Macro Highlights: Political and economic troubles in South Africa

Macro Highlights - 19/10/2016

François Léonet, economist, member of our Economic Research team, comments in the Macro Highlights of this week, the political uncertainty in South Africa that exacerbates an existing situation of weak GDP growth due to low commodity prices and unresolved socio-economic imbalances.

After Brazil and Turkey, it is now South Africa’s turn to be hit by political turmoil. The country’s political equilibrium was weakened when Pravin Gordhan, the Minister of Finance, was charged with fraud while he oversaw the country’s finances. It has been further undermined by allegations that President Jacob Zuma engaged in political interference. Zuma has also been mentioned in several scandals involving corruption and the misuse of public funds.

This political turmoil could cost South Africa its investment-grade credit rating, which would limit the country’s ability to seek financing on international markets and weigh on its growth outlook. The bond market in particular could suffer.

These events are part of a broader political upheaval, which is reflected in the setback suffered by the African National Congress (ANC) in municipal elections in August. The ANC has ruled the country since apartheid ended in 1994, and its current leader is Zuma. The ANC’s decline is also apparent in the loss of major cities, including Johannesburg and Pretoria, which have switched allegiance to the main opposition party, the Democratic Alliance.
The next legislative elections will not take place until 2019. This offers little hope for change for citizens weary of political scandals and weak and non-inclusive economic growth. Income inequality is particularly egregious in South Africa, which also suffers from high unemployment. The South African economy is unable to create enough jobs to absorb new workers on the labour market,  and unemployment currently sits at 26.6% – 51.3% for 15-24-year-olds.
Labour unrest is a distinct possibility, and this would add to the country’s political risk. Such unrest is not limited to job seekers but also includes striking workers, especially in the mining industry, which is currently undergoing restructuring.

The country’s narrow range of exports is dominated by commodities, which exposes it to fluctuations in international prices. Metals and ores accounted for 61% of total exports in 2014 (see right-hand chart). And South Africa’s exposure to China – 20% of exports go there – is a particular concern: the world’s second-largest economy is expected to slow further in 2017, and its commodity needs are changing.

Matters could get worse for South Africa: its credit rating could be lowered by rating agencies at the end of November or early December. This would be a blow in terms of GDP growth and access to international capital markets. The country risks losing its investment-grade status, which would force some institutional investors to withdraw from this market in accordance with legal requirements. This would probably push down the currency, which in 2016 was supported by rising commodity prices, leading the South African Reserve Bank to maintain or even push up its benchmark rates (see left-hand chart).
Government spending, which has been decelerating in recent years and plays less of a role in value creation in the country, would drop significantly. It would not be able to compensate for low levels of private investment or restore balance to the wealth distribution system.

Apart from these considerations, recent developments in South Africa are a reminder that the emerging-market bloc is really a disparate group of countries. The stark differences between Brazil, Russia, India, China and South Africa suggest that the term BRICS has little meaning anymore (see right-hand chart). The differences are apparent in their GDP growth and inflation trends, their monetary policy and, to an increasing extent, the pace at which they adopt and apply structural reforms. Emerging markets are in vital need of reforms in such areas as cleaning up bank balance sheets, restoring manufacturing competitiveness, increasing flexibility on overly rigid labour markets and reducing reliance on the commodity cycle.

Some countries understand this, like India and, to a lesser extent, China. On the other hand, Brazil, Russia and South Africa have some way to go in these areas. Unless they act, they may face an economic wakeup call, like the one that shook Brazil.

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