Supply-side structural constraints, such as a persistent power deficit and a fractious labour environment, will constrain the country’s ability to expand export capacity
Current government policy favours substantial state involvement in the economy. Ill-conceived social policy and high-levels of rent seeking activity will also continue to result in substantial capital misallocation.
These dynamics will ensure that the country’s two key economic imbalances, namely the fiscal and current account deficits, will remain large and entrenched as a feature of the country’s economic fundamentals.
A depressed commodity price environment, with the exception gold, and higher energy prices will lead to a deterioration in terms of trade, and create additional external headwinds for the economy.
Rising global interest rates and a reduction in US Dollar liquidity will make it difficult for South Africa to fund its current account deficit resulting in a sustained depreciation in the currency.
As noted in prior publications, the Rand is particularly vulnerable to moves higher in global bond yields, given the country’s large fiscal and current account deficits. Both of these are unlikely to improve meaningfully over the near term. Despite the large depreciation in the currency over the past two years, profitability in South Africa’s mining sector remains challenged. This is due to sharply rising labour and electricity costs and, more recently, falling commodity prices. We, therefore, expect the trade balance to remain in deficit for the foreseeable future. As such, excluding temporary and periodic recoveries, we expect the Rand to depreciate against the US Dollar in a sustained manner for the rest of the decade.
Another concerning negative trend is the steady rise in government expenditures relative to the size of the national economy or Gross Domestic Product (GDP). Inevitably, a larger share of government expenditures as a proportion of GDP also requires a larger tax burden or higher taxes in order to fund these expenditures. Given rising public sector debt, which when including loan guarantees extended to the country’s various parastatals (mainly Eskom) is expected to reach 60% of GDP in the next few years, there appears little room for additional fiscal stimulus going forward.
As the chart above shows, government expenditure has doubled from 16% to 33% of GDP since 1960 and given the political imperative for a larger public sector under the ANC, it is unlikely that this concerning long-term trend will change, at least until the next national elections in 2019. Nevertheless, the country is fast approaching a point where austerity or consolidation measures may no longer be optional and as such, local bond yields may at some point over the next one to two years and well before the next elections start to price in an additional risk premium related to the large and growing public sector.Tags: Eskom, ZAR