in 2014, compared with 30.3 percent in India and 45.4 percent in China (figure 5).8
A well-defined roadmap for developing infrastructure would likely boost fixed investment and spark economic activity. However, to carry out such plans, the South African government will have to expand its revenue base, especially since the country’s debt-to-GDP ratio has risen sharply over the last five years. Part of this can be achieved by reducing rampant unemployment. Targeted skill-development programs could pull more workers into the labor force, therefore boosting the tax base as well as the country’s low national savings rate of 15.5 percent (compared with 50 percent in China, 34 percent in India, and 20 percent in Russia). Finally, diversification of the economy away from commodities would render it less vulnerable to global headwinds. It remains to be seen how South Africa’s policy decisions chart its economic progress.