27 Dec 2017
Mike Haworth – Investment Strategist, Sasfin Wealth
As 2017 draws to an end, we look back and see a difficult year from a macroeconomic point of view – characterised by low output growth, with many industries struggling throughout. Headline inflation decelerated owing to the strong rand but stronger international commodity prices helped reduce the drag on growth from a current account deficit. The fiscal aspect of the economy is now facing especially difficult challenges. The one important takeaway from 2017 is that the economy struggled but never collapsed.
Looking ahead – dangers lurking
Looking to 2018, both National Treasury and the South African Reserve Bank have reduced their forecasts for the next three years. The projected growth trajectory for real Gross Domestic Product (GDP) is 0.6% in 2017, 1.2% in 2018, 1.5 % in 2019 and 1.9% in 2020. This means that South Africa’s real economic output growth rate is not expected to rise above 2% for the next three years. South Africa’s headline inflation rates for the next three years have also been lowered. The low economic growth rates barely rise above the population growth rate of about 1.7% per annum. This implies that after the past three years of declining real GDP per capita, it is likely to remain static over the next three years. Socially and politically this trend is problematic, as structural imbalances in the economy grow larger.
There are two downside risks to the economic forecasts in our opinion. The first is that if the government’s radical economic transformation policies are implemented aggressively in 2018, a major shift in the racial ownership of companies, procurement mix and mix of management can be expected to impact aggregate growth in the short- and medium-term. Secondly, the serious water shortages in the Western Cape could erode that province’s contribution to national economic growth.
It is important to stress that despite projected slow growth and some policy and climatic challenges, the economy is not expected to collapse. There are a number of structural factors driving demand in the economy. South Africa is judged to be 66% urbanised and this figure is expected to continue to rise steadily. The informal sector is expanding, by necessity, and there is a massive social protection system in place.
Retail sales growth is expected to be constrained by the low aggregate wage growth but the recent deceleration in inflation is providing a marked boost to low-income household real disposable income. The stronger rand has also reduced the consumer durables inflation and there is a cyclical recovery in the consumer durables market. Passenger vehicles sales have rebounded due in large part to the lower interest rate and pent up demand.
We expect fixed investment growth to be weak in 2018 where the public sector is constrained by its fiscal challenges and the low confidence in the private sector and uncertainty about regulation is throttling private sector investment activity.
Approaching a fiscal cliff?
The recent Medium-Term Budget Review showed much higher expected budget deficits and an altogether higher public debt trajectory indicating that fiscal consolidation was likely to be extremely difficult over the next three years. The serious underperformance of the state-owned companies together with expanding revelations of unpaid bills, corrupt procurement, irregular expenditure and a rapidly growing interest bill are driving expenditure growth at a rate well above expected revenue growth rates despite tax rate increases. There is a high and growing likelihood over the next six months of the international credit rating agencies downgrading South Africa’s domestic sovereign debt to sub-investment grade. This could force foreign bond investors out of the South African fixed interest market, which could weaken the rand and push up the public sector’s new debt funding costs.
One important positive in what is a mixed and complicated outlook, is the strength of the trade account; there has been a marked recovery in the trade balance to a surplus for most of 2017 owing to higher commodity prices and slower import demand. This position is likely to continue in 2018 given the slow, steady acceleration in growth projected, by the International Monetary Fund, in the global economy to reach its 30-year average rate.
The politics of politics
The political environment has become overwhelmingly dysfunctional which is having a serious negative impact on trust between the government and private citizens and business. The breakdown of trust is eroding confidence and paralysing private sector investment. It appears that the domestic political environment is becoming increasingly bumpy ahead of the ANC’s 54th National Conference in mid-December 2017. This conference is an elective affair where policy matters area discussed and resolved and where a new ANC president will be elected.
On the assumption that the conference does in fact take place in December, the results of the internal ANC presidential election will be pivotal to the country’s growth trajectory from 2018 to 2020. This is an opportunity to change the strategy, manner, policy and Cabinet that is currently interfering with the natural growth rate of the economy. Broad policy changes are not expected because they are ANC-based and there is a general election in mid-2019. The 18-month period between the end of 2017 and the general election are likely to be politically turbulent where constructive growth enhancing economic policy changes are unlikely to be forthcoming.
The South African economy will not collapse but nation-building policies could have a massively positive effect on confidence and mood in the country given its extremely low level currently. South Africa is resource-rich and has a number of natural advantages, so by removing the political roadblocks there is no reason why this economy cannot recover substantially over the next three years.