South Africa Set to Remain a Regional Underperformer

8/12/2019 South Africa Set to Remain a Regional Underperformer

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Africa Economics Focus 1

AFRICA

ECONOMICS FOCUS6th

Sep.

2012

Recent events in South Africas mining sector, while tragic, are also symptomatic of widereconomic problems that are likely to mean the country falls short of achieving its significant

growth potential over the next decade. We believe that South Africa will continue to muddle along

at growth rates of around 3%, despite having the capacity to achieve around 5% with the aid of

supply-side reforms. Accordingly, it will continue to be outperformed by other emerging markets,

particularly those in sub-Saharan Africa, but also those in Asia.

In the near-term, weakening aggregate demand due to high unemployment and a deterioratingexternal environment will weigh on the outlook.We expect growth to slow from 3.1% in 2011 to

around 2% in 2012, with a modest pick-up to 2.5% in 2013.

In the medium-term, a raft of supply-side measures is needed to raise South Africas productivecapacity. In particular, steps need to be taken to increase investment levels. Whats more,

investment needs to be funded by sources other than volatile, short-term portfolio or banking inflows.

These helped to drive growth in the boom years of 2005 to 2008, but their subsequent reversal

caused South Africa to slip into recession in 2009. There are a number of options available to

policymakers in order to boost investment in a sustainable way. These include improving the

efficiency and transparency of state institutions and raising domestic savings.

Additionally, there is a need for wide-scale reform of the dysfunctional labour market, theconsequences of which have been demonstrated tragically during the ongoing labour unrest in themining sector. In particular, the geographic mismatch between areas of economic activity and dense

populations, skills-shortages and trade union power all require addressing.

Should at least some progress be made in these areas, then it is feasible that South Africa can liftaverage growth rates to around 5% per annum. Whats more, this could be achieved without the

rise in rapid rise in commodity prices and foreign financing that drove growth from 2005 to 2008.

But we are sceptical as to whether this will happen. In particular, the ruling ANCs close ties toCOSATU, the powerful federation of labour unions, will make wide-scale reform very difficult,

especially in the context of upcoming elections in 2014. We are, however, more positive on the

prospects of the authorities raising investment levels. So, all in all, we think that South Africa willcontinue to muddle along in the next decade, at a steady but hardly spectacular pace.

Shilan Shah

Tel: +44 (0)20 7808 4062

South Africa set to remain a regional underperformer

North America Europe Asia2 Bloor Street West, Suite 1740 150 Buckingham Palace Road #26-03Toronto, ON London 16 Collyer QuayM4W 3E2 SW1W 9TR Singapore 049318Canada United Kingdom

Tel: +1 416 413 0428 Tel: +44 (0)20 7823 5000 Tel: +65 6595 5190

Managing Director Roger Bootle ([email protected])Chief Emerging Markets Economist Neil Shearing ([email protected])Africa Economist Shilan Shah ([email protected])


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Africa Economics Focus2

Over the past 30 years, the global economy has

been reshaped by the rise of the emerging markets,

most notably China, Central and Eastern Europe,

India and Latin America. However, Sub-Saharan

African (SSA) countries have remained on the

periphery of these developments.

But, with companies increasingly looking further

afield for investment opportunities, and given

Africas abundance of resources, both natural andhuman, many have suggested this will be Africas

decade. The extent to which this turns out to be

true will depend largely on the performance of

the continents economic and political

powerhouse, South Africa. In this Focus, the first in

Capital Economics Africa service, we examine the

medium-term prospects for South Africa.

Setting the scene: why focus on South Africa?

There are a number of reasons that we have

launched our Africa service with a Focuson SouthAfrica. Firstly, it is comfortably the largest

economy in the region, with an estimated GDP in

2011 market exchange rates of over US$400bn.

(See Chart 1.)

CHART 1:GDP(2011,US$BN,MARKET EXCH.RATES)

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S.Africa Nigeria Angola Ghana Kenya Ethiopia Cted'Ivoire

Source IMF

This represents around 30% of the entire SSA

economy, and 0.7% of world GDP. The economy

is roughly the same size as Argentinas or

Thailands. Secondly, population size is another

important factor. At 51m, South Africa has one of

the largest in SSA. It is also the 25thmost populous

country in the world similar in size to Spain and

South Korea. (See Chart 2.)

