“Beyond policy uncertainty, among the factors that are hampering the recovery are: (1) the decline of the capital stock in the economy, particularly of machinery and equipment; (2) labour market hysteresis: loss of skill and productive ability due to large-scale long-term unemployment, sub-employment, and inefficient job-worker matching; (3) the significant increase in financial leverage/debt (government and households), which limits the capacity to increase spending through additional borrowing.
“After years of taking a prominent central role in the economy, the public sector is now entering a multi-year process of consolidation and retrenchment, driven by the unsustainable debt dynamics, but the private sector is not yet in a position to pick up the baton and support the recovery.”
I came across this excerpt in a recent report from Goldman Sachs. It does sound rather familiar.
The outlook for South Africa certainly feels rather bleak at the moment. The economy is contracting, and the impediments appear enormous. Several years of contracting investment, a lack of skilled workers and high levels of government and state-owned company debt will not be resolved in a short period of time.
To compound the problem, some in the ANC appear willing to damage key institutions to protect their own positions, rather than getting the economy growing. Three events that could improve confidence are a viable operational plan for Eskom that dovetails with a financial solution, progress in controlling central government expenditure and the arrest of some of those accused of state capture.
So far, there is no sign of progress on any of these issues. Unions have been key supporters of President Cyril Ramaphosa and this has seemingly reduced the space to cut headcount in the public service or Eskom.
While the Public Protector, who claims to have been placed in her position by the God she serves, has been investigating the potential missteps of President Ramaphosa, the SA Reserve Bank and Public Enterprises Minister Pravin Gordhan, she has shown no visible sign of investigating the many claims of public malfeasance that have been disclosed at the Zondo Commission of Inquiry into State Capture. More worryingly, her pronouncements on the Bank are damaging.
Despite the years of Zuma degradation, the remaining strength of South Africa’s institutions is one of the core pillars of our credit rating. Institutional strength is the main support behind Moody’s investment grade rating of South African debt. The Bank is the bulwark of this institutional assessment.
Any statements that undermine this assessment could ultimately lead to higher borrowing costs for South Africa – thus diverting government expenditure to interest payments and reducing the portion available for essential services. South Africa’s bond yields are already pricing in a rather poor debt trajectory. Since the budget deficit is expected to near 6% of GDP in the current financial year, this is not surprising. The spread between South African government debt and the emerging market average remains near the levels we saw when Nhlanhla Nene was fired as finance minister in December 2015. The inflation-adjusted yield in South African long bonds is among the highest in the world.
It might surprise you to learn that the Goldman Sachs analyst was not writing about South Africa. He was, in fact, describing Brazil’s structural constraints. Despite these, in the last 12 months, Brazil’s 10-year bond yield has rallied 200 basis points. At the same time, South Africa’s 10-year yield has sold off 30 basis points. However, Brazil’s structural challenges remain.
What changed in the interim was a structural decline in inflation expectations and a growing belief that the Brazilian government was committed to controlling expenditure. That country’s expenditure time bomb is social security – where the government is attempting to pass a reform bill. South Africa’s expenditure time bomb is Eskom.
The good news is that local investors provide a solid underpinning to local bond yields. The largest foreign investor sale of South African government debt in history, of R9.6-billion, took place last Friday. Despite this, yields were little changed. Now, all we need to see is some credible progress to budget consolidation in South Africa, preferably one that involves putting Eskom on a more sustainable path. If this is achieved, together with the persistent downside surprises to South African inflation, South African bond yields could rally notably, freeing up much-needed money for other government spending.
That is a much better plan than “quantity easing” – but it involves some tough decisions. And it would provide a solid step to boosting local confidence and getting the economy going. BM
Graffiti is actually the plural of graffito.