The State of South Africa’s Economy: Half Year Review and Prospects

LAGOS, Nigeria, Capital Markets in Africa: Although there have been some positive developments of late – a stronger trade performance in Q2, another reasonable score in the purchasing managers’ index (PMI) survey in July, and a rally in the rand – many of the South African economy’s fundamentals remain very poor. Indeed, NKC African Economics has recently lowered its real GDP growth forecast for 2016 to zero although we still expect the economy to grow modestly in the quarters following the sharp contraction in Q1.

Brexit takes the world by surprise
A recent development that received considerable media attention was the so-called Brexit vote in June. With regards to the impact on the South African economy, the immediate effects following the vote were mostly negative, with the rand knee-jerking weaker by over 8% during Asian trade on June 24, before recovering again during European trade. A larger negative effect was seen on the South African bourse, with all sectors on the Johannesburg Stock Exchange (JSE) All Share trading in negative territory, except the gold mining sector, which climbed sharply as investors sought safe-haven destinations. In the weeks following the referendum, the rand, along with the JSE, has strengthened on the back of positive emerging market sentiment. In turn, emerging markets have benefitted from a more dovish US Federal Reserve (US Fed) and easing monetary policy stances of several developed economy central banks, as low returns in these economies have prompted investors to look towards economies like South Africa for higher yields.  Over the medium term, we expect to see some deterioration in demand from the UK for South African exports, which accounted for just over 4.1% of South Africa’s total exports last year, according to Trade Map.

Monetary policy, inflation pressure
With regard to monetary policy, the South African Reserve Bank (SARB) decided to hold interest rates steady again at its most recent meeting in July. SARB Governor Lesetja Kganyago noted that although the central bank’s consumer price inflation outlook moderated slightly from the previous MPC meeting in May, the SARB still expects price pressures from food to intensify due to repercussions from the worst drought on record still filtering through to the economy. The SARB’s concern about the state of the economy was reflected in the fact that it cut its 2016 real GDP growth forecast from 0.6% to zero (in line with NKC’s most recent projection). Overall, the tone of the last MPC statement was considerably less hawkish than in previous meetings, although the MPC did note that its decision in July to keep rates on hold was merely a pause in the central bank’s tightening cycle.

Recovery in mining and manufacturing
On a more positive note, the volume of domestic mining production increased by 1.9% m-o-m on a seasonally-adjusted basis in June, compared to the upwardly revised 2.7% m-o-m increase recorded in May. While the monthly increase was not enough to see mining production emerge from negative y-o-y territory, the latest data implies a rebound from the very poor readings in Q1. Seasonally-adjusted mining production increased by 4.1% q-o-q in the second quarter, compared to the sharp 68.3% q-o-q contraction during the first three months of 2016. As such, we expect the positive mining production numbers in Q2 to help the economy avoid a technical recession, which is defined as two consecutive q-o-q contractions.

Furthermore, local manufacturing production increased for a third consecutive month in June. According to Statistics South Africa (StatsSA), overall manufacturing production increased by a seasonally-adjusted 0.7% m-o-m in June, following the 1.3% m-o-m expansion recorded in the preceding month. On an annual basis, the monthly expansion saw manufacturing production increase by 4.5% y-o-y in June, compared to a 3.9% y-o-y rise in May.

The improved headline reading in June, which marked the highest y-o-y rate since July 2015, provides further evidence of a nascent recovery in the South African manufacturing sector, in line with our baseline view. Similar to mining production, the manufacturing sector is set to help the overall economy avoid a technical recession, with manufacturing production increasing by a seasonally-adjusted 2% q-o-q in Q2, compared to the lacklustre 0.3% q-o-q increase in Q1.

Low Business and Consumer Confidence
That said, most measures of domestic business and consumer confidence remain downbeat. Even the forecast recovery in the manufacturing and mining sectors is set to be greatly constrained by soft demand from China, generally sluggish global trade and low commodity prices. At the same time, inflation is likely to move further above target in H2 2016 because of rising food prices, and this will undermine consumers’ purchasing power. As a result, the recent decision of the central bank to keep interest rates on hold is likely to be a temporary development, and we expect one more rate hike of 25bps this year.

At the same time South Africa’s economic fundamentals remain dismal – illustrated by the unemployment statistics for Q2. According to the latest Quarterly Labour Force Survey (QLFS), total employment dropped by 129,000 to 15.663 million during the second quarter of this year – representing a decrease of 0.8% q-o-q. Overall unemployment declined by 90,000 in Q2 – seeing the unemployment rate tick marginally lower to 26.6%, compared to 26.7% in Q1 – but this is purely because of an increase in inactivity. When looking at the expanded unemployment numbers, which include those that were available for work but had ceased looking for a job, the unemployment rate increased from 36.3% in Q1 to 36.4% in the second quarter. Extremely high unemployment remains a salient feature of the South African economy, and with real GDP growth grinding to a standstill, it is unlikely that the situation will improve anytime soon.

South Africa’s Outlook
Looking ahead, South Africa’s economy, and consequently its sovereign debt rating, is set to continue to face several hurdles over the medium term, including: fiscal consolidation efforts, monetary tightening, a rigid labour market with a high rate of unemployment, poor industrial relations, very sluggish economic growth, a sizeable current account deficit and a shifting political climate. Nevertheless, the major international rating agencies granted South Africa a reprieve during their most recent reviews of the country, based on its prudent debt repayment history, sound fiscal and monetary policies, and adequate portfolio inflows helping to finance the current account deficit. However, much will need to be done, particularly in the area of structural reforms, before there is any chance of positive adjustments to South Africa’s sovereign debt rating. Indeed, a downgrade to sub-investment grade status by S&P Global Ratings before the end of the year is still very much on the cards, particularly if the outlook for GDP growth remains so weak.

Contributor Profile
Hanns Spangenberg is a Senior Economist at NKC African Economics. He received an undergraduate degree in finance and economics from the University of Alabama at Birmingham (UAB) in the US in May 2009 while attending under a Division One collegiate tennis scholarship. A Master of Commerce degree in Economics, with research focusing on a behavioural finance perspective analysis of the Financial Crisis and Basel II regulations, was awarded by the University of Stellenbosch in South Africa in December 2012. Hanns joined NKC African Economics in January 2013, after returning from an academic exchange programme to Maastricht University in the Netherlands. Currently focusing on macroeconomic coverage of South Africa, Botswana and Mozambique Hanns has previously covered other Sovereigns such as Mauritius, Malawi, Namibia, South Sudan and Sudan.

This article features in the September edition of INTO AFRICA Magazine, which focuses on reviews of Africa’s economies in the first half of 2016.