Why South Africa’s economic outlook is looking bleak

Key Points
  • South African Reserve Bank Governor Lesetja Kganyago warns underlying demand in South Africa's economy is extremely weak.
  • The OECD says South African needs structural reforms to revive economic growth.
  • Meanwhile Fitch Ratings has criticised the government's new economic growth plan.

With the mounting problems facing South Africa, CNBC looks at the investment case for the country and whether its economic outlook is starting to look bleak.

Last Thursday, the South African Reserve Bank cut its benchmark interest rate for the first time in five years, dropping the rate by 25 basis points to 6.75 percent in an effort to avoid a recession.

"Domestic growth prospects have deteriorated further following the surprise GDP contraction in the first quarter of 2017. The economy has now recorded two successive quarters of negative growth, and although a near-term improvement is expected, the outlook remains challenging," said the central bank's Governor Lesetja Kganyago, according to a Reuters report.

The central bank revised down its growth forecasts for country; it estimates 2017 full year GDP growth of 0.5 percent, down from 1 percent. Kganyago warned that underlying demand in South Africa's economy is extremely weak, adding that it is unclear whether any drivers of economic growth will emerge in the absence of structural initiatives that would reduce uncertainty and boost confidence.

"Policy uncertainty, a recent example being in the mining sector, is likely to constrain investment," he added.

How can the government boost growth?

Meanwhile, the OECD reported on Monday that South African needs structural reforms to revive economic growth.

"Building stronger and more inclusive growth will require bold action from policymakers," OECD Secretary-General Angel Gurría said in a press release.

"Ensuring a better future for all South Africans will require increased access to higher education, a stronger and fairer labour market, deeper participation in regional markets and a regulatory framework that fosters entrepreneurship and allows small businesses to thrive

Will the government's new economic plan help?

The credit agency Fitch Ratings also weighed in on South Africa last Wednesday, criticizing the new economic growth plan unveiled by the government's minister of finance, Malusi Gigaba, earlier in July.

"The South African government's newly announced Inclusive Growth Action Plan is unlikely to significantly boost economic growth prospects," the agency said in a press release.

Waldo Swiegers | Bloomberg | Getty Images

"Most initiatives focus on state-owned enterprises governance, containing pressure on public finances, and boosting black economic empowerment and addressing inequality, which would only have an indirect impact on growth prospects."

Fitch Ratings reduced its outlook for South Africa's 2017 GDP growth to 0.6 percent from 1.2 percent in June. That was after cutting South Africa's credit rating to junk in April following President Jacob Zuma's surprise decision to fire the respected finance minister Pravin Gordhan.

If things are bad, why has South Africa's MSCI index outperformed rivals?

However, some investors are still choosing to invest in the region. Renaissance Capital's weekly report in equity fund flows found the South African MSCI index to be the top performer among global emerging markets. Assets under management grew by 5.9 percent in the week to July 19, compared to 2.9 percent from emerging markets as a whole. In fact, South African shares are doing very well; the iShares MSCI South Africa exchange traded fund has returned 9.74 percent over 1 year and closed on Friday with a net asset value of $60.70, not far off its 52-week high of $62.09. The broad recovery in commodities this year has boosted South African miners.

South African President Jacob Zuma
Stefanie Loos | Reuters

Despite this performance, risk analysis company Verisk Maplecroft warns the region is becoming less attractive as an investment destination and says the economic outlook for the next ten years is looking bleak, according to their core drivers report published earlier this month.

"Economic growth will remain sluggish, causing unemployment to rise and compounding problems associated with inequality. Meanwhile, pressure from unions to protect jobs will fuel strikes, reducing the productivity of key sectors," the Verisk Maplecroft report said.

What's the biggest risk for investors?

The key risk for investors, according to the report, is political instability. The ruling African National Congress will appoint its next leader in December this year. The choice of leader, who will likely take over as president once Zuma steps down, will determine whether the ANC continues to move towards the left or adopt a pro-business stance.

"Zuma's administration has progressively reduced investors' confidence in the government's ability to manage the country's structural problems and investment's contribution to GDP will fall."

Verisk Maplecroft warns the economy will continue to underperform and be stuck with a bad credit rating until a pro-business administration takes over.

What's happening in Zuma's South Africa?
What's happening in Zuma's South Africa?

Follow CNBC International on Twitter and Facebook.

Recommended Video
What's happening in Zuma's South Africa?
What's happening in Zuma's South Africa?