Finance Minister Pravin Gordhan’s rhetoric about the economy is disarmingly upbeat, but its underlying message spells hardship for the average consumer.
He has dismissed fears that the country will go into a recession and has undertaken to prevent what some see as an inevitable downgrading of South Africa to junk status by ratings agencies.
His statements seek to address the many concerns facing citizens, from soaring food prices and inflation to a rand at its all-time weakest, low demand for locally produced commodities, sinking consumer confidence, rising electricity prices and increasing government debt.
His comments are among a flurry of grandstanding remarks made by emerging market leaders before the World Economic Forum in Davos. They are scrambling to regain some of the $735-billion that flowed out of emerging markets in 2015.
Local markets responded positively to the minister’s reassuring outlook, but it could take a drastic clampdown on spending and a possible increase in taxes to live up to Gordhan’s views.
Arthur Kamp, an investment economist at Sanlam Investment Management, said: “South Africa is facing low commodity prices and weak productivity. We have got pretty wide current account and budget deficits and we don’t have sufficient capital inflows. There’s a high risk of inflation and a very weak currency, which doesn’t seem to be responding to anything.”
Since the second week in January, palladium has dropped to a five-year low, platinum was priced at its cheapest ever compared with gold, and the gold trade has slumped. As a commodity-exporting developing economy, South Africa has been hit hard.
David Crosoer, the head of research and investments at PPS Investments, said: “South Africa has more robust institutions than Russia or Brazil, and a marginally better economic outlook, but we’ve been priced as if we’re similar to them. All three countries have faced similar changes.
This is an opportunity for investors who think there has been an overreaction, or a warning for those who think things could still get a lot worse.”
According to research conducted by Mazi Capital, global commodity prices could slump even further.
“If you look at the early 2000s, before the supercycle, average commodity prices were still below where they are now,” said Asanda Notshe, Mazi’s portfolio manager. “It gives you an indication of where the equilibrium may be.”
On the upside for South Africa, United States crude oil has hit a new 12-year low, selling at less than $28 a barrel. But neutralising the benefits of this are rising electricity costs, with Eskom having requested a 16% tariff increase, and “the very weak rand,” said Kamp.
Although the currency was on a downward trajectory most of last year, it took a sharp turn for the worse in December when President Jacob Zuma unexpectedly axed then finance minister Nhlanhla Nene.
In January, it plummeted further still, hitting a record low of R17.99 to the dollar when Zuma publicly defended his much-decried decision. This week it has hovered between R16.35 and R16.95 to the US currency.
The effects of the weak rand are being compounded by the worst drought in two decades. The price of white maize in South Africa soared to a record high of R5?200 a tonne this week on fears of a shortage. In nondrought years, the country is self-sufficient and exports its excess to neighbouring countries. But that will change this year.
“To the extent that we have got a shortage of maize or some of the products, like meat, we will have to import that,” the Reserve Bank governor, Lesetja Kganyago, said on November 19.
This year South Africa will have to deal not only with the loss of income from those exports, but will also be forced to use its weak currency to import what it needs.
“All indicators suggest that cereal inflation is going to rise very sharply over the coming months,” Stanlib’s chief economist, Kevin Lings, wrote in a note. “Consequently, we expect food inflation to end 2016 sharply higher at about 15% year on year.”
Food has a weight of 14.2% in the inflation basket and most analysts agree the Reserve Bank’s 6% upper limit for inflation will be exceeded this year. Other analysts, including Crosoer, predict it could even get “very close to double digits”.
To curb this, most expect the Reserve Bank’s monetary policy committee to raise interest rates when it holds its first meeting of the year at the end of the month. But analysts are divided about whether this is the correct course of action.
According to Notshe, the rand is responding to “exogenous factors”. “The weak currency is not a rand-only phenomenon. When the rand is moving through factors that are beyond our control, it becomes difficult to justify reacting to that by hiking interest rates,” he said.
According to Investec economist Brian Kantor, the relationship between the past year’s rate hikes and the falling rand has demonstrated that the currency has not strengthened on this move. Instead, he argues, the Reserve Bank should be lowering interest rates to boost domestic demand.
This week, the International Monetary Fund cut its 2016 growth projections for South Africa’s gross domestic product by almost half. Its revised expectation is that the economy will expand by 0.7%. Barclays Bank revised its projection down to 0.9% and Bank of America Merrill Lynch now forecasts a mere 0.4% growth.
All in all, analysts believe Gordhan is in a very tight corner. The benefit of the treasury sticking closely to its spending framework last year was undermined by lower-than-expected growth. Gordhan now needs to do something spectacular, said Notshe, which most analysts understand to mean curb (or ideally cut) costs and increase revenue.
The bloated government wage bill is an obvious starting point but the ruling party is facing an election year and a restless electorate. “There’s probably no way that government can cut 10% off the wage bill – especially not this year,” said Notshe,” Notshe said.
Instead, the undercurrent of Gordhan’s remarks points to a rise in taxes. Kamp said: “Gordhan was the first to start clamping down on real government expenditure and it was quite effective. But, at the same time, the only way we’re going to be able to balance the books is by increasing tax revenue.”
But Notshe warned that a tax-induced cash boost to the economy may not be enough to placate the rating agencies.
“Tax is a lever one can pull, but it’s a short-term gain,” he said. “The ratings agencies will be looking at whether the effects of that can be sustained.”