South Africa’s Path to Junk Status: A call to action

“After climbing a great hill, one only finds that there are many more hills to climb.” - Nelson Mandela

The immediate market reaction to South Africa appointing its fourth finance minister in only two years - announced at midnight on Thursday the 30^th of March 2017 - came as no surprise: the Rand plummeted, bonds and stocks sold off, the cost of insuring government debt against default rose, the country’s credit rating was junked and the ruling African National Congress (ANC) party erupted in revolt.

South Africa’s bonds now run the risk of being delisted from the main international indices, while the country remains beset by crushing levels of unemployment and growth rate has fallen well behind the rest of sub-Saharan Africa. 

According to The International Monetary Fund’s latest annual report, the South African economy will grow a meagre 0.1% in 2017, with a gain of only about 1% from the following year and with per capita income in 2017 set to fall to 2010 levels.

The overall effects are chilling: 355,000 South Africans lost their jobs in the first quarter of 2016, bringing official unemployment up to 26.7%. Violent protests over the quality of service delivery is a constant reminder of the anger welling up and the dangers of a populist backlash against a political elite increasingly seen as out of touch.

World Bank development indicators show growth at least one-third lower than the 4.5% growth rate achieved by sub-Saharan Africa as a whole and far below emerging Asia’s growth of 8.1%. Even worse, since 2008 South Africa’s growth has stalled at just 1.5%.  

Given this grim reality, a tone of pessimism is understandably prevalent, as many worry that the economy is perpetually stuck in a low-growth trap. Given the multiple exogenous factors that have conspired against South Africa and an economy that continues to be bruised by sluggish demand from China, even its agricultural output has been hit hard by a punishing drought. 

The question remains: why has South Africa’s growth been so feeble over the past decade?

External shocks have certainly played a significant role, such as the rebalancing of the Chinese economy has reduced demand for exports globally and a concomitantly steep fall in commodities prices, adversely affecting South African exports in iron ore, coal, and platinum. 

Yet these external shocks are only one part of the story. So while South Africa is still reeling from the effects of external misfortune, the country has a host of home grown problems, such as the political dysfunction at the helm. 

Discontent with President Jacob Zuma’s leadership is now reaching fever pitch. His actions now risk an economic meltdown and a party revolt after his determination to get rid of Pravin Gordhan – South Africa’s internationally respected and independent-minded former finance minister. Zuma is throwing caution to the wind with two aims: to demonstrate his primacy through a domestic power play and to make good on patronage promises in order to shore up support from those who depend upon his presidency.  

Gordhan evidently stood in the way of these aims as the finance ministry cracked down on corruption and cronyism. The president’s calculus appears to be that while objections to Gordhan’s ouster were loud, the ANC and his external opponents are too divided to unite in action against him. He may well prove correct, all to South Africa’s detriment. 

Foreign interests and domestic businesses alike have been loud in their condemnation of the president’s actions because where South Africa to become a default risk, it will set off a vicious cycle. Investors will flee and the Rand - which lost about half its value against the dollar since 2011 - will fall even further.

Prices and interest rates will shoot up for average South Africans and be playing fast and loose with South Africa’s already fragile economy will also have dangerous political consequences for its democracy.

Yet, the broader, longer-term structural challenges remain the vast and growing gap between South Africa’s accomplishments and its acute economic needs.

Compounded by the chronic issues of infrastructure bottlenecks, skills mismatches in the workforce, regulations that stifle competition and entrepreneurship that keep one-third of the labour force unemployed or too discouraged to seek work, the cost of insufficient action have now reached a critical inflexion point. 

A call to action

South Africa has made remarkable progress in the two decades since its transition to democracy, nearly doubling its GDP in real terms. While income inequality remains a profoundly difficult problem, living standards have improved significantly. 

An estimated 3.6 million people, living on less than 2.5 U.S. Dollars a day, have been lifted out of extreme poverty – the rate more than halved to 16.5% of the population. Access to infrastructure, education and healthcare has improved markedly, with social grants now benefitting over 16 million people. Moreover, South Africa remains a highly diversified economy with some world-class companies, often with a footprint across the African continent and beyond, particularly the financial sector which is deep, sophisticated and resilient and that has an internationally respected corporate governance framework ranked second on the World Economic Forum’s rankings. 

So what are the bold opportunities and sectors that might reignite South Africa’s progress, if the government and businesses were to prioritize them? 

FDI Spotlight identifies a “big five” that have the potential to increase GDP growth by 1.1 % each year, adding one trillion Rand ($87 billion) to annual GDP by 2030.

