Hero to zero – we have been warned
The Brazilian economy, once held up as a shining example for South Africa to emulate, has since plummeted into economic turmoil. It seems to be a bad omen for the local economy, which some analysts fear could go the same way.
The two share several characteristics, including poor growth prospects and current account and budget deficits, a bloated public sector, a high debt to gross domestic product (GDP) ratio, declining labour productivity, low global competitiveness, vulnerability to commodity prices, a volatile and weakening currency, and an endemic culture of corruption.
“South Africa is a microcosm of the big Brazilian story. And everything they have done wrong, we are trying to do wrong too,” said Lyal White, the director of the Centre for Dynamic Markets at the Gordon Institute of Business Science. South Africa’s only saving grace might be its ability to keep a tight grip on the state purse strings.
When Brazil’s GDP growth peaked at 7.7% in 2010, the South American nation was held up as an example for South Africa to follow. In 2012, its combination of rapid economic growth and steady reduction in extreme poverty persuaded Cosatu that income-led growth was possible in South Africa. Inspired by Luiz Inácio Lula da Silva, the president of Brazil from 2003 to 2010, the trade union federation motivated for what it called a local “Lula moment”.
But, as White put it, Brazil has since gone from hero to zero and is the worst-performing major emerging market this year.
And a new kind of Lula moment is taking place. This week it was reported that two of his close associates, one his chief of staff, will stand trial for alleged involvement in a corruption scandal at the state-owned oil company, Petrobras. High-ranking officials are alleged to have accepted bribes from firms in return for lucrative contracts.
Following negative growth in both the first and second quarters of the year, Brazil’s credit rating was downgraded last week to sub-investment grade, or junk status, by the ratings agency Standard & Poor’s. This signals increased risk to investors and raises the cost of borrowing for the government.
Experts disagree on whether South Africa will go the same way. Chris Hart, an Investment Solutions strategist, for one, thinks we will soon follow suit. “It is almost baked in the cake, because there are no growth drivers,” he said.
Sluggish growth and deficits make a country vulnerable to a downgrade, he said. For Brazil, a current account deficit of 4.17% of GDP and a budget deficit of 0.6% of GDP contributed to its downgrade. In South Africa, the current account deficit is 5.4% of GDP, and the budget deficit 3.8%.
Azar Jammine, the chief economist of Econometrix, said South Africa is far from a downgrade. “Generally we have been experiencing sluggish growth, but it is not collapsing the economy. South Africa still, despite its problems, has better infrastructure and is reasonably well diversified.
“The South African government has controlled its spending a lot more rigorously than Brazil … Brazil overdid it; they went berserk and there was a huge fallout.
“Our saving grace, as the treasury has mentioned, is that not all the money earmarked to be spent is spent, so there is a little extra cash here and there,” said Jammine.
Peter Attard Montalto, an emerging markets economist at Nomura, said Brazil is experiencing an institutional crisis, meaning large downgrades to sub-investment grade were possible. But South Africa is not in that position, although there were future risks.
“Equally, Brazil is experiencing a much more immediate fiscal stress, whereas South Africa is coming off a period of good revenue momentum and a fiscal cliff arguably seven to 10 years further out than for Brazil.”
For these reasons, Montalto said, Brazil is instructive as a guide to long-term risks for South Africa.
But, according to Hart, there are worrying parallels, such as interventionist, left-leaning governments.
“In both countries, there is a degree of pragmatism, but also a degree of populism,” he said.
At the top of the commodity boom, things worked “quite nicely” and bolstered consumption expenditure. “In the meantime, they never positioned their economy to be truly competitive and [they] sit well down the ranks in terms of world economic competitiveness.”
Ranked on global competitiveness by the World Economic Forum, South Africa is 53rd and Brazil is 56th out of 148 countries.
Despite some diversification in South Africa, the start of the value chain in both countries is resources, Hart said, adding that in South Africa, mining, manufacturing and agriculture are in recession.
“In South Africa, we can add labour unrest to our problems and that is a big turn-off for investors.”
White said: “I would argue South Africa hasn’t diversified much more for commodities than Brazil has … Both nations expect depreciation of our currencies to inject competitiveness. There is a mindset that externalities will change competitiveness.”
Montalto said the downside for South Africa is that it does not recognise either publicly or privately that its problems are mostly home-grown. “In Brazil there is a recognition of this, albeit somewhat late.”
White said productivity is the most important thing. Brazil’s had been in decline since 1980. Last year, the labour-broking firm Adcorp reported that labour productivity in South Africa is at its lowest in 46 years. “South Africa in my mind is like Brazil,” said White. “We are not improving our productivity to keep pace with global competitiveness. And we are not going to attract FDI [foreign direct investment].”
Brazil is notoriously hard to do business in and has some of highest levels of red tape and in the world, White said.
In boom times, it dictates terms of investment and taxed inflows, and investors are still prepared to climb barriers, Hart said. But now, one would expect a move to make the economy more competitive from a regulatory and tax point of view.
“But, instead, the government is becoming more interventionist rather than less. And, in South Africa, we are seeing the same,” he said. “We are channelling enormous resources away from growth and into regulatory compliance.”
Iraj Abedian, the chief executive of Pan-African Investment and Research, said the lack of business confidence is a major drawback, and, in South Africa, some “unwise pieces of legislation and [the] general political milieu” are not helpful. “For example, at the current rand forex level, our tourism sector should be booming, but the visa regulation has stumped the sector badly.”
Tax structures in both countries, Hart said, are not optimal or competitive. South Africa and Brazil both had a corporate tax rate of 34%, among the highest in emerging market countries.
According to Raymond Parsons, a professor at the North-West University business school, negative global economic developments, including the slowdown in the Chinese economy, “has exposed South Africa’s weaknesses rather than caused them”. Realistically, he said, “the jury is still out between a recession … and a low growth trap. We still await definitive economic data, but the omens are not good.”