Country risk: South Africa’s future is on a knife-edge

It’s official. South Africa’s economy crashed in the second quarter of 2020 – although not unexpectedly, given the tight lockdown that was enforced to stop coronavirus from spreading.

GDP contracted at a seasonally adjusted annualized rate of 51%, according to Statistics South Africa – its biggest crash in 60 years, with all sectors barring agriculture in steep decline.

The downturn was magnified by the closure of all non-essential means of production, a collapse in spending by consumers impeded by movement restrictions, deferred investment and a slump in exports. Yet the anticipated third quarter revival spurred by the economy reopening might not prove to be the beginnings of the end that investors have been yearning for.

Terminal decline

South Africa’s problems were brewing long before Covid-19, with recession kicking in last year, acute fiscal problems mounting and the cash-strapped state-owned electricity provider resorting to load-shedding.

Its country risk score kept on sliding and the country finally shed its remaining investment grade (from Moody’s) in March this year, just a month before Fitch and Standard & Poor’s lowered their respective sub-investment grades from BB+ to BB and BB to BB-.

This erosion of creditworthiness was not unexpected given the loss of faith among experts taking part in Euromoney’s ‘crowd-sourcing’ survey, showing South Africa’s risk score worsening proportionately in recent years and causing the country to slide to 80thin the global rankings:

Survey contributor Magdalena Polan, a global emerging markets economist, has downgraded other countries in the survey, and so South Africa is not a unique case as far as she is concerned.

This is despite the sharp second quarter contraction which was possibly worse given that the informal economy was even more affected by the lockdown and social distancing than the formal part.

However, she adds that: “It does put South Africa on even weaker footing with a higher public debt and deficit, even higher unemployment, even higher inequality, and the risk of growing political disagreements within the ruling African National Congress, which diverts attention from urgent economic reforms.”

According to Rafiq Raji, another expert economist taking part in the survey: “Although the authorities are expected to quicken the pace of needed structural reforms, there is clearly now a need for more monetary and fiscal stimuli and so what was already an overly stretched fiscus may suffer even more deterioration.”

Although the authorities are expected to quicken the pace of needed structural reforms, there is clearly now a need for more monetary and fiscal stimuli and so what was already an overly stretched fiscus may suffer even more deterioration 

 - Rafiq Raji

Polan and Raji echo the views of other contributors welcoming the financial support for South Africa from the IMF. It offers some cheap funding, and will ensure the government’s policy responses are sound and balanced.

However, it's just a fraction of the country’s large financing needs and even deeper fiscal effort that will be needed to stabilize the public finances.

In July, the IMF approved $4.3 billion of emergency financial assistance under its Rapid Financing Instrument, but the macro-fiscal picture remains bleak, not least if the Covid-19 crisis continues.

According to the IMF’s forecasts, real GDP is forecast to fall by 7.2% this year, the unemployment rate will hit 36% (worsening South Africa’s social problems), the fiscal deficit will widen to 13.7% of GDP, and central government gross debt is seen increasing to 78% of GDP.

Political wrangling

It will also keep on climbing – even as growth returns and the fiscal deficit improves in future years – to 87% of GDP by 2023, according to the IMF, making the country vulnerable to renewed economic slowdown and/or delayed reforms.

Downgrades to economic risk factors are expected to continue and there is perhaps limited scope for further improvement in political factors, such as corruption and government stability, which had been rising somewhat this year.

It's also a good moment to take some difficult decisions – and the markets will be watching whether policymakers focus on reform or on political unity

 - Magdalena Polan

Political wrangling within the ruling African National Congress (ANC) does not help, says Raji.

“Although president Cyril Ramaphosa recently managed to fend off attempts to remove him as party leader, his challengers are not likely to give in just yet," Raji says.

“There is bipartisan support for boosting the beleaguered South African economy. However, some of the potential measures desired by ANC stalwarts, like nationalizing the central bank, creating a state-owned bank, and so on, border on the extreme.”

“Overall, South Africa’s challenges remain acute and are even more pressing because of the pandemic,” says Polan. 

“It's also a good moment to take some difficult decisions – and the markets will be watching whether policymakers focus on reform or on political unity.”