25 February 2016

South Africa: Moving South Africa Away from Junk Status?

Photo: Nick Roux/Wikimedia
South African rands - bank notes and coins.

Finance Minister Pravin Gordhan has just presented his first Budget Speech since being reappointed after the unceremonious firing of Minister Nene. The speech follows on the presentation of the State of the Nation Address by President Jacob Zuma on the 11th of February. Both speeches marked watershed moments in South Africa’s history as the economy faces some of its worst challenges in post-apartheid history. However, Gordhan’s speech was to ensure that South Africa avoids being downgraded into junk status by rating agencies. It is these challenges, both internal and external, which have bred uncertainty from foreign investors and credit rating agencies.

Minister Gordhan’s Budget Speech and President Zuma’s SONA were preceded by the presentation of the World Bank’s biannual South Africa Economic Update of 2016. The World Bank’s report gave a glimpse into some of the issues plaguing the South African economy, and it is sobering to note that the President and Finance minister both touched on some of these issues in their presentations. The World Bank noted that the country is facing the 5th consecutive year of slowing growth, characterized by falling incomes and job losses. South Africa’s average income per capita has fallen rapidly in the past 5 years, and poverty has increased from 36.5% in in 2014 to 37% in 2016. Real GDP grew only 1.3% in 2015, and the outlook for 2016 is even grimmer with growth predicted at 0.9%.

These challenges are caused by both external and internal headwinds, highlighted as a common thread the Budget Speech, the SONA and the World Bank Report. The main external headwinds come from the drop in commodity prices, slowing demand from China and the effects of the US recovery and interest rate hike. The commodity drop has particularly hit the mining sector in South Africa, which has been forced to curb its production and cut employment. This sector might further be battered when the striking season commences in winter.

Domestically, South Africa faces a drought spurred by El Nino that is hard hitting agriculture and the rural poor, threatening to put 50,000 South Africans in poverty in the last year.

President Zuma asserted the need to keep the National Development Plan of doubling incomes and eradicate poverty by 2030. The World Bank has, however, noted in its report that the South African economy has to grow by 8.2% annually from 2018 if the NDP goals are to be realized.

What was evident from the Budget Speech and the SONA is the realization by Government that the country’s challenges cannot be resolved by simple fiscal and monetary policy. The 2015 nine-point plan was revisited by the President and elaborated by the Minister, and reflects a need for a structural shift in addressing South Africa’s challenges. What is commendable is that Government has finally decided to deal with inefficiencies within the SOEs upon a realization that there is a need to go beyond fiscal and monetary policy, and both Zuma and Gordhan have now committed to measures of rationalisation. Minister Gordhan has rightly asserted the government's need to create public private partnerships within the currently inefficient and highly fragmented SOEs. This is highly commendable as it will increase efficiencies and also eliminate the patronage role that these state owned firms are playing. Furthermore, this will save the taxpayers a lot of money which currently gets disbursed through bail outs.

South Africa is already the most unequal country in the world according to its Gini coefficient, and inequality is projected to continue to grow due to the drought and high unemployment. Tensions over inequality came to a head with university student protests across the country over unequal access to education. The government pledged a 0% increase in student fees for the coming year, with additional education spending increases outlined in the budget speech.

A big question remains as to where the government will derive these and other funds to spearhead social transformation, as the country faces a tight budget and already steep public debt. The budget speech has proposed increased taxes on sugar sweetened beverages, alcohol and tobacco, an increase in the general fuel levy, a tire levy, and increases in the incandescent globe tax and the plastic bag tax. These are in place of the highly anticipated VAT increase, and it is quite a relief that the poorest of the poor have, for now, been spared the increase.

Government has to a large degree reached a ceiling in revenue collection and the need to increase the tax base cannot be overestimated. This can only be done through having more SMEs entering the economy, and currently South Africa unimpressively ranks 120/189 in the World Bank’s assessment of the ease of starting a business. It was encouraging that the Minister, who has been running Local Government himself, has noted that municipalities are to blame mostly for barriers to entry. Zuma highlighted the creation of the Department of Small Business Development as a step in the right direction, which Gordhan elaborated will be receiving R475 million in additional funding.

Zuma also highlighted the Black Industrialist Programme to promote SMEs, yet this programme may not achieve its intended results, as it is likely to be susceptible to rent seeking and patronage. Government has a duty to create a favourable climate for SMEs to thrive, as highlighted in the World Bank report, as opposed to choosing winners and losers among potential entrepreneurs.

Both Zuma and Gordhan once again highlighted recent infrastructure projects and plans, which has been a key pillar of Zuma’s presidency. Noted in particular were power projects targeting electricity constraints which hamper domestic production, and water projects which will help to relieve drought burdens. Gordhan noted in the budget speech that focus will be not just on building new infrastructure, but also on repair and maintenance of existing infrastructure.

In addition, the Investment Promotion Agency that the DTI is setting up will be a welcome development in easing FDI entry into the country.

Another measure highlighted in both presentations was the national minimum wage. The minimum wage is not necessarily advisable given that wage growth in past years has already far outstripped inflation, and such actions have led to further job cuts. That Government has only assured the country that a minimum wage would not compromise the need to increase employment without elaboration reflects its lack of confidence on this policy measure.

Instead, labour policies should focus on increasing labour productivity. South Africa’s lower labour productivity, like in most developing countries, can be attributed to low skills capacity. This means more funds should have been directed towards upskilling labour. And most importantly equipping people with the right skills. In the budget speech Gordhan did highlight that talks are in progress to reduce workplace disputes; however, given the union power in South Africa, it unclear whether this will have a significant effect.

South Africa stands in a tough spot. The effects of external downward economic pressures are unavoidable, and even if domestic prospects were positive, there is no way that South Africa could achieve its National Development Plan goals of doubling incomes and eradicating poverty by 2030. Fiscal constraints present tough questions on how to target the country’s key issues of inequality and unemployment with little public money to spare.

Both the SONA and the Budget Speech presented turning points in South Africa’s post-colonial economic history. As argued, the economy faces challenges similar to the ones it faced in the nineties when the US$ was quite strong. However, the current causes are more complex and will require more complex and multifaceted approaches. The fact that it’s an election year makes employing tough approaches even trickier. Credit should be given though to the Minister and the President for laying the groundwork towards stabilising the economy after identifying both the external and internal challenges facing the economy and suggesting plausible solutions. What remains to be seen is the implementation of both the SONA and the Budget speech. The jury is out there on both Gordhan and but most importantly President Zuma to not allow politics to trump everything, leading to policy uncertainty and an inevitable investment downgrade.

Azwimpheleli Langalanga is the visiting Research Fellow and Chelsea Markowitz, a Research Assistant at the Economic Diplomacy Program of the South African Institute of International Affairs.

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