As a leading commodity producer and exporter, South Africa’s current account deficit appears uncharacteristic given the backdrop of strong commodity price performance.
This is due mostly to a combination of rising imports and poor exports during this commodity cycle. There are various factors, but regulatory risk remains the greatest concern.
South Africa’s industrialisation phase was brief and the transition to a services-based economy quite quick. The rise in the services sector and imports can be attributed partly to an established and large white middle class, while the more recent rapid growth in the black middle class has also spurred consumption growth.
Moreover, exchange control liberalisation and relatively developed financial markets helped to divert capital inflows to the (consumption-dominant) private sector. The consumer boom and government’s infrastructure roll-out have spurred investment in recent years, also contributing to rising imports.
This situation was worsened by underinvestment during the 1980s and 1990s that resulted in capacity closure for certain inputs.
Given that government’s infrastructure roll-out is long term, and import intensity will continue, it is important to look at why exports, and the mining sector in particular, have not done more to stabilise, or at least cap, the pace of deterioration in the current account deficit.
Despite the decline of mining as a percentage of GDP, the sector and commodity prices remain important to the South African economy.
Mining output contributes 6,5% to GDP and the sector accounts for 5,8% of formal employment. Direct mining constitutes 33% of total nominal exports and is a major forex earner. The mining sector accounts for 45% of the total market capitalisation of the FTSE/JSE All Share Index.
Despite higher gold, platinum and even coal prices, mining output growth and export volume growth remain lacklustre, while overall sales are up in line with the increase in rand commodity prices.
Strong global industrial production in the past four years suggests it is hard to blame external demand for South Africa’s mining output woes. Rather, lower output from the gold sector is more likely because of higher costs associated with deeper mining and due to lower quality ore.
Wage pressure is generally strong in the highly unionised mining sector and likely to be exacerbated in the near term by the paucity of skills.
Yet the biggest reason for the underperformance of mining output in the past two years is the underinvestment in the industry during 2004/05. This can be attributed to various factors:
• Rand appreciation following the 2001 currency crisis resulted in projects not meeting their hurdle rates and which were therefore shelved;
• Long-term commodity price assumptions have only gradually been revised upwards as the sustainability of growth in China and the decoupling thesis is still to be tested;
• Lagging infrastructure investment in the past 25 years has contributed to curbing much-needed mining investment; and
• Investment in roads, electricity, rail networks and ports has only recently gained significant momentum.
The most uncertain constraint on investment has been increased regulation, beginning with the 2002 Mineral and Petroleum Resources Development Act, which converted old order mining rights to new order rights.
This is in turn linked to the BEE Mining Charter with a 2014 deadline, compared with the application deadline of 2009 for new order rights.
Finally, the Royalty Bill of 2002, which levies royalties on mining revenue, has still not been finalised — the third and final draft is due for release for comment shortly.
In addition to the uncertainty of ever-changing regulatory requirements, the application process for rights conversion under the Mineral and Petroleum Resources Development Act has been slow and disappointing.
Although the direct importance of mining as measured by real economy indicators has declined, it remains a crucial source of foreign exchange revenue. Furthermore, commodity prices are still seen as a barometer for the rand and the economy. If elevated rand commodity prices are met with greater export volume growth, the current account deficit could stabilise sooner than expected.
Carmen Nel is an economist with Merrill Lynch South Africa