CHART 2:POPULATION (2011,MILLIONS)

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Brazil Nigeria Turkey S.Africa S.Korea Spain Kenya

Source IMF

Overall, this leaves South Africa with GDP per

capita of roughly US$8,000 at market exchange

rates. (See Chart 3.) Admittedly, this figure is lower

than some of the larger emerging markets, such as

Brazil and Russia. However, it far exceeds the likes

of China and India, and is comfortably ahead ofany other SSA country with a population over two

million.

CHART 3:GDPPER CAPITA (2011,US$000,

MARKET EXCH.RATES)

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Russia Brazil S.Africa Colombia China Angola India

Source IMF

Furthermore, South Africa is the leading

destination for foreign direct and portfolio

investment into SSA. Financial markets are deep

and easily accessible. In terms of market

capitalisation, the Johannesburg All-Share Index is

among the 20 largest benchmark equity indices in

the world. Among major emerging economies, it is

second only to Brazils BOVESPA. (See Chart 4.)

South Africa set to remain a regional underperformer


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CHART 4:EQUITY MARKET CAPITALISATION

(SEP.2012,US$BN)

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Brazil S. Africa Russia India Indo. Turkey Poland

Source Bloomberg

Beyond its economic importance, South Africa is a

major geopolitical player. It is Africas only

member of the G-20, making it the continents

main representative on a global level. South Africa

is also a regional leader, taking up prominent roles

in numerous organisations such as the African

Union and Southern African Customs Union.

Therefore, this Focus aims to address two key

questions. First, what is the countrys medium-termoutlook and second, what do policymakers have to

do to ensure it achieve its potential?

A look backwardsBefore we can answer these questions, it is

important first to take a look backwards and assess

how the country has performed in the recent past.

For a detailed discussion of the key drivers of

South African growth, please refer to Annex 1 at

the end of this Focus.

The key point, however, is that South Africas

economic performance since the end of apartheid

in 1994 has been disappointing. This

underperformance is best illustrated by comparing

growth in GDP per capita across a range of

countries relative to their starting points in terms of

income levels. The logic here is that countries with

lower GDP per capita have the greatest scope for

catch-up growth.

Chart 5 plots average growth in GDP per capita for

a number of countries between 1991 and 2010 (on

the y-axis) against GDP per capita in 1991 (on the

x-axis). We have marked on a line of best fit,

which does suggest that poor countries tend to

grow faster than rich countries. Those economieswhich lie above the line have, broadly speaking,

exceeded their potential while those below it have

disappointed. South Africa lies beneath the line.

CHART 5:GDPPER CAPITA GROWTH (19912010)

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9

0 10 20 30 40 50 60 70 80 90 100

GDPpercapitagrowth(%

y/y)

GDP per capita (1991, % of US)

South Africa

China

Poland

France

Sources A. Maddison, Capital Economics


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To illustrate this further, we can look at examplesof other countries that started at the same income

level as South Africa in 1991. For instance, Poland

started at comparable level. However, per capita

growth has since risen by more than double the

rate that South Africa has sustained. On the other

side of the same coin, Frances GDP per capita

growth has matched that of South Africa since

1991. But France started from a much higher base,

and so, theoretically, South Africa would have

been expected to achieve a faster rate of growth.

What is holding South Africa back?

There are a number of economic challenges that

need tackling in order to improve the outlook. In

the near-term, global headwinds, largely

emanating from the ongoing euro-zone debt crisis,

leads us to expect moderate growth over the next

two years. We forecast growth to slow from 3.1%

in 2011 to around 2% in 2012, with a modest

pick-up to 2.5% in 2013. Looking ahead even

further, the attention of policymakers needs to turn

to remedying both supply and demand-sideconstraints in order to boost growth rates.

A key supply-side issue that policymakers will

need to address is raising the level of investment to

improve South Africas economic capacity.

Worryingly, investment has been falling as a share

of GDP over the past decade, averaging less than

20%. This is too low in comparison to other

emerging markets, especially when viewed against

the emerging Asian economies, where high

investment rates are supporting rapid economicgrowth. (See Chart 6.)

CHART 6:INVESTMENT (2011,%OF GDP)

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China India Vietnam Mexico Turkey Nigeria Brazil S.Africa

Average = 25% of GDP

Sources IMF, Capital Economics

A lack of investment is harmful for growth and canmanifest itself in a number of ways. For South

Africa, the starkest example is in its infrastructure

problems. In particular, frequent disruptions to the

electricity supply have caused problems for the

economy since 2007. This is mainly because of a

failure on the part of the authorities to invest in

new generating capacity, and a continued

reluctance to liberalise the sector to improve

competition. (See Chart 7.)

