Given the deterioration in real economic activity in the first two quarters of 2018, average real gross domestic product (GDP) growth for the year is likely to print significantly lower than last year’s modest increase of 1.3% – even if the economy rebounds in the second half of the year. Growth of 0.75% at best is expected in 2018, while our current potential growth rate is only around 1.5%.
WHAT WENT WRONG?
Considering the buoyant mood that prevailed at the start of the year, it’s fair to ask: what went wrong? One important development is the spike in oil prices, which has weighed on South Africa’s terms of trade. Further, in addition to the necessary but painful VAT rate hike of 1% in April 2018, individuals’ tax on income and wealth has increased to its highest level on record relative to personal disposable income. Together, these developments have eroded households’ real personal disposable income and purchasing power. As a result, the promising bounce in final household consumption expenditure in the second half of 2017 gave way to an outright decline of 1.3% (seasonally adjusted and annualised) in the second quarter of 2018.
At the same time, given slow profit growth and lacklustre returns on domestic investment spending, firms have curtailed domestic activity and employment creation. Total fixed investment spending decreased 0.5% (seasonally adjusted and annualised) in the second quarter of 2018, following a material fall of 3.4% in the first quarter.
At the least, it’s reasonable to expect the GDP data to improve in the second half of this year as the impact of the drought, transport sector strike and temporary shutdown of oil refineries fades. This optimism is supported by the historically reliable leading real economic activity of the South African Reserve Bank (SARB), which points to firmer economic growth.
GLOBAL FINANCIAL CONDITIONS
However, tightening global financial conditions and the apparent escalation of the global trade conflict are weighing on emerging market economies, especially those with significant macroeconomic imbalances, including South Africa. The accompanying volatility of the rand limits the SARB’s ability to respond.
It’s helpful that core consumer price inflation is currently contained and real private sector credit extension is soft. However, South Africa is a small, open economy and short, sharp falls in the rand can ignite inflation expectations. Ultimately, the job of the SARB’s Monetary Policy Committee (MPC) is to anchor inflation expectations at a level consistent with its inflation target. Accordingly, should the MPC’s inflation forecast reflect a sustained breach of the upper end of the target range, the Bank can be expected to increase its repo rate.
SUPPLY-SIDE ISSUES
The growth stimulus package announced by the government last week focuses on providing greater economic policy certainty, and emphasises the need to shift government spending towards infrastructure projects. On balance, the package is positive, but more is required to lift South Africa’s potential growth rate. There’s widespread agreement that South Africa’s poor growth rate reflects structural economic rigidities and the erosion of its industrial capacity – in essence, the supply side of the economy isn’t functioning efficiently.
Our policymakers are clearly mindful of the intensifying focus on the fundamentals of emerging market economies. There’s little, if any, room to loosen the government’s purse strings further. However, although the growth package addresses some economic policy concerns, South Africa should be far more proactive in pursuing a strategy that improves its sovereign debt ratings.
The country’s fiscal consolidation programme of recent years hasn’t been successful. Although the growth package is a material step in the right direction, the government’s gross loan debt ratio remains on an upward trajectory, its expenditure is still skewed towards consumption rather than investment, and general government net worth (fixed assets less liabilities) has deteriorated since the global financial crisis. In addition, non-financial state-owned companies recorded a cash deficit of R60 billion in 2017/18.
The increase in total public sector expenditure from 23.8% of GDP in 2007 to 27.9% of GDP in 2017 has been accompanied by a material decline in South Africa’s potential economic growth rate. In effect, the government has absorbed a large slice of available savings, while persistent sovereign debt rating downgrades have pushed real interest rates higher. This must have crowded out private sector investment spending – especially if we also consider the material deterioration in South Africa’s rating for its business environment. For example, in 2017, the country was rated a lowly 82nd in the World Bank’s Ease of Doing Business Index, where a rating of 1 represents the most business-friendly country.
ENCOURAGING MEASURES
Encouragingly, measures are being put in place to address governance, financial management and efficiency issues at state-owned companies. If successful, this would go some way towards improving South Africa’s economic outlook – especially if greater economic policy certainty emerges at the same time.
However, even though we may enjoy some improvement in activity as we head into 2019, a sustained, robust upswing that effectively addresses the excessively high unemployment rate of 27% is likely to remain elusive. Note that since 2000, the lowest unemployment rate recorded was 23% – in 2007 – but this was only achieved following four years of real GDP growth in excess of 4%.
South Africa cannot rely on global tailwinds alone. Risks to the outlook for the global economy are building. Apart from tightening financial conditions and trade war threats, as noted above, China has the difficult task of deleveraging its economy while maintaining growth momentum.
UNLOCKING ECONOMIC POTENTIAL
South Africa therefore needs to find a way to lift its own game. A sustained high level of government expenditure hasn’t been accompanied by strong economic growth rates. Rather than relying on more of the same, policymakers must find a way to unlock the economic potential of its citizens.
Overall, pursuit of strong economic growth is likely to be best achieved through policies aimed at sovereign debt rating upgrades to lower real interest rates, deregulation and deconcentration of the economy (promotion of small business development) and improvements in the ease of doing business.
