Exogenous developments such as a slowing Chinese economy and potential rising US interest rates mean emerging markets like South Africa are set for a turbulent period.
The post-2008 financial crisis spawned a period of capital inflows in emerging markets. With Europe experiencing sluggish growth and the US embarking on quantitative easing policy, there was plenty of cheap money available and investors chasing yields in frontier markets, such as South Africa.
Now, with a looming US interest rate hike, a Chinese slowdown, and a drop in commodities prices alongside a reviving Europe, capital is expected to flow back into developed markets that are perceived to be more secure. Indeed, the South African Rand has already weakened over 10% against the dollar this year, as investors have sold off emerging market assets.
While South Africa is vulnerable to such exogenous shocks, its low growth and declining attractiveness as an investment destination can equally be attributed to domestic factors. This is evident when you compare Sub-Saharan Africa’s recent growth rate to that in South Africa.
While developing economies in the continent are growing off a low base, there is a consistent growth rate disparity. From 2011-2014, Sub-Saharan Africa grew at an average of 4.3% per year while South Africa grew at a more modest pace of 2.37%. The last two years, 2014 and 2013, saw particularly anemic growth of 1.5% and 1.9%, respectively.
In terms of FDI, while South Africa was the largest African recipient in 2013 at $8.3bn, flows into the country dropped by 31.2% to $5.8bn in 2014 and are expected to further decline this year.
A general factor behind successful investment and business cases is the presence of policy certainty. Investors will not deploy capital if the prospect of constantly changing policies, or worse expropriation, is conceivable. While South Africa has a well-developed legal and tax framework and sufficient policies promoting and regulating investment, they have been subject to change or have lacked implementation.
Take a look at the National Development Plan (NDP). It is a long term plan for the country to achieve its socio-economic targets by 2030 that has been lauded by the IMF, World Bank, and OECD for providing a clear long term growth strategy. It looks to put a dent in the stubbornly high unemployment rate of 25% down to 6% by growing at a rate of 5%.
However, traction on implementation has been sluggish to non-existent, while domestic constraints, including an electricity shortage and labour unrest, make meeting those targets tricky. Not only that, but there exists policy incoherence as the department of economic development’s New Growth Plan (NGP) and the department of trade & industry’s (DTI) Industrial Policy Action Plan (IPAP) seem to conflict, offering contrasting accounts of constraints.
The IPAP and the NGP characterizes the economy as being consumption-led while the NDP says nothing about it. More importantly, the three documents have very different ideas of where jobs will come from, with NGP and IPAP focusing on the productive sectors of manufacturing and infrastructure, but the NDP looking at small services firms serving the domestic market. Without a scorecard or any tangible developments, it is difficult to see what sectors have been prioritized and what progress has been made.
Recently, the South African government has replaced bilateral investment treaties with major trading partners via an overarching Protection and Promotion of Investment bill. This shift has raised alarm over expropriation and arbitration of disputes.
To address the previously disadvantaged communities, a broad based black economic empowerment plan (B-BBEE) has been put in place. While general compliance is not an issue, the number of times the codes have been amended and the goal posts moved has been a concern, requiring sufficient lead time.
This issue has been magnified in the mining industry, where the definition of “once empowered, always empowered” has led the mining houses to go to court with the department of mineral resources over interpretation of the Mining Charter’s 26% empowerment target.
South African Chamber of Commerce & Industry (SACCI) Business Confidence Index (BCI) (source: Bloomberg)
The energy sector is introducing the Mineral Resources Petroleum Development Act (MPRDA) to regulate a mature mining industry and a nascent oil and gas industry. Issues remain over the percentage of free carry awarded to the state as well as ministerial discretion over declaration of certain minerals as strategic.
At a time when oil prices are low and international oil companies are more selective in deploying capital, this doesn’t bode well for a country with large potential shale gas reserves. The lack of progress on the clarity of MPRDA, which recently went back to parliament for consultation, in addition to a moratorium on gas exploration licenses has led firms like Shell to pull their expert from the country.
Source: Merchantec
In the tourism sector, a recent decision to tighten up the visa application process has resulted in a plunge in arrivals from key markets such as India and China. At a time when consumer spending is declining, commodities prices dropping and manufacturing output declining, the government has identified service sectors like tourism to carry the burden of growth.
Yet, the immediate impact of this policy is clear as arrivals from India and China have dropped over 15% and 50% respectively year over year with the tourism business index dropping to its lowest level in four years.
Lastly, the possibility of higher taxes is a concern, as the treasury embarks on fiscal consolidation to combat rising twin deficits.
As a result of these challenges and low economic growth, there will likely be a reduction in domestic and foreign investment. The private sector is sitting on a lot of capital, providing potential capacity for expansion, but is unlikely to ramp up fixed capital formation in the next few years until there is greater clarity in the medium term.