CHART 7:ELECTRICITY PRODUCTION (%Y/Y)

2005 2007 2009 2011-10

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10

Sources Thomson Datastream, Capital Economics

The problem is self-perpetuating. A lack of

investment hampers output in other energy-

intensive sectors such as mining, which will

dampen investor sentiment even further.According

to the World Banks 2012 Doing Business Report,

the lack of quality access to electricity is one of the

major constraints facing local and foreign

companies.

Another perennial issue is institutional weakness,

which has negatively affected both foreign and

domestic investment. In fact, the most frequently

cited investment constraint is a lack of protection

against crime. South Africa ranks 137 thout of 142

countries in the business costs of violence and

crime sub-section in the World Economic Forums

2012 Global Competitiveness Report, making it the

lowest ranked country in SSA and the lowest

among other emerging market peers. (See Chart 8.)


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CHART 8:BUSINESS COST OF CRIME AND VIOLENCE SCORE

(2011,HIGHER SCORE =LOWER COST)

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Poland China India Chile Russia Nigeria Mexico S.Africa

Source World Economic Forum

More generally, institutional corruption also acts as

a deterrent for potential investment. South Africa

ranks 64th out of 182 countries in Transparency

Internationals 2011 Corruption Perceptions Index.

(See Chart 9.) Admittedly, this makes it an

outperformer in comparison to other SSA

countries, coming in 7th place out of 48 countries

in the region. Nonetheless, this still demonstrates

that there is considerable scope for improvement.

CHART 9:CORRUPTION PERCEPTIONS SCORE

(2011,HIGHER SCORE =LOWER CORRUPTION PERCEPTIONS)

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Chile Botswana Turkey S.Africa China India Nigeria

Source Transparency International

Low domestic savings are the keyWhile infrastructure constraints and relatively

weak institutions both help to explain South

Africas low investment level, it is also

symptomatic of a wider problem the countrys

extremely low domestic savings rate. In China,

domestic savings are equivalent to around 55% of

GDP and in India, the domestic savings rate is just

under 35% of GDP. But in South Africa, domesticsavings are equivalent to around 17% of GDP. (See

Chart 10.) As a result, the pool of funds from whichinvestment can be funded domestically is smaller.

CHART 10:SAVINGS &INVESTMENT (%OF GDP)

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2003 2004 2005 2006 2007 2008 2009 2010 2011

Investment

Savings

Source IMF

Of course, a low savings rate does not necessarily

imply a low investment rate. South Africa, as it did

in 2005 to 2008, could borrow from abroad. But

things are not so simple. Relying on foreign capital

flows to finance investment increases an

economys external vulnerabilities, and makes it

susceptible to a sudden cut in funds in the case of

a deteriorating global environment.

Whats more, the necessary increase in the

investment rate is simply too large to be financed

through foreign capital inflows alone. South Africa

ran a current account deficit of around 3% of GDP

in 2011. But given that investment needs to rise by

around 6% of GDP to keep up with other emerging

markets, this would require running a current

account deficit of almost 10% of GDP well

above the levels normally regarded as safe by the

likes of the IMF (up to 5% of GDP). The bottom

line is, therefore, that South Africas investment

rate can only be increased in a sustainable

manner through an increase in domestic savings.

But what is to blame for the low savings rate? A

starting point here is the government budget. Since

2000, South Africa has run a public sector deficit

averaging 1.9% of GDP per annum. In net terms,

the government has been a dissaver. (See Chart

11.) A quick fix to the low savings problem would,

therefore, be to tighten fiscal policy.


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CHART 11:BUDGET BALANCE (FISCAL YEARS,%OF GDP)

00/01 02/03 04/05 06/07 08/09 10/11-7

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Average

Surplus

Deficit


Indeed, the Finance Ministry has committed to

doing this, as it aims to cut the deficit to around

3% of GDP by 2015.

However, this could create problems in itself.

Fiscal tightening has the effect of reducing

aggregate demand at a time where growth is

expected to remain slow. And of course, aggregate

demand needs to be supported to ensure that any

increase to supply via higher investment levels is

not futile in terms of its effect on growth.

But we think that some of the decline in aggregate

demand can be counteracted by simultaneously

loosening monetary policy. Indeed, the South

Africa Reserve Bank cut its benchmark repo rate by

50bps to the historically low level of 5.00% in July

2012. Looking ahead, with core inflation pressures

likely to remain subdued, we expect interest rates

to be cut by another 100bps (to a new record low

of 4.00%) over the next 18 months.

