By Arthur Kamp
The government of national unity (GNU) established in the weeks following South Africa’s May 2024 National Election has chosen a reform path underpinned by mostly centrist economic policies and respect for the Constitution.
GNU and reform-driven growth
While the domestic macroeconomic outlook will be heavily influenced by the inflation and interest rate ‘steer’ from the United States (US) and other developed markets, the country’s GDP growth picture will be influenced by the ability of GNU partners to find common ground in diverse areas like healthcare, international relations, labour and procurement – and their commitment to economic reforms.
Aside from some rather glaring policy differences, the loose political alliances formed post-elections will face major tests in the coming years thanks to the next round of local elections, likely in 2026, and the 2027 African National Congress (ANC) party elections which will test support for President Cyril Ramaphosa. If it survives these tests, the GNU could pull the economy from its decade-long doom loop.
The negative doom loop derives from the complex interplay of declining foreign capital inflows and infrastructure failures that pushed the country’s real economic growth potential to below 1%. Under this lower growth scenario, government finances have come under significant pressure, further weighed by rising unemployment and the growing number of citizens dependent on the state for welfare grants.
At the dawn of the 2024 National Election, South Africa was battling to make headway in the context of larger budget deficits, a rising debt ratio, and sovereign debt rating agency downgrades, putting upward pressure on interest rates, and weakening the rand. Our doom loop culminates with the ‘crowding out’ of the private sector and lower foreign capital inflows due to insufficient potential returns on investment. Our hope is that economic reforms under the GNU will steer South Africa to a higher growth scenario; the alternative slide towards populism would be fiscally catastrophic.
Low net foreign capital inflows have been a binding constraint on economic growth since about 2014. Without this capital, South Africa cannot run a large enough current account deficit, forcing the country to save more and consume less. For an economist, the stark illustration of this savings ‘shift’ comes courtesy of the growth in government’s share of total outstanding bonds, rising from 60% in 2008-9 to over 80% today.
On its own, government absorbing a huge slice of available savings is not critical, provided it spends efficiently. Unfortunately, the ratio of expenditure on consumption versus infrastructure remains hopelessly misaligned. As a consequence, the balance sheet of the state is deteriorating, pushing the country further along an unsustainable fiscal path. This penchant for consumption rather than investment is a leading cause of rating agency downgrades and pressure on interest rates.
US, global inflation and interest rate view
Before commenting on local inflation and interest rates, we must consider these measures from a global and United States perspective. Why the US? Because the US dollar, as the world’s reserve currency, sets the tone for emerging market currencies and interest rates, including South Africa. And because the US Federal Reserve (Fed) still sets the world benchmark interest rate.
At our H1 Update, Santam Investments observed that despite positive signs of global disinflation, global central banks were waiting for the Fed to cut interest rates – and that situation persists to present day. Core inflation in the US and other developed markets remains sticky, with the Fed taking a cautious approach to rate cuts due to the firm US labour market. The main driver of the aforementioned disinflation has been a material improvement in global supply chain pressures; but there are a range of macro factors working against this.
As for starting to cut interest rates, the Fed closely monitors the US core Personal Consumption Expenditures (PCE) price index, or core PCE deflator. This deflator increased by 2.6% year-on-year in May 2024 and needs to get closer to 2% before the Fed is likely to cut. The general core CPI index sat at 3.4% year-on-year in June 2024, still a bit sticky, and also significantly above the desired 2% level.
For some positive news, the so-called super core inflation index is showing early signs of reducing wage pressures. Overall, however, the Fed will want a better balance in labour market supply and demand before cutting the Federal Reserve Rate. When the Fed finally starts cutting, we expect as much as a 1.5% move over the 12 months from September 2024. These cuts should precipitate easier global financial conditions; reduce pressure on emerging market currencies; and, hopefully, do the same for emerging market interest rates.
One cause for concern is that the deflationary effect from lower global goods prices is beginning to fade. There are three structural forces in play that could keep inflation sticky, and prevent central banks from cutting rates. These include geopolitical risk, which is reigniting global supply chain pressures; a marked decline in global growth expectations; and increased global protectionism. The result of geo-economic and geopolitical fragmentation is a lower growth higher inflation trade-off than previously.
Against this backdrop, developed market central banks may prefer high real interest rates for a bit longer. For Santam Investments, the key fact emerging from our detailed assessment of global inflation and interest rates is that we are shifting out of an era of very low real interest rates to one of higher real interest rates in the benchmark interest rate of the world, which feeds through to the rest of the world.
SA outlook
Returning to South Africa, the South African Reserve Bank (SARB) has done a sterling job in terms of maintaining its inflation target. But stable inflation coupled with rising bond yields has resulted in lower private sector borrowing and investment – real credit extension is negative at the moment, and has still not recovered since the 2008-9 Global Financial Crisis.
Sans private sector borrowing, the economy cannot grow to its full potential. Other growth constraints include infrastructure, with the SARB estimating that load shedding cost the country 1.5% in GDP growth last year. Headway has been made in addressing electricity supply concerns, but logistics and water infrastructure shortcomings pose a significant threat to growth too.
Sanlam Investments believes that 3% annual GDP growth is achievable if the economic reforms targeted under Operation Vulindlela are achieved. The project, which aims to improve the country’s infrastructure, is gathering momentum thanks to many of the necessary legislative reforms finally being put in place. Why does this reform-led GDP growth matter? Because if we continue on our current GDP trajectory, unemployment will top 40% by 2035; if we grow at 5% per annum, we can reduce unemployment from the mid-30s to around 20%.
Electricity has been the primary beneficiary of Operational Vulindlela to date, as evidenced in the SARB’s latest Financial Stability Review. It reveals a sharp upward trend in production capacity registered with NERSA, up by seven gigawatts since mid-2022, and around three gigawatts in installed rooftop solar. If government can emulate its electricity successes in transport and other critical areas of the economy, and implement its reform programme successfully, it may yet reignite foreign capital inflows.
For households and consumers, the focus remains on the currency, inflation and interest rates. Sanlam Investments believes the rand is trading more or less where it should be presently. Over the longer term, based on a purchasing price parity assessment, the rand does seem relatively cheap against the US dollar – perhaps held back by the Lady R incident, and the Financial Action Task Force (FATF) grey listing. As for interest rate cuts, although the SARB does not follow the Fed blindly, it still uses Fed rate decisions as one of the tools to guide domestic decisions.
The bank is, however, under pressure to cut rates, and its next MPC meeting will be hard-pressed to ignore the 12-month core inflation forecast of just 4.5%. Sanlam Investments expects the local Repo rate to fall from 8.25% presently to around 7.5% by the end of next year. And households should also start benefit from Operation Vulindlela successes as medium-term GDP growth trends towards the 2%-3% channel.
* Kamp, Chief Economist at Sanlam Investments.
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