Country risk: South Africa’s resilience is tested

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South Africa’s fall from grace is well documented.

Once a sought-after emerging market, the country has struggled to retain the faith of investors, highlighted by a sharp fall in Euromoney’s country-risk survey.

This is due to various economic problems and policymaking challenges that are related not least to an unresolved electricity crisis and unbearably high unemployment of around 34% contributing to the burden of public debt.

The survey score for employment/unemployment, already low, has fallen further this year, and similarly the structural indicator score for labour market/industrial relations.

Overall, South Africa’s long-term, five- and 10-year score trends are negative, and at 99th out of 174 countries in the global risk rankings, it is a high-risk, tier-four option, on a par with the Bahamas, Thailand, Mauritania and Vietnam, plus more of a risk than China or India among the Brics, while remaining a safer bet than Russia and Brazil.

Positively, the year began well, with strong GDP growth, flattered by base effects, but supported by commodity exports at high prices.

Yet, high energy, food and fertilizer prices, coupled with the deteriorating global economic growth environment, are a toxic mix for civil strife in a country with high unemployment and poverty, and such vast income and wealth inequality.

There is little trust in government to sort out these problems and business confidence is low against a backdrop of factionalism in the African National Congress, the only party to rule since the end of Apartheid.

President Cyril Ramaphosa is losing support, too, against soaring crime levels and xenophobic attacks, poor public-service delivery and abject living standards.

In July, annual inflation measured by the consumer price index increased at the faster pace of 7.8%, up from 7.4% in June, while also moving further away from the 3% to 6% target range of the South African Reserve Bank (SARB), the central bank.

Most analysts nevertheless foresee inflation peaking and beginning to fall before the end of this year, assisted by early monetary policy tightening and a relatively strong resource-backed currency.

As Isaac Matshego, senior economist at Nedbank Group, says: “The second-round inflationary pressures are relatively subdued, which is partly the benefit of a reasonably steady ZAR/USD, but also the SARB’s credibility as an inflation fighter.”

Coal, palladium and platinum are bolstering exports earnings and driving the current-account surplus, as well as providing much-needed budget revenue, but inevitably there is a good deal of caution among analysts, too.

“For now it is ok, because of the tax bonanza (due to commodities), but as soon as this slows down debt will again become a major issue,” says Dawie Roodt, chief economist at Efficient Group, who goes on to mention there is pressure to raise public spending, so by next year the debt-to-GDP ratio will start rising again.

Hugo Pienaar, chief economist at the Bureau for Economic Research (BER), notes that the stark deterioration in the growth outlook for the eurozone and the UK are concerning as they are key export markets for South Africa.

New alignments are happening and this will lead to unstable labour relations until the political scene calms down 

 - Dawie Roodt

This affects investor risk perceptions negatively and it will tend to weigh on the rand. Also, incomes are being squeezed by inflation, especially high costs for food and transport, so wage demands are rising.

There was a national strike organized by the Congress of South African Trade Unions (Cosatu) on August 23, which seemed to have little impact on economic activity and investor sentiment.

Nedbank’s Matshego says: “The turnout was poor, suggesting that South Africans, more than anything, appreciate that all efforts need to be directed towards strengthening the economy.”

But more action is looming, according to Andre Louw, a professor at the University of Pretoria (UP), which could have serious consequences.

“Investors are used to this by now, but it is not acceptable,” he says. “The reasons are the high level of unemployment, which has become structural, and the high cost of living, including fuel prices. As their demand for pay increases cannot be met and unrest is looming, this puts off investors.”

Efficient Group’s Roodt agrees the strike was “mostly a flop”, with little direct impact, but the real story is what is happening behind the scenes. There is huge infighting among the labour leaders. Memberships are falling, politics is changing and their finances are collapsing.

“New alignments are happening and this will lead to unstable labour relations until the political scene calms down,” he says. “It is quite possible that Cosatu, for example, may decide to support another party.”

Cosatu is a partner of the ANC, but is split in its support for the government and the populist Economic Freedom Fighters, a left-wing party formed by Julius Malema.

Pienaar at BER notes with some optimism that the frequency and intensity of load-shedding was reduced substantially in August, compared with July and June. South Africa’s state-owned electricity company Eskom is working hard to return generation units to service, he says, and Ramaphosa recently announced notable reforms to the energy sector.

“Although it will not end load-shedding in the foreseeable future, these reforms have the potential to unleash significant amounts of green-energy investment,” says Pienaar. “This will boost private-sector fixed investment in the coming years and contribute to improved real GDP growth, and over time add much needed power-generation capacity.”

While noting that some action is being taken to expedite certain bureaucratic processes regarding renewable energy, Louw at UP says it will take time to stabilize and correct.

“Corruption and sabotage are making things very difficult for Eskom’s management,” he says. “The lack of maintenance and replacement of Eskom power generators during the past 20 years is catching up. They also have major debt issues. This scares investors.”

Given the need to invest massively in infrastructure, the high level of unemployment and the inability of Ramaphosa to progress his much-vaunted economic reforms, the debt situation will remain difficult 

 - Tony Hawkins

Matshego agrees by stating that power shortages still persist and they will likely continue for two to three years, depending on the development of other power sources.

“The government has effectively liberalized the power-generation sector by lifting the 100MW limit on embedded power generation, ie private entities can install power generation capacity for as much as they need, and they can sell their excess generation to the national grid through the new distribution company that will emerge out of the restructuring of Eskom,” he says.

“Municipalities in good financial standing with Eskom can procure electricity directly from independent power producers. The new power policy promises to mobilize significant investments in the renewable energy sector and help the country to generate enough power to meet the economy’s needs.”

Most analysts also pointed out the pressure on the public finances caused by public-sector unions demanding higher wages.

As Matshego says: “The government has offered a 3% wage hike, higher than the 2022 fiscal budget objective of keeping the wage bill steady between 2022 and 2024.

“The unions are pushing for increases in line with the current inflation rate, and it will be challenging to get them to accept a lower increase after Eskom workers secured 7%.”

Tony Hawkins, a professor at the University of Zimbabwe Graduate School of Business, also mentions that Western investors will consider South Africa’s ambivalence over the Ukraine war a risk, notably because high unemployment and labour unrest are already factored in to the country’s investor image.

He goes on to say that electricity and energy supply generally will constrain economic growth over the medium term to levels well below those required to reduce unemployment and poverty.

“Given the need to invest massively in infrastructure, especially energy and social services, the high level of unemployment and the inability of Ramaphosa to progress his much-vaunted economic reforms, the debt situation will remain difficult,” says Hawkins. “No early resolution is expected.”