Private sector savings must riseBut while there is scope for South Africas

government to save more, this alone cannot

explain why the overall level of domestic savings is

much lower than in some parts of Asia. In India,

for example, the general government budget deficit

has averaged just over 7% of GDP over the past

five years far higher than in South Africa. Yet

domestic savings are much higher in India.

Clearly, other private sector-related factors are at

work. One of these is the pensions system. The

problems that South Africa suffers are quitedifferent from those of other major emerging

markets such as Turkey or Brazil. In these

countries, state pensions are very generous, whichdiscourages private savings from a younger age.

But in South Africas case, the major failure is in

the governments regulation of the private

pensions system. In particular, there is currently a

dearth of competition, with private pensions only

being provided by a small number of companies.

This means that the costs to consumers of entering

a private pension scheme are often prohibitively

high. The good news for South Africa is that, in

theory at least, making the necessary reforms to thepensions system will not create the same level of

political opposition as is likely to be the case in

Turkey or Brazil.

Finally, despite having one of the most

sophisticated financial systems in the emerging

world, there appears to be a lack of access to

financial services among small businesses and low-

income groups. According to a World Bank study,

only around 15% of the low-income group

participate in the financial system. Most rely on

informal, community-based schemes, known as

stokvels to fill this void. But these lack adequate

regulation, and are vulnerable to fraud. The net

result is that there is often simply no outlet for

people to save.

In Table 1, we highlight some of the major policies

and measures to look out for in the coming years,

which can help determine how well policymakers

are faring in their efforts to raise investment levels.

The list is not exhaustive, but should be a useful

guide as to whether progress is being made.

On balance, we believe that the authorities will

make at some least progress in raising investment

levels. There is wide acceptance of a dire need to

raise domestic savings levels. We think that at least

some improvement to the pensions system and

access to financial services will be made in the

coming years. Furthermore, the government

appears committed to intermittently raising energy

tariff prices through to 2014, despite the rises

proving to be politically unpopular in 2011. Thisshould ultimately plug a funding gap and pave the

way for future investment.


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But, on a less positive note, investor sentiment is

likely to wane in light of a number of recent

events, particularly in relation to the mining

sector. The first is the ruling African National

Congress (ANC) partys most recent five-yearly

policy conference, held in June 2012. Admittedly,

during the conference, President Zuma ruled out

nationalisation of the mining sector. But the

nationalisation debate has been replaced by talk of

greater state involvement through higher taxes. We

think that if all of the measures discussed were tobe implemented, it would make the mining tax

regime one of the least competitive in SSA.

The second is the high levels of labour unrest

throughout the mining sector. This has hit the

headlines in recent weeks following the tragic

deaths of 34 miners at the Marikana platinum mine

in August 2012. But in reality, unrest has been

growing for the best part of two years. Given the

complex relationship between labour unions, state

security and the government in South Africa

(which is explored in the next section), there

appears to be no quick-fix solution to the unrest.

As a result, further outbreaks of violence cannot beruled out. This is likely to add to investor wariness

over the next few years.

TABLE 1:RAISING INVESTMENT LEVELSProblem What to look for

Beneficial outcome

likely?

Infrastructure deficit Energy tariff rises (2012 to 2014)Tariff rises could quicken inflation in the short-term, but could also help to plugEskoms funding gap in the medium-term. Tariff hikes can be regarded as a positivesignal for potential investors, as it suggests that the government is willing toimplement politically unpopular measures in order to reduce the energy deficit.

Yes

Institutional weakness Protection of State Information Bill (2013)The much maligned bill is up for discussion in the National Council of Provinces in2013, having been passed by the national assembly in November 2011. It has beencondemned by numerous democracy advocacy groups for repressing the freedomof the local press, as its ambiguous wording means it can be manipulated to blockreporting on public sector corruption. Should the bill be formalised into law, as we

believe it will be, it will further dampen investor sentiment towards the country.

Expansion of Violence Prevention Through Upgrade (VPUU) Scheme (2013 2014)An expansion of the scheme can be regarded as positive news by investors, giventhe impact it has had in dramatically reducing crime in the Cape Town township ofKhayetlisha. However this is not to say that its success will immediately bereplicated elsewhere. If a rolling out of VPUU does occur, it will be in FY2013/14at the earliest.

No

Too early to say

Low Domestic Savings Pensions Reform (ongoing)The government has acknowledged the need to raise domestic savings and isaiming to reform the pension system to achieve this. Measures that have beendiscussed include a compulsory preservation scheme, which would effectivelyprevent workers from withdrawing retirement savings until they actually retire.

