Positive surprises are always welcome. In a country chronically short of good news, there was some last week in the form of data showing the South African economy has been performing much better than expected. Economic activity (measured as real gross domestic product, or GDP) expanded by 1.9% in the first quarter of the year compared to the fourth of last year. Economists were pencilling in growth of 1.2%. The growth rate for the fourth quarter was also revised up, from the initially reported 1.2% to 1.4%.
Compared to the first quarter of last year, the economy grew by 3%, and is now finally above pre-pandemic levels in real terms as chart 1 shows. In nominal terms, adding back inflation, the value of economic activity is well above the pre-Covid level and indeed is pretty much back on the pre-Covid trend. All in all, despite the setback of the July 2021 riots, the economy rebounded from the Covid shock much quicker than even the optimistic forecasts made in 2020.
The bumper first quarter also means that even if there is no growth in the remaining three quarters, full-year economic growth will be above 2% which would be the second strongest result- since 2013 (2021 saw 4.8% growth rebounding from the 2020 slump).
Chart 1: Level of SA gross domestic product in rands
Source: Refinitiv Datastream
While the overall economy has now recovered from the Covid shock, not all economic sectors or components have.
Formal employment, for instance, is still close to 1 million lower than in late 2019. The total wage bill is above pre-pandemic levels in nominal terms. This means that those of us who’ve kept our jobs have earned more than enough to offset those who haven’t. It also implies that job losses were concentrated among lower income earners. Inequality, already among the worst in the world, deepened further due to Covid.
The recovery in aggregate incomes also means that consumer spending levels are above pre-pandemic levels, even in real terms. However, here too there is an uneven recovery. Real spending on durable goods such as cars and furniture recovered first, perhaps surprisingly given the discretionary nature of these items. But it does reflect the global trend of people spending more on sprucing up their homes. Spending on non-durables (mainly food) and service (the largest category) is also back to pre-pandemic levels in real terms. However, spending on semi-durable goods (mainly clothing) is not.
Chart 2: Real household consumption spending
Source: Refinitiv Datastream
Household consumption is the biggest component of economic activity when measured in terms of spending. Where the consumer goes, usually, so goes the economy. The sharp increase in food and particularly fuel prices – with more to come, seemingly – is therefore likely to lead to slowing spending growth unless job creation picks up.
One can also measure economic activity in terms of production. Here manufacturing was the best performer in the first quarter in line with buoyant global manufacturing activity. However, this increase barely registers on a longer-term horizon where there has been much volatility but little growth. April’s production numbers already show the impact of the devastating floods.
The agricultural sector has also performed well over the past two years, supported by good weather and elevated selling prices. However, it is a small part of overall activity.
In contrast, the construction sector is still battling. It was negative in the first quarter and is still 20% below where it was on the eve of the first lockdown in 2020. Sadly, the sector was already on a downward trajectory even before Covid. The data suggests that the uptick in residential construction activity has not offset weakness in non-residential buildings as well as the lack of big infrastructure projects. It could also be that the many residential renovation projects that have clearly been taking place over the past two years are not being properly captured in the data.
Persistent production problems
Mining production fell in the first quarter for the third quarter in a row. Technically, therefore, the sector is in a recession which might come as a surprise given how elevated global commodity prices are. However, the high selling price means that mining companies are still very profitable even with persistent production problems. It does mean, however, that growth would have been much stronger had companies been able to raise output to meet strong global demand. The same is true for the ability to export. In particular, exports of coal through the Richards Bay Terminal are some 20% lower today than five years ago even though global coal prices are at record levels. This is largely due to inefficiencies on the part of Transnet Freight Rail.
As is common knowledge by know, one of the biggest obstacles holding the economy back is the underperformance of parastatals that have virtual monopolies in key network industries, notably Eskom and Transnet. Loosening their grip on the economy is as important as improving their performance. There is some progress on both counts.
Transnet has invited private companies to bid for slots on its railways, but so far participants have complained that the conditions on offer are not commercially viable. Transnet has also invited companies to bid to run certain port terminals. Meanwhile, energy regulatory NERSA registered 16 projects in the past few days that will allow companies to generate electricity for own use. This is a big step and likely the first of many more.
The other big obstacle is simply confidence in the future. Years of economic sluggishness, corruption scandals and policy uncertainty mean ordinary South Africans and businesspeople alike are unsure about what the future holds. Even goods news tends to be treated with scepticism.
The RMB/BER Business Confidence Index reflects this. It dipped back to 42 points in the second quarter from 45 in the first, meaning that most business executives surveyed are not satisfied with business conditions. The better-than-expected economic recovery has not translated into a noticeable rise in business sentiment.
Fixed investment spending by businesses is therefore another key variable that remains well below pre-pandemic levels though it has been increasing since falling to a 16-year low in 2020.
