World Economy

Facing slowing growth and credit downgrades, South Africa's economy is stuck in the mire

Key Points
  • The World Bank has cut South Africa’s growth forecast for 2019 through to 2021, citing weak investor sentiment and lingering policy uncertainty.
  • Growth for 2019 is now projected at 0.8%, half a percentage point lower than April’s forecast and unchanged from 2018, according to the bank’s October Africa’s Pulse report.
  • The Absa Manufacturing PMI dipped to 41.6 in September from 25.7 in August, the second consecutive sharp decline in factory activity and South Africa’s largest in a decade.

South Africa looks increasingly likely to miss its projections for GDP (gross domestic product) growth and faces a potential "junk" credit rating from all three major ratings agencies, as domestic and international pressures weigh on Africa's second-largest economy.

The World Bank has cut South Africa's growth forecast for 2019 through to 2021, citing weak investor sentiment and lingering policy uncertainty. Growth for 2019 is now projected at 0.8%, half a percentage point lower than April's forecast and unchanged from 2018, according to the bank's October Africa's Pulse report.

Growth is expected to hit 1% in 2020, 0.7 percentage points lower than the previous forecast, and 1.3% in 2021, again half a percentage point lower than prior estimates.

Africa's second-largest economy sidestepped a second recession in two years in the second quarter, as GDP posted a 3.1% quarter-on-quarter expansion after contracting in the first quarter.

However, growth is expected to be almost flat in the third quarter, according to BankservAfrica's monthly economic transactions index.

President Cyril Ramaphosa during a pre-World Economic Forum breakfast briefing on January 18, 2018 in Johannesburg, South Africa. 
Moeletsi Mabe| Sunday Times | Gallo Images | Getty Images

In a recent note, UBS Chief Emerging EMEA Economist Gyorgy Kovacs said early indications point to zero GDP growth in the third quarter, though suggested this was lower than analysts' models and a lot could change once full figures emerge for August and September.

The Absa Manufacturing PMI dipped to 41.6 in September from 25.7 in August, the second consecutive sharp decline in factory activity and South Africa's largest in a decade.

"As regards to sectors, July high-frequency data points to weakness in mining, mainly in PGMs (platinum group metals), manufacturing (mainly in petroleum and chemical products and basic iron & steel), utilities and vehicles sales," Kovacs added.

The Reserve Bank of South Africa's latest quarterly bulletin showed the economy entering its 70th month of a downward cycle, its longest since 1945.

Losing power

Recent electricity production figures also showed a significant downturn, highlighting a long-running obstacle underpinning South Africa's economic headwinds.

"The electricity sector has been a problem for years, but particularly in the first quarter, there were really serious power cuts, and it looks like the state run electricity generator is still failing to boost output," said John Ashbourne, senior emerging markets economist at Capital Economics.

"That was still a problem in the third quarter and looks like it will continue to remain one."

South African state power utility Eskom Holdings, which splashed the cash to approve over $13.2 billion worth of projects around the country when the economy was booming in 2007, has now become a debt-stricken headache for Pretoria.

A freight train leaves an Eskom power plant in Hendrina, South Africa, on February 22, 2018, after having discharged its load of coal.
Marco Longari | AFP | Getty Images

Eskom supplies 95% of the nation's power and has been without a permanent CEO since July, while failing to generate enough revenue to cover costs. The company has been allocated bailouts totaling 128 billion rand ($8.46 billion) over three years.

Finance Minister Tito Mboweni is due to deliver his mid-term budget policy statement on October 30, and will need to reconcile substantial bailout packages for Eskom with slow growth and falling tax revenue.

"There have also been some pretty widespread strikes in mining and a few other sectors, so there isn't one massive factor - there are a lot of different things going wrong all at once," Ashbourne added.

"It looks like the bounce back that we saw in the second quarter wasn't sustained, and that growth was very weak in the third quarter and it is even possible that the economy shrank again."

Heading to 'junk'

Two days after Finance Minister Mboweni unveils his budget policy, Moody's makes a call on South Africa's credit rating.

Both S&P Global Ratings and Fitch already have South African debt at sub-investment grade, colloquially labelled "junk," with Moody's the only major ratings agency yet to downgrade, with its rating currently sitting at "stable."

Ashbourne told CNBC that the two big concerns for Moody's would be slow growth, which has been causing debt to rise, and the power sector.

"There is a fear that if the situation at Eskom continues to escalate, and the amount of money that it needs to call on for aid continue to rise, then at some point South Africa will lose its last rating," he said.

However, Capital Economics has taken the view that markets have largely priced in a downgrade, meaning that any short-term market move will most likely not cause sustained economic impact.

Corrective measures

Without corrective measures, UBS analysts anticipate that South Africa's budget deficit could reach -5.4 to -5.6% of GDP, an overshoot of between 0.9 and 1.1 percentage points, based on fiscal pressures building on both the revenue and spending side of the budget.

"Tax revenues are clearly underperforming the targets, mainly corporate and personal income taxes and domestic VAT receipts," Kovacs said.

"We see scope for a 0.4-0.6% of GDP lower tax collection than planned in the 2019/20 Budget. Time proportionate government spending is running at the fastest rate in recent years – which in part reflects advance payments to Eskom."

Ashbourne said further monetary policy easing may offer some relief. South Africa cut its main interest rate in July, but expectations for further loosening this year are low.

"It seems like the central bank's focus on inflation has precluded it from taking any action, which is unfortunate for the rest of the economy," he added.

VIDEO2:1502:15
Eskom bailout to be headline of South Africa budget

The "persisting policy uncertainty" cited by the World Bank included "whether a solution could be found for Eskom, fiscal slippages would be averted, and structural reforms would be undertaken."

A key obstacle to reform that South African President Cyril Ramaphosa has faced deep internal divisions within his governing ANC (African National Congress) party.

Mboweni's recent growth plan for the South African economy proposed increased private sector participation in the energy, telecoms and transportation sectors, entering previously uncharted policy waters and surprisingly gaining the support of the ANC's National Executive Committee.

However, promises of reforms in the past have shown little sign of progress, leaving market participants waiting for more concrete indicators of implementation.

"Eskom is the one that people worry about the most because of the power cuts which everyone can see, but there are also really big problems with the port operator, the railway company, a lot of these firms which honestly would be much better off just being broken up or sold off, or at least part of them being sold off," Ashbourne said.

He added that while Ramaphosa had shown signs of embracing a big shift in policy, he had so far been unable to achieve consensus within his own party and unwilling to "railroad" internal opponents.