However, this may not be politically viable, as a similar proposal in the 1980s ledto mass protests. A more feasible measure is the removal of restrictions on wherepension funds can invest, in order to make the industry more competitive. Thegovernment is also aiming to implement regulation which would make the costs toconsumers more transparent.

Improving access to financial services (ongoing)There are signs that policymakers are making strides in this area. Efforts to formalisestokvels have had fairly positive results the countrys four largest banks all havesavings products designed to cater for the community-based schemes. Furtherformalisation of the practice and the opening of more bank branches outside of themajor cities will improve access to financial services among low-income groups.

Too early to say

Yes

Source Capital Economics


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Labour market reform remains criticalThe second part of the challenge for policymakers

is to reduce unemployment. This will involve

implementing wide-scale reform to the countrys

dysfunctional labour market.The starting point for

any analysis of South Africas labour market

problems is the non-accelerating inflation rate of

unemployment (NAIRU), which, as the name

suggests, is the unemployment rate at which

inflation remains stable.

Estimating a countrys NAIRU is extremely difficultand it is not an exact science. But on balance, we

think that South Africas NAIRU is between 20-

25%. This is extremely high, particularly in

comparison to other emerging market economies

at a similar stage of development, such as Mexico

and Turkey (See Chart 12.)

CHART 12:UNEMPLOYMENT RATE (%)

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1990 1994 1998 2002 2006 2010

S.Africa

Turkey

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Source Thomson Datastream

The challenge is, therefore, to lower the NAIRU in

order to increase South Africas supply capacity.

But why is unemployment so high in the first

place?Much of the problem is a throwback to the

apartheid era. There are logistical constraints, as

areas of booming economic activity tend not to be

in the same vicinity as areas of high population

density. Furthermore, the skills deficit, particularly

among the local black population, desperately

requires addressing.

Another issue is that labour relations in South

Africa are far more heavily skewed in favour of

unions than in other emerging market economies.

The reason for this is that labour relations are

determined by the historical ties between the ANC

and the Congress of South African Trade Unions

(COSATU), the powerful labour federation. TheANC draws much of its electoral base from

COSATUs two-million strong members. Protracted

wage disputes and work stoppages organised by

COSATU over the past several years give a stark

demonstration of the bodys political clout. This

has taken a heavy economic toll, particularly in the

manufacturing and mining sectors.

In the mining sector, some critics argue that

COSATUs process of collective bargaining has put

greater emphasis on wage growth for white-collarworkers in the sector than it has done in ensuring

adequate health and safety standards and

remuneration for blue-collar employees. Labour

costs have therefore comfortably outstripped

productivity gains over the past few years,

weighing on the sectors profitability. This is turn

has led to marked decline in mining-sector

employment.In fact, this was a major factor in the

Marikana tragedy, as violence initially flared up

between affiliates of COSATU and a rival union,

which had been set up by disillusioned formermembers.

The process of higher wage bargaining over higher

employment is also evident in the manufacturing

sector, where wages have increased by two-thirds

more than productivity since 2000. (See Chart 13.)

CHART 13:MANUFACTURING REAL WAGES &PRODUCTIVITY

(2000=100)

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2000 2003 2006 2009 2012

Manufacturing Wages

Manufacturing Productivity

Source Thomson Datastream, Capital Economics

The ANC is well aware of the unemployment

problem. In November 2010 it launched the New

Growth Path, a large initiative aimed at creating

five million new jobs and reducing headline


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unemployment by 10%-pts by 2020. However, the

crucial point is that any fundamental reforms to the

labour market will likely come as a result of

change in the dynamic of the relationship betweenthe ANC and COSATU. Table 2 highlights some of

the key policy measures needed to reform labour

markets. As with Table 1, the list is by no means

exhaustive. But it can help to give an indication of

how much progress is being made in this area.

On balance, we are sceptical about the likelihood

of any large-scale labour market reform being

implemented over the next few years. In fact, very

little progress will be made until 2014 at the

earliest. This is when presidential and

parliamentary elections are due to be held, so it is

highly unlikely that the ANC will risk displeasing a

key part of its electoral base.

Beyond 2014, we still doubt that there will be a

fundamental shift in dynamics. Given the ANCsstranglehold over politics, and the removal of

populist youth leader Julius Malema from the

party, it seems likely that incumbent President

Jacob Zuma will stay win the 2014 elections.

Zuma has particularly strong ideological ties to

COSATU, stemming from both playing prominent

roles in the anti-apartheid movement. Furthermore,

COSATUs public support for Zuma was a key

reason for his victory at the ANCs previous

leadership election, at Polokwane in 2007. Wetherefore doubt that he will take the necessary

steps to break the break away from the federation.