The private sector accounts for two thirds of overall fixed investment spending. The other third is conducted by general government (items like schools, bridges, clinics, roads, military hardware) and state-owned enterprises (power stations, rail engines, airplanes). Public sector fixed investment has declined.
Chart 3: Fixed investment spending as % of GDP
Source: Refinitiv Datastream
The National Development Plan which was passed ten years ago but quickly forgotten by policymakers called for a target of raising total investment spending to 30% of GDP to sustain higher levels of economic growth. It is currently at 14%. Allowing the private sector to invest in areas previously monopolised by the public sector is one of the easiest ways to raise this ratio. As noted, this process is starting but requires a sustained commitment to business-friendly reforms and policy certainty. This in turn requires political continuity.
Things took an unexpected turn politically in the past few days after news broke that a large amount of foreign currency was stolen from President Ramaphosa’s game farm. It is too soon to know how politically damaging it will be for him. He still seems likely to win re-election as ANC president later this year, but the probability of a different outcome has certainly increased.
However, it is important to note that one of the things he has been most criticised over was the consensus-building approach that slowed the pace of reforms considerably. Yet it is exactly this approach that should ensure that reforms stick even if he was to leave the scene for whatever reason.
Finally, no discussion of the domestic economy can be complete without placing it in its global context.
Last week the World Bank cut its forecast for 2022 global growth to 2.9% from the 4.1% it still expected as recently as January. It is one of the sharpest downgrades on record. The reasons are familiar by now: China’s harsh Covid lockdowns, Russia’s invasion of Ukraine which has seen food and energy prices surge, and aggressive monetary tightening, especially by the US Federal Reserve. The forecast for 2023 is for 3% growth. In other words, no recession is foreseen.
However, the World Bank warned that if any of these risk factors worsened – if the oil price spiked higher, if the Fed hiked interest rates more than currently expected or if China was to go into lockdown again – the outcome would be worse. It remains a real possibility that global growth could come under even more pressure in coming months and South Africa will not escape its effects.
The renewed weakness on global equity markets last week reflects this risk, particularly with US inflation hitting a 40-year high of 8.6% and therefore probably forcing the Fed’s hand into continued rate hikes.
How it affects SA
A global economic downturn usually hits the local economy through four channels. Firstly, there is less demand for exports, notably commodities. However, given the current supply disruptions due to the war in Ukraine, it is hard to know how energy and food prices will behave.
Secondly, fewer foreign tourists normally arrive. Since inbound tourism is already well below pre-pandemic levels, at least the decline will not be off a high base.
Thirdly, capital tends to flee riskier destinations such as South Africa in favour of the safe havens such as the US when the global economy weakens. The dollar tends to strengthen, and the rand tends to weaken.
Finally, the weaker currency can put upward pressure on inflation and by implication, interest rates. It depends on what happens to other prices, however. In the last global recession, in 2020, the rand slumped but so did the oil price. Inflation therefore declined and the Reserve Bank cut interest rates. The current environment of high global inflation means the Reserve Bank and its global peers are likely to be reluctant to cut rates even in the face of economic weakness. Some might continue pushing ahead with increases even if there is a recession. This makes it a particularly uncertain environment. Fortunately, South African inflation is lower than in the US and Europe, unusually so, and the rand has been relatively resilient so far.
One important difference from previous global cycles, particularly previous Fed hiking cycles, is that South Africa’s current account is in surplus. For much of the past 30 years, the current account was in deficit, meaning it had to be financed by portfolio inflows that could reverse quickly, destabilising the currency.
In the first quarter, the current account surplus was R143 billion or 2.2% of GDP. This was largely due to a positive trade balance thanks to elevated commodity export prices. As noted above, it is not clear how these prices will behave in a global slowdown, though they normally fall. Nonetheless, the current account surplus provides a much better starting point.
Chart 4: SA Current account balance as % of GDP
Source: Refinitiv Datastream
More broadly, it also means the economy is earning more than enough hard currency to pay for key imports, such as oil. Many developing countries face the acute problem in this environment of finding enough hard currency to import increasingly expensive food, fuel, fertilizer, medicines, and machinery. Often, they also need to pay interest on dollar-denominated debt, putting further demands on scarce foreign currency.
No one would say that the local economy is booming or that all or even most of its binding constraints are being addressed. One can spend days listing the challenges it faces. However, it remains a fact that the recovery from the Covid-crash has been much better than expected, aided by commodity price jumps. It is also clear that some progress is being made in addressing key bottlenecks. This means that in the absence of further global shocks, reasonable economic growth rates around 2% in real terms are sustainable in the medium term. South African assets arguably price in a worse outcome. The combination of improving domestic fundamentals – or put differently, the removal of some of the worst-case scenarios – plus attractive valuations mean local equities and bonds should still play an important role in a diversified portfolio now that retirement funds are allowed significantly more global exposure.