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Investment views

Policy-making calls for skilful political manoeuvring - Taking Stock Winter 2018

17 July 2018

By Nazmeera Moola, Co-Head of SA & Africa Fixed Income

 

On 14 February at 11pm, Jacob Zuma finally resigned as President of South Africa. In the weeks that followed, South Africa experienced Ramaphoria. For a brief moment it seemed like we could put the economic nightmare of the past decade behind us.

Unfortunately, very weak first quarter growth numbers, a crippling bus strike, the return of load shedding brought on by striking Eskom employees and the unnerving threat of land redistribution without compensation have all coincided with an emerging market sell-off to result in a very sharp slide in the rand, local bond market and domestic South African equities.

Through 2017, South Africa’s currency and bond markets were protected by massive inflows into emerging market bond and equity funds. Portfolio inflows into emerging markets in 2017 totalled US$98bn – of which, roughly US$10bn found its way into South Africa during the year.

If global capital flows provided a gentle supporting wave to counter South Africa’s political dysfunction in 2017, the second quarter of 2018 has seen the tide flow out in a brutal manner. Since the start of April, South Africa’s bond and equity markets have experienced US$5.7bn of outflows (as at 30 June 2018).

This is not a South Africa specific story. Emerging markets as a whole have experienced outflows totalling US$9.4bn since the beginning of April 2018 (as at 30 June 2018). One of the key drivers is tightening global liquidity as the US Federal Reserve and European Central Bank begin to reverse quantitative easing and shrink their balance sheets. Tightening credit conditions in China are adding to the squeeze.

However, South Africa cannot solve the global issues. All we can do is attempt to insulate the economy by fixing the government balance sheet and boosting growth to 3%. Neither is easily achieved – especially as political manoeuvring by the various political parties, interest groups and even within the ANC means that key policy areas are being tossed around like a damaged life raft on a stormy sea.

The policies required are widely discussed. They were cited by all the credit rating agencies in their most recent updates:

  1. Achieve certainty around property rights in mining and agriculture. While the historical issues are well known and complex, investment will remain tepid without clear tenure rights in these two key areas. Given the recent surge in illegal land invasions, progress is also needed for long-term social stability.

  2. Stabilise state-owned companies. A range of state-owned enterprises are facing financial doom in either the short or medium term. However, none threaten the financial stability of South Africa as a whole as much as Eskom. It has utilised R250bn in government guarantees and has another R100bn unutilised. In addition, Eskom has a further R200bn of unguaranteed debt that cannot be ignored. The new CEO and board have worked hard to stabilise the liquidity of the utility since their appointment in January 2018. However, more drastic action is required. If the solvency of the utility is not urgently addressed, there is a real risk that all of this debt comes crashing onto the sovereign balance sheet in the coming years. The risks are so large that it needs special attention.

  3. Rein in the public sector wage bill. South Africa spends 14% of total GDP on general government employees – in comparison the OECD average is 10%. Thailand and Chile each spend 6%. Reducing the share of government spending diverted to wages will stabilise government finances, while also freeing up resources for other imperatives, such as better educational facilities and state-provided housing.

These three measures are enough to retain an investment grade (IG) rating from Moody’s. And they should be enough to regain an IG rating from S&P and Fitch. However, these measures are necessary but not sufficient for the long-term health of South Africa. Beyond these, a range of other reforms are needed to sustainably raise growth levels. Higher growth is also the solution for South Africa’s biggest social time bomb: an unemployment rate of 27.7%, which means that 6.2 million people who are seeking a job, are unable to find one.

The South African state is not user friendly. A five-hour wait at Home Affairs gave me some inkling of the experience of the average citizen that relies on the state for health, education and housing. It is inefficient and unresponsive.

The good news is that President Ramaphosa has acknowledged these failings repeatedly, starting with his state of the nation address. Here are a few measures that government has within its control to change, that could substantially benefit the long-term growth and job-creating potential of the country.

 

  1. Reduce the administrative burden. Bureaucracy has grown significantly across government (municipal, provincial and national) in the last decade. This has introduced an administrative burden on business – particularly small businesses. Key problem areas are tax administration, labour law administration and municipal permits.

  2. Co-ordinate infrastructure delivery. Cape Town’s water crisis exemplifies the problem. Due to infighting between the three spheres of government, Cape Town remains short of water. While Day Zero has been avoided so far, there is no certainty that this issue will not recur.

  3. Improve education at the schooling level. Only with a vast improvement in education will the average black child have the same opportunities as the average white child in South Africa. The problem is not money – it is the quality of teaching. A good first step would be to improve the quality of support provided by provincial and national government to teachers.

  4. Expedite skilled visas. It is exceptionally difficult to get visas for foreign skilled workers. South Africa has a skills shortage – and skilled workers create jobs for unskilled workers.

  5. Focus state companies on delivering customer service. Given their single shareholder, the management team of most of these entities have focused on serving their political masters, rather than on providing customer service. This has increased costs at the ports, airports and on the multi-purpose pipeline.

  6. Focus government on delivering customer service. Though my experience with Home Affairs was tedious, my application was processed – and my new passport is due for delivery in two weeks. In contrast, the average South African has to deal with schools where teachers are absent 10% of the time, hospitals that make them wait for most of the day and housing that doesn’t arrive.

 

All these hard steps are the solution to South Africa’s economic and social ills. Unfortunately, the political manoeuvring to achieve these should not be underestimated.

 


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