TABLE 2:LABOUR MARKET REFORM

Problem What to look for

Beneficial outcomelikely?

Regional Mismatch E-tolling and improvements to transport links (2012 - 2014)From a logistical perspective the government is aiming to solve the geographicmismatch problem by improving transport links between townships and majorcities. However, the programmes are being funded by tolls that are being chargedon existing highways, which may dissuade travel and actually increase themismatch in the interim. The long-term success therefore depends on the scale ofimprovements and the total incurred via the e-tolling.

Too early to say

Skills deficit Schooling 2025 (2013 to 2025)Schooling 2025 is a long-term strategy set out by the ANC during the conference inJune 2012. The strategy includes, among numerous other things, a wider scope offree education, universal access to computers for everyone above grade 3, andbetter provision and distribution of textbooks via a liberalised publishing sector.

Theoretically, the measures will help to reduce the skill deficit, but with the financeministry committed to fiscal tightening, considerable changes to revenue collectionare required in order to fund the programme.

Teacher incentives and accountability (ongoing)One way of reducing the skills deficit among the black population would be toincrease the incentives and accountability of teachers with regard to secondaryschool test scores, which are among the lowest in the world. But progress in thisarea has been disappointingly slow. Pay incentives appear unfeasible at themoment due to the finance ministrys move towards fiscal tightening.

Too early to say

No

Trade union power ANC national conference (December 2012)President Zuma is clear favourite to win the party leadership elections, whichwould pave the way for him to run for another term of presidency in 2014. Other

ministerial posts are also being contested. Should these be won by COSATUsupporters, the ANC-COSATU alliance is likely to remain firmly intact.

Amendment of Labour Relations Bill (early 2013)The bills, which include a ban on broking and laws to regulate contract work, havethe backing of COSATU. If passed, as we expect to be the case, they would addfurther rigidity to the labour market, and exacerbate unemployment concerns.

No

No



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The growth outlookBringing all of this together, we can map out a

trajectory for South African growth. (See Table 3

and Chart 14.) There are three scenarios that

emerge. The first is a no change scenario, whereby

labour market rigidities and low investment

constrain growth capacity to around 3%. The

second, optimistic scenario is where

considerable progress is made in both these areas.

In this scenario, if investment levels rise by 5-6%

of GDP, and the unemployment rate is steadilyreduced by 10%-pts over the next decade, annual

real GDP growth could reach about 5%.

TABLE 3:POTENTIAL GDPGROWTH (%Y/Y,NEXT 10YRS)

NoChangeScenario

OptimisticScenario

CoreScenario

Real GDP Growth (y/y) 3.0% 5.0% 3.5%

Of which contributions by:

Labour 0.5% 2.0% 1.0%Capital accumulation 1.0% 1.0% 1.0%Total Factor Productivity 1.5% 2.0% 1.5%


CHART 14:REAL GDPFORECAST (2004=100)

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2004 2008 2012 2016 2020

Optimistic scenario

Core scenario

No change scenario


But we are sceptical as to whether such wide-

ranging reforms needed to achieve this can be fully

implemented in the coming years.

This leads to the third, core scenario, where the

labour market remains extremely rigid due to the

ANCs reliance on COSATU support, but small

improvements are made in raising investment

levels. In this scenario, growth is likely to averagearound 3.5% per year.

This represents an average annual increase of 2%in GDP per capita terms. This rate of growth is

likely to outperform most developed markets. But,

in the context of South Africas current level of

income per capita, it will remain disappointing.

Summary

To sum up then, a combination of domestic

structural problems and a weakening external

environment leads us to expect South African

growth to slow from 3.1% in2011 to just over 2%

in 2012, with a modest pick-up to 2.5% in 2013.Looking further ahead, there is much for the

government to get its teeth into to improve the

growth outlook. Considerable levels of supply-side

reforms are needed to raise capacity, with

particular focus on raising investment level.

Additionally, wide-scale labour market reform is

required.

Should at least some progress be made in these

areas, then it is feasible that South Africa could

boost average growth rates to 5% per annumexperienced in 2005 to 2008. This could occur

without a heavy reliance on commodity price rises

and foreign financing.

However, given the ANCs close ties to labour

unions, we are sceptical that wide-scale reforms

will be implemented.A more likely scenario is that

some, slow structural progress will be made in the

coming years. If this is the case, South Africas

economy will muddle along at rates of around 3%

per annum. This is by no means disastrous. Butequally, it suggests that South Africa will continue

on the same unspectacular growth path that is has

done since 1994. Most likely, it will continue to be

outperformed by other emerging economies,

particularly the rest of sub-Saharan Africa and Asia.