South Africa must draw on its skilled labour force to grow into a globally competitive manufacturing hub, focused on high-value categories like automotive, industrial machinery, equipment, and chemicals, and focus on infrastructure productivity by investing heavily in electricity, water, and sanitation. A true partnership between the public and private sectors must be forged, making this expenditure more productive by maximizing the use of existing assets and prioritizing those projects with the greatest impact.

South Africa’s electricity shortage has constrained and often hamstrung growth and despite new capacity created, another shortfall is projected between 2025 and 2030. Natural gas plants, which are fast to build, entail low capital costs, and have a low carbon footprint, can provide diversity to the power supply. 

South Africa also has highly developed service industries, yet it currently captures only 2% of sub-Saharan Africa’s market for service imports, which is worth nearly half a trillion Rand ($38 billion). With the right investments, service businesses could ramp up exports to the region.

With consumption rising for raw and processed agricultural goods in markets throughout sub- Saharan Africa and Asia, South Africa has an opportunity to triple its agricultural exports by 2030. This could serve as a key driver of rural growth, benefiting the nearly one in ten South Africans who depend on subsistence or smallholder farming.

Successfully delivering on these priorities will move South Africa closer to realise its long-held vision of a “rainbow nation”.
Yet, to really move South Africa onto a path of accelerated growth, the public and private sectors will need to undertake a coordinated, radical and sustained effort to raise productivity and strengthen competitiveness.  

Even more critical will be to prepare the millions of young people for the jobs of the future. To achieve this South Africa will need to radically reshape its system for developing human capital and, in particular, to drive a massive expansion of vocational training programs that build both the technical and personal skills needed for surviving in a more competitive world. 

Given that the formal economy is not absorbing potential workers sufficiently, there is a crucial structural issue at play: there are those included and successful in the advanced economy such as large businesses, banks, and unionized workers, - who maintain entry barriers against potential competitors; and small and medium-sized enterprises and the unemployed. One of the key issues keeping the one-third on the outside is the current approach to wage bargaining practices involving big businesses and big labour, which serves well the interests of long-established businesses and employed workers.

These wage agreements bind entire sectors to what has been previously agreed and present huge obstacles to small and medium-sized enterprises, which in other countries typically employ the most people.

At the same time, the private sector has been coddled in ways that create privileged markets and that work against the interests of consumers, damaging competitiveness by keeping business costs high. Many South African companies enjoy high-profit margins, often built upon barriers that both hurt consumers and block potential competitors. 

This anti-competitive behaviour is common in many industries, including construction, farming and telecommunications. Government regulations often reinforce these practices by entrenching vested interests or through inefficiencies that limit the enforcement of anti-competitive behaviour.

There is also the severely challenging issue of state-owned enterprises (SOEs), such as power utility Eskom. Eskom plays a crucial role in the economy but is often plagued by inefficiencies, poor management, and weak balance sheets and the private sector is often unable to enter key sectors dominated by SOEs that only serve to establish existing bottlenecks in the economy. 

Even some of the best-performing SOEs like Transnet pose problems that often reverberate through the wider economy. For example, the container-handling costs at South Africa’s ports are 175% higher than the global average, raising the cost of South Africa’s exports and thus constraining the country’s competitiveness. 

The National Planning Commission has also decried South Africa suffering from high levels of corruption. The current economic slowdown has only exacerbated many of these issues. With an economic pie that is shrinking, more energy is spent fighting for a larger slice – as opposed to growing the pie.  

There have also been entirely counterproductive measures introduced, such as the recent restrictions on temporary employment and stricter visa requirements, causing a general uncertainty about South Africa’s regulatory environment and badly damaging its globally leading tourism industry. All of this damages investor confidence, as well as the trust that must be woven into the fabric of all stakeholders. 

South Africa’s core economic problems have not been tackled in a comprehensive fashion. The primary goal must be to re-energize growth by seeking inclusion and job creation. This will require filling infrastructure gaps, encouraging more competition, reaching agreement on sensible labour market policies and industrial relations, improving education and training, and insisting on better governance and an intolerance of systemic graft. 

These reforms must be undertaken with the same commitment that brought South Africa to democratic change. It is how South Africa can build stronger, more inclusive growth and serve as a beacon of economic change, just as it once emerged as a model for political change.

What is needed now is a new approach, not just a matter of tax cuts or spending increases. Rather, it is a question of fundamental, transformational reforms that can boost employment, reduce inequality, and promote economic inclusion.

This approach should focus not just on levelling the playing field but opening it up for individuals and businesses to thrive. This will by no means be easy - tackling vested interests and promoting a truly inclusive economy will require buy-in from all stakeholders, and for them to take a long-term vision of their interests in a more dynamic and equitable South Africa of the future.