Oct 1, 2020
In his latest address, President Ramaphosa noted that South Africa would soon be ready to roll out its economic recovery plan. The good news is that it appears that COVID-19 has resulted in business and labour finding plenty of common ground, including an accelerated renewable energy programme, a fast-track spectrum auction, increased private participation in port terminals and simplification of mining regulation.
South Africa’s political economy is unable to deliver credible macroeconomic reforms. We can make announcements about them – we just struggle to execute. The root cause seems to be a combination of a lack of bureaucratic capacity and a government that is focused on playing defence. The latter is the bigger problem: government is focused on minimising its risks. This means that policy errs towards preserving current jobs rather than trying to create new jobs and by over-regulating sectors in a way that smothers entrepreneurship.
For several years, the result has been sclerosis in decision making. Moreover, the path of least resistance has been to maintain or support the status quo. The consequence is a persistent contraction in private sector fixed investment, resulting in a decline in potential GDP growth, anaemic realised growth, rising unemployment, weak tax revenues and an unfolding fiscal crisis.
Unfortunately, “business as usual” is no longer sufficient to produce the growth needed to create jobs or to stabilise the government debt burden. In order to grow South Africa’s economy at more than 1% per annum, government will need to take risks.
The hard decisions they have to take will result in some short-term losers, who are likely to be noisy in their opposition. However, without these changes, growth will not improve. And the long-term risks of social instability due to insufficient job growth and a debt crisis will grow.
A starting point is for government to prioritise the focus areas. Given the shortage of bureaucratic capacity, this approach is doomed to fail in South Africa. Therefore, there needs to be a ruthless prioritisation of initiatives – and progress on these areas must be measured.
As a start, the South African government needs to let go of some sacred cows. Let’s start with SAA. There may well be a key role for some parts of SAA in the future. However, the current configuration is not sustainable. Since 2008, government has pumped R22bn into SAA. A further R16.4bn is allocated by the Treasury to cover the guaranteed debt in the current and forthcoming years. The business rescue practitioners claim that they need a further R10bn to make the airline viable. Government appears ready to provide this.
Instead of wasting further taxpayer money on a doomed venture, the government should be focusing its energy on ensuring that South Africa has the necessary local, regional and international airline access required to support growth. This may involve some portions of SAA merging with private partners. It may involve closing some portions of the airline. The economy almost certainly will not require the airline in its current incarnation.
Another example is Eskom. The instability of electricity supply is the single biggest constraint to South Africa’s growth. It is likely that the global economic recovery will result in a rise in infrastructure investment and thus a boost to commodity prices. Companies should respond by increasing investment in the mining industry to expand production. Unfortunately, any company considering investment will flag the electricity constraint as a reason to invest elsewhere.
The debacles of Medupi and Kusile have shown us that Eskom cannot build new capacity. In contrast, there was a rapid build-out of renewable energy generation – until the government halted the procurement. Modelling by Meridian Economics suggests that a rapid transition to renewable energy generation will result in power that will cost no more than power from the older coal capacity – if the cost of maintaining those plants is included. It will certainly be cheaper than building new coal plants. The result would be a strong pick-up in investment as many renewable projects are quickly built out, creating jobs and stabilising the power system. The modelling suggests that a long-term renewable build programme would create more jobs than those that would be lost in the coal industry and Eskom.
Such a move would also allow South Africa to secure green finance at favourable terms to support the power system. For this, a change to the latest Integrated Resource Plan (IRP 2019) away from coal is needed. The longer-term benefits are large and tangible.
If either of these decisions are made, there will be noise. The relevant unions will oppose the abandonment of SAA. Coal companies and coal haulers will oppose a shift to green energy.
As a result, short-term risk mitigation will massively exacerbate the medium-term risks. With a bit of courage, potential growth of 3% per annum is easily attainable, which our debt stabilisation model indicates will be more than sufficient to stabilise the debt-to-GDP model in the next five years.
From a portfolio perspective, our highest conviction views in the Ninety One Cautious Managed Strategy remain high-quality global equities and SA bonds. We believe this approach provides investors with a good balance between offshore growth and domestic income when seeking inflation-beating returns over the medium term while needing to protect capital over the short term. It is easy to be pessimistic about local bonds given the fiscal and growth outlook and resultant rising debt to GDP. But at current levels, yields are pricing in many of these risks and provide far greater certainty than businesses that are only exposed to the local economy.
While local equity valuations are more attractive than they have been for some time, the future prospects for many ‘SA Inc.’ businesses are highly dependent on a sustainable economic recovery – and for that, courageous decision making is needed. If we continue to play defence, investors are bound to be disappointed as current valuations of many of these businesses incorporate some level of recovery. The catalyst for higher growth, fiscal sustainability, higher employment and the outperformance of SA Inc. shares is courageous decision-making.Download PDF