11/13


Annex 1: Post-apartheid economic performance

South Africas economic performance since the

end of apartheid can be split into three distinct

periods; 1994 to 2004, 2005 to 2008, and 2009 to

2011. In this annex we study each of these periods

in turn.

1994 2004: steady but unspectacular

Trade and financial sanctions and protracted

political deadlock helped turn the years 1984

1993 into poorest decade of growth performance

since the Second World War. In this context, then,

average annual growth of 3% during the first ten

years after the end of apartheid in 1994 can be

considered a relative disappointment. This

becomes even more apparent when compared to

the per capita growth rates seen elsewhere in the

emerging world.

During this decade, the mining sector witnessed

diverse performance. A number of sub-sectors such

as platinum group metals posted solid

performances. But the gradual decline in goldproduction was a major drag on growth, as

profitability fell due the maturity of mines and

more costly health and safety regulations. (See

Chart 15.)

CHART 15:GDPBY INDUSTRY (%-PT CONTRIBUTION)

1994 1996 1998 2000 2002 2004 2006 2008 2010-3

-2

-1

0

12

3

4

5

6

7

-3

-2

-1

0

12

3

4

5

6

7Manufacturing Mining Services


Instead, the major driver of growth was the

services sector, as the supply of increasingly

sophisticated financial services was finally able to

keep pace with demand, as South Africa reaped

the benefits of being re-integrated into the globalfinancial system.

2005 2008: a turnaround in performanceIn marked contrast, between 2005 and 2008

average annual growth rose to 5%. Some

commentators have attributed this to the boom in

global commodity prices during these years.

Indeed, it is true that South Africa is a net exporter

of commodities. Furthermore, all three of South

Africas major commodities - platinum, gold and

iron ore - witnessed rapid price rises during this

period. (See Table 4.)

TABLE 4:COMMODITY PRICES (YEARLY AVERAGE)

2005 2006 2007 2008

Gold (US$/oz) 449.0 614.1 705.3 874.3

Platinum(US$/oz)

901.5 1151.1 1320.7 1615.4

Iron Ore(US$/mt)

28.8 34.3 37.6 63.2

Source Bloomberg

However, a frequently misunderstood point is that

a change in commodity prices a rise in commodity

prices is a price effect rather than a real effect.

Therefore, it has no direct impact on real GDP

whatsoever.

Of course, that is not to say that South Africa hasnt

benefitted from higher commodity prices. After all,

it earned more from exports in these years than

had previously been the case. In economic jargon,

its terms of trade improved.

Between 2005 and 2008, export revenues from the

three largest commodity groups increased by acumulative US$50bn. Of this, we have calculated

that US$17bn can be attributed to price increases.

The implication of this extra income is that South

Africa was able to spend more.

However, we must also account for the fact that

South Africa is a net oil importer. From 2005 to

2008, oil prices also rose dramatically. Repeating

our calculations, we estimate that South Africa

imported a cumulative US$9bn worth of oil due to

price rises. On balance then, we estimate that, as

a result of the 2005 to 2008 commodities boom,

South African net income increased by a

cumulative US$8bn.


12/13


Who benefits?The boost to welfare from higher commodity prices

has spread into the wider economy through three

channels. Firstly, the income of mining companies

will have increased, meaning that wages paid to

workers and dividends paid to shareholders have

risen. Secondly, extra income will have passed into

the wider economy by being spent on other orders,

such as construction or machinery to more general

service providers. Thirdly, the government has

benefitted, as it imposes a 28% mining tax rate.

Given that the government mostly spends

revenues, we can assume that this has translated

into higher demand. However, we must also

account for the fact that mining firms are likely to

repatriate a large share of their profits, and also at

least some of the boost in demand would seep into

imports. In fact, South Africa has a marginal

propensity to import of about 30%. Taking these

various factors into account, we calculate that,

between 2005 and 2008, the commodities boom

added roughly US$4bn to domestic demand.

Boost to domestic demand

The impact of this boost to demand on the real

economy is dependent on South Africas supply

constraints. If the economy was operating at full

capacity, firms would be unable to increase

production to response to extra demand. Instead,

increased demand would simply be inflationary.

But if there was spare capacity, then the boost to

demand could elicit an increase in domestic

production and thus increase real GDP.

