The dust is settling on the past few weeks of hard-to-hear economic and fiscal news. The sense of gloom was somewhat lifted by the promise of a private sector-backed, government-led infrastructure programme that could help nudge the South African economy out of recession and closer to its 2% long-term potential growth rate.
However, without a pick-up in private sector investment into the private sector itself, the domestic economy is unlikely to achieve its still limited potential, let alone move beyond it, and thus the government cannot afford to see the infrastructure programme as a silver bullet.
But what conditions will need to prevail before the private sector, historically the engine of economic growth, begins to reinvest in South Africa’s economic future?
For years the government has been crowding out the private sector, absorbing the bulk of South Africa’s savings as the public sector’s borrowing requirement has burgeoned. With the domestic household savings pool too small, the government has had to rely heavily on foreign investors and corporate savings to meet its funding needs.
Says Investec economist Annabel Bishop: “With foreign investors funding just under 40% of South Africa’s government borrowings, the government a dissaver and household savings relatively low, corporate savings have been key contributors to funding the rapid expansion of government debt and expenditure that has occurred over the course of this decade via the banking system.”
To reverse this trend and return to a healthy private sector investment environment, the following requirements would need to be met from a macroeconomic perspective: private investors would need to have confidence in the country’s economic future, as well as certainty about government policies going forward. The investment environment would also need to be conducive, namely, potential returns would need to be viewed as sustainable and sufficiently attractive, borrowing costs would need to be affordable and potential risks foreseeable and manageable.
For years these conditions have not been met and, as such, the rate of investment in South Africa has declined to exceptionally low levels. The COVID-19 pandemic has done unquantifiable damage to the already difficult investment environment; destroying any confidence the private sector had in the economy’s ability to grow and removing any certainty about the way forward in the next few months, let alone the next year or two.
Business confidence, which is arguably the most important indicator of the private sector’s appetite to invest, is at levels not seen since the BER Business Confidence Index began taking the temperature of the private sector in 1975. In the second quarter, the Index fell to 5%, showing just how few of the survey respondents believed business conditions were satisfactory.
COVID-19 has understandably shattered business confidence but even prior to the pandemic the level of confidence was, to be generous, underwhelming and still way off its 80% reached in the first quarter of 2007 before the financial crisis hit. The Index fell to a low of 25% in the third quarter of 2009 in the midst of the crisis and then increased to 52% by the fourth quarter of 2014 before declining thereafter.
To see business confidence return to anywhere near its previous heights, Sanlam Investments economist Arthur Kamp sees the non-negotiables as government getting the fiscal situation under control and a change in the narrative about South Africa’s economic future. “We want investors to be saying that the next move in our country credit rating is going to be better rather than worse,” he says.
High government borrowings and regulations have suppressed private sector fixed investment and shifted funding away from the private sector to government, elevating the cost of credit, says Bishop. Currently, long term real interest rates are trading at relatively high levels of 5.5%, based on a 10-year government bond yield of about 10% and inflation at 4.5%, which is the middle of the Reserve Bank’s target range.
Alleviating the fiscal pressure on the economy would reduce the high real rates that corporate borrowers currently have to pay in the capital market and set in motion a virtuous circle that sees the higher prospective returns as a result of more promising future economic prospects and lower borrowing attracting local and foreign investors.
For the virtuous cycle to be sustained, however, policy certainty will need to prevail. Kamp says the government’s fiscal policy stance will need to be consistent, particularly when it comes to corporate tax. “Treasury has acknowledged that the corporate tax rate is high and not competitive with the rest of the world,” says Kamp. “However, if fiscal policy remains unsustainable and necessitates further tax increases, then the private sector will be wondering when those are likely to become corporate tax increases. Uncertainty about this feeds back into the investment outlook.”
The independence of the SA Reserve Bank to pursue its inflation mandate is also, as always, a crucial component in the policy mix because, says Kamp, it enables investors to make decisions based on the certainty that the inflation rate is likely to remain low and stable and real interest rates may come down.
He is confident that South Africa will remain an attractive investment destination as long as it has the resources available and is able to satisfy these conditions – a talk ask in current conditions but not out of the question in a new normal if government proceeds along the right track.
Government, the private sector and labour efforts to get the infrastructure programme off the ground as an important step towards shifting expectations about South Africa’s future, says Kamp. “South Africa has a young and growing population and the fact that Africa is seen as a growth frontier will also benefit hugely.” BM/DM
"The sad truth is that most evil is done by people who never make up their minds to be good or evil." ~ Hannah Arendt