By Dirk Mostert and Dr Christie Viljoen of Strategy&, part of the PwC network
With global inflationary pressures and related headwinds expected to last into 2023, South Africa will need to focus its energy on the reforms that will allow our economy to become more productive and competitive.
Persistently high global inflation
The global macroeconomic environment continues to suffer under levels of inflation not witnessed in decades on the back of supply chain disruptions and reduced fiscal buffers. European countries, affected by the ongoing Russian invasion of Ukraine, are grappling with energy supply concerns as winter approaches.
These inflated energy prices could also pass through to non-energy prices, especially food. Indeed, Russia’s announcement on 29 October to suspend their participation in the United Nations-brokered grain export treaty via the Black Sea corridor and their subsequent reversal of this decision four days later highlights the uncertainty around food security that will likely fuel inflation further.
Rising interest rates and investment outflows
To counter persistent inflation, key central banks including the US Federal Reserve, the Bank of England, and the European Central Bank had to aggressively raise interest rates during the course of 2022. The current outlook is for these policy rate increases to continue, then to peak during the first quarter of 2023 and, once inflation eases off, to decrease to 2.0%-2.5% towards the end of 2024.
Amid these uncertain times and attractive interest rates from a risk-reward perspective, the US dollar has been the beneficiary of investor flight to safety, trading at parity with the euro since 11 July. Conversely, developing economies like South Africa have seen investment outflows due to the reduced interest rate yield spreads.
Economic growth and commodity prices
Globally, the cost-of-living crisis under these tightening financial conditions is pressuring households and consumers, negatively affecting their overall demand, ability to service mortgage debts as well as their levels of savings.
The next two quarters could potentially see recessions in Europe, the US, Canada, and some economies in Latin America. China faces a property market downturn and a slowdown in their manufacturing and service sectors.
However, Asia Pacific, the Middle East, and Africa are expected to show modest growth during this period, which could avoid a global downturn in 2023. The International Monetary Fund’s (IMF) October world economic outlook growth projections indicate a real GDP growth rate of 3.2% in 2022 followed by a 2.7% growth rate in the year thereafter.
As the global growth slowdown intensifies, commodity prices are expected to ease in the next two years, but they will remain considerably above their average over the past five years. The uncertainties around the war in Ukraine leave ample room for further supply-side shocks and subsequent commodity price volatility.
Impact on South Africa
South Africa is widely expected to achieve a real GDP growth rate of approximately 2% in 2022. However, the global macroeconomic environment has led to exchange rate weakness of the local currency and higher interest rates. These headwinds, coupled with South Africa’s local, structural challenges — with electricity supply disruptions arguably being chief among them — mean that economic growth in 2023 could be curbed to 1.5%.
The projected reduction in global growth over the next couple of quarters could allow supply chain pressures to ease somewhat and aid the expectation of a deceleration in inflationary pressures into 2023.
Expectations are that South Africa will record an average headline inflation rate of 6.8% in 2022, returning to around 5.1% in 2023. Similar to the global trend, the Reserve Bank’s Monetary Policy Committee (MPC) is expected to raise interest rates further by 50 basis points to 6.75% on 24 November and another 50 basis points to 7.25% in 22Q1, before allowing the rate to subside to 7% by 22Q4.
South Africa’s outlook – factors that we can influence
Notwithstanding the global economic outlook, South Africa needs to address a number of local challenges to improve productivity and global competitiveness to unlock economic growth and job creation opportunities.
Failing this, the risk faced by South Africa at present is that the breakdown in social cohesion experienced in recent years continues on a negative trend over the short- to medium-term. For private companies, this increases operational and security risk for business activities.
Minister of Finance, Enoch Godongwana, delivered the Medium-Term Budget Policy Statement (MTBPS) in Parliament on 26 October. On a positive note, revenue collection exceeded projections across most tax categories and disciplined budgeting and high commodity prices allowed the budget deficit to narrow from 5.5% in February to 4.9%.
The country’s debt burden remains substantial, having increased sevenfold from R577 billion in 2007/08 to over R4 trillion in 2021/22. However, a primary budget surplus of 0.7% of GDP is projected for 2023/24 and net government debt is expected to stabilise at 69% of GDP in 2024/25.
6 key challenges to the country’s economic and fiscal sustainability
PwC highlighted six key challenges to the country’s economic and fiscal sustainability:
- A transfer of Eskom’s debt to the sovereign balance sheet
The National Treasury plans to transfer between a third and two-thirds of Eskom’s R400 billion debt to ensure the power utility becomes financially stable. While the relevant debt instruments and method of implementing the relief are not yet finalised, Finance Minister Enoch Godongwana’s comments have led Moody’s Investor Services to confirm on 1 November a change to their outlook for Eskom from negative to positive. More detail will be provided in the annual budget during February 2023.