Measuring the extent of spare capacity is difficult,

but on balance it does seem as though the post-

apartheid decade of tepid growth, relatively low

inflation and rising unemployment left a significant

amount of spare capacity in the economy. As a

result, there is no reason to believe that capacity

constraints would have prevented output from

increasing as a result of increased demand.

Using the GDP deflator, we have calculated that

the real value of the increase in domestic demand

between 2005 and 2008 is around US$3bn. At the

same time, real GDP increased by a cumulative

US$22bn. This implies that just under one-seventhof real GDP growth from 2005-2008 can be

attributed to the impact of higher commodity

prices.

In other words, had commodity prices remained

stable between 2005 and 2008, South African real

GDP growth would have averaged something like

4.2%, instead of the 5% it actually managed.

This is a substantial contribution, but it is by no

means overwhelming. Clearly, other factors were

at work. After all, growth of 4.2% would still have

been higher than 3%. A look at contributions to

GDP growth by expenditure during this period

reveals that investment played a considerably more

prominent role than had previously been the case.

Between 1994 and 2004, investment made an

average annual contribution of under 1%-pt. But

from 2005 to 2008, it accounted for over 2%-pts

per annum. (See Chart 16.)

CHART 16:REAL GDP&INVESTMENT

1997 1999 2001 2003 2005 2007-1

0

1

2

3

4

5

6

-1

0

1

2

3

4

5

6Real GDP (% y/y)Investment (% -pt contribution)


Alongside this, the current account deficit widenedmarkedly. After years of remaining roughly in

balance, the deficit ballooned to 7% of GDP by

2008. This suggests that much of the increased

investment activity during the boom years was

being funded from overseas. A look at the

breakdown of South Africas capital and financial

accounts shows how the current account deficit

was being financed. (See Chart 17.) In line with the

broader appetite for riskier emerging market assets

during this period, much of the financing came

from foreign portfolio investors piling into South

African bonds and equities.


13/13


CHART 17:NET CAPITAL INFLOWS (ZARBN,12M SUM)

2004 2005 2006 2007 2008-60

-40

-20

0

20

40

60

80

-60

-40

-20

0

20

40

60

80Portfolio

Other

FDI


Additionally, there was a clear uptick in other

investment. This is especially true from 2006

onwards, with a notable surge occurring from mid-

2007. Included in the other investment

category is banking flows, the counterpart to

which is the amount of external debt held by the

banking sector. (See Chart 18.)

CHART 18:SHORT-TERM EXTERNAL DEBT (US$BN)

0

5

10

15

20

25

30

0

5

10

15

20

25

30

2003 2004 2005 2006 2007 2008

Other institutionsBanking sector

Sources IMF, Capital Economics

There is ample evidence here that the sector took

on increased levels of short-term debt fromoverseas, rising from around US$7bn in 2004 to

almost US$20bn by 2008. In other words, banks

were borrowing from abroad to finance loans for

local investment and consumption.

Clearly, the composition of external financing was

heavily skewed towards short-term inflows. These

tend to be volatile in nature, and can easily dry up

or reverse direction in the case of a deteriorating

external environment. In the case of a protracted

global downturn, this left the South African

economy highly vulnerable to going from boom to

bust.

2009 2011: small recession, sluggish recoveryTherefore, it comes as no surprise that South Africa

slipped into recession in 2008-09, as commodity

prices crashed and capital inflows reversed.

However, although the economy contracted by

1.8% in 2009, South Africas recession was not as

severe as a number of other commodity producing

emerging economies. For example, neighbouring

Botswana, the worlds largest diamond exporter,

suffered a recession of nearly 5% of GDP. Further

afield, the oil-rich Russian economy contracted by

almost 8%.

Perhaps more worrying is the fact that, in

comparison to some of its emerging market peers,

South Africas recovery since 2009 has been

lethargic. (See Chart 19.) Admittedly, the headline

growth numbers arent a huge cause for concern.

GDP expanded by 2.9% in 2010 and 3.1% in

2011. But, the crucial point is that this recovery

has been uneven, with an over-reliance on

household consumption. Indeed, investment and

export levels are yet to reach their pre-crisis peaks.

CHART 19:GDP(SEASONALLY ADJUSTED,Q12008=100)

90

95

100

105

110

115

90

95

100

105

110

115

2008 2009 2010 2011

Poland

Brazil

South Africa


Overall then, it is fair to conclude that,

notwithstanding the commodities and foreign

investment driven boom of 2005 to 2008, since

1994 South African growth has been

disappointing.

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South Africa Set to Remain a Regional Underperformer