- Actions to avoid Financial Action Task Force (FATF) grey listing
The National Treasury took a leading role over the past 12 months in finding answers to the FATF grey listing risk. The Finance Minister said the state is “doing everything necessary” to prevent the grey listing.
This includes two bills tabled to parliament to address weaknesses in the legislative framework which are expected to be passed by the end of this year. However, the MTBPS did not comment on the fact that in-progress legislation will likely not count towards the progress report that South Africa needs to provide the FATF in November 2022. In other words, the key legislative changes needed to avoid grey listing might be approved too late to succeed in this endeavour.
Lullu Krugel, PwC South Africa Chief Economist, says: “If grey listed, South Africa would see its private sector endure increased international transactional and compliance costs. Research by the IMF shows that in the 89 emerging and developing countries grey listed during 2000-2017, this resulted in a drop in capital flows equal to 7.6% of GDP over a period of nine months. This would result in negative pressure on the rand exchange rate, higher import inflation, and possibly additional interest rate increases.”
However, the National Treasury’s sense of urgency is a positive step in achieving critical reforms to curb corruption in South Africa.
- Clearing the backlog in processing critical skills visas
While most foreign-owned firms in South Africa have a majority of local representation among their staff, their operations are frequently dependent on the presence of foreign nationals in key positions. Foreign-owned firms have voiced their frustration with the current delays in getting these visas approved.
The importance of skilled workers for business performance and economic growth has been highlighter before. However, the MTBPS did not address the delays in processing the applications, which we hoped would be supported with additional finance and human resource capacity.
- A framework for a comprehensive social security system
The Finance Minister indicated in September that the MTBPS was likely to contain some comments about income support as part of a larger framework for a comprehensive social security plan. For now, the temporary R350 COVID-19 Social Relief of Distress (SRD) grant was extended for another year (to March 2024) as the National Treasury continues to look at how a possible permanent extension thereof can be financed.
This would require increased fiscal revenue, reduced spending elsewhere, or a combination of the two. The MTBPS did not elaborate on progress in fleshing out the details of the comprehensive social security plan.
- Management of the public wage bill
The MTBPS was expected to firmly reiterate that the government is not reneging on its pledge to reduce the pressure exerted on the budget by remuneration costs. Indeed, the Finance Minister pencilled in a 3% increase for public servants. The increment is notably lower than what labour unions are currently asking for.
At the time of writing, the Public Servants Association has indicated that members will embark on a strike on 10 November that will affect the activities of government departments, especially home affairs and transport. Further strike action by other associations remains a possibility.
It is worth noting that the levels of inequality in South Africa leave large numbers of communities reliant on critical state-funded services. To this end, as per the MTBPS, education, health and social development will receive the lion’s share of the R3.56 trillion social wage over the next three years.
- Progress with the Infrastructure Fund pipeline
February 2022 saw the last substantive update on project feasibility for the government’s keystone infrastructure endeavour aimed at crowding-in private investment into major infrastructure projects.
While Minister Godongwana noted that the government is still committed to crowding-in private investment into the delivery of public sector infrastructure, the MTBPS document provided no substantive update about the pipeline of projects.
It also highlighted a likely R4.2 billion in unspent allocations to the Infrastructure Fund during the current fiscal year. On a positive note, the National Treasury recommitted to allocating R100 billion to the fund over 10 years. Given the country’s electricity generation and water distribution infrastructure inefficiencies, one should expect large allocations to bolster supply in these two critical areas.
The Presidency published an investment plan on 4 November providing more details on how they intend to allocate the US$8.5 billion (over R150 billion), pledged by the US, the UK, the European Union, Germany and France at 2021’s United Nations-led climate talks (more commonly referred to as COP26).
Over the next five years, R136 billion will be invested in electricity infrastructure, R12.5 billion in developing green-hydrogen projects, and R3.5 billion in the electric-vehicle industry.
Finally, to this list of six, we also add consideration for the Just Energy Transition. With the 2022 United Nations Climate Change Conference (COP27) ongoing, there is a keen focus on any official statements that could provide more detail on this topic.
Climate risk was mentioned several times in the MTBPS, and it noted that fiscal policy will continue to play a role in shifting economic incentives towards cleaner forms of energy. In this regard, the Finance Minister noted that South Africa is finalising negotiations on the pledges by the International Partners Group for the country’s Just Energy Transition. The MTBPS did not contain anything new about this topic and we suspect the government is keeping major announcements for COP27.