The state of the South African economy: Challenges, signs of resilience and post-election prospects

Occasional Paper 5/2024

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AUGUST 2024

Dr Roelof Botha

Economic Advisor to the Optimum Investment Group

Abstract

South Africa’s first Cabinet under the government of national unity (GNU) has been met with an overwhelmingly positive response from business leaders and global capital markets alike. But, as the dust settles on these promising appointments, focus shifts to the real work: economic growth and employment creation. A most pressing obstacle is the restrictive monetary policy stance by the South African Reserve Bank. The gains made post-Covid have been wiped out by the highest interest rates in 15 years – putting the financial resilience of households, and other key indicators of economic activity, under pressure.

This paper closely examines this obstacle to growth and then finds a number of positive developments in the macroeconomy and the economic policy environment, likely due to the transition to a GNU that is committed to preserving South Africa’s democratic constitution. The private sector is prepared to become more involved in repairing infrastructure, and fundamental fiscal policy is in place. A resilient rand, combined with an imminent sharp drop in interest rates and consumer inflation, heralds higher growth. And plans are afoot to clean up the state capture mess, especially the mismanagement of state-owned enterprises and municipalities. The time is ripe for a sea change, from ideological objectives to creating employment opportunities at pace.

Introduction

Now that the dust has settled on South Africa’s transition to a government of national unity (GNU) and the appointment of a new, expanded cabinet, much of the focus of public debate will shift to progress with the stated intention of prioritising economic growth and employment creation. Based on government’s track record ever since the state capture era, it would require substantial assistance by the private sector in facilitating new investment in the repair, maintenance and expansion of the country’s infrastructure.

This paper examines one of the most pressing obstacles to the expansion of capital formation and household consumption expenditure, namely an overly restrictive monetary policy stance by the South African Reserve Bank and then proceeds with a discussion of a number of positive developments in the macroeconomy and the economic policy environment.

The timing for a new era where emphasis shifts from ideological objectives to creating employment opportunities at pace is good. The world economy is expected to grow at more than 3% over the next couple of years and most of South Africa’s key trading partners are likely to experience macroeconomic stability. Furthermore, due to a much larger degree of price stability, interest rates are bound to start declining during the third quarter of the year – providing much-needed debt-servicing relief to consumers and businesses alike.

The cost of restrictive monetary policy

Ever since the onset at the end of 2021 of restrictive monetary policy in South Africa, the financial resilience of households has been under pressure, with a strong (and predictable) inverse correlation between higher interest rates and the Altron Fintech Household Resilience Index (AFHRI) trend. This inverse correlation is also evident with a variety of other key indicators of economic activity, including the gross domestic product (GDP), real household consumption expenditure and retail trade sales.

The gains that were made with the post-Covid recovery have now been wiped out by the highest interest rates in 15 years, with the current real prime overdraft rate (prime minus the consumer price index – CPI) at a level of 6.7%, which is more than double the average rate that existed during the tenure of the previous Governor of the SA Reserve Bank, Gill Marcus.

Of particular concern is the fact that inflation, as measured by the CPI, has been comfortably within the Reserve Bank’s target range (3% to 6%) for the past twelve months. In a deviation from the erstwhile monetary policy approach of target range flexibility, it seems that the Monetary Policy Committee (MPC) has now opted for the approach of the Federal Reserve in the United States, namely a target point, which the MPC has apparently set at 4.5%. Due to the permanent volatility of emerging market currencies and the strong influence on price levels of temporary currency weakness, such an approach is decidedly unwarranted for an emerging market economy that is battling with an extremely high unemployment rate and low economic growth.

The damage that has been inflicted on the economy due to the intransigent and restrictive stance of the MPC includes the following:

• Since the end of 2021, the cost of credit (and of capital) has increased by 68% (measured against the nominal prime overdraft rate)

• Unnecessarily high interest rates have a profound negative impact on the ability of households to maintain their standard of living and on the ability of businesses to invest in new productive capacity. On the national average mortgage bond level administered by BetterBond of R1.1 million, home-owners are now paying around R4,000 per month more on the instalments.

• In real terms, total household credit extension, which is valued at more than R2 trillion, has declined by 5.5% since 2013, which means that there has not been any growth in this key enabling macroeconomic indicator over the past decade. It is simply not possible for the South African economy to grow at meaningful and sustained rates in the absence of real growth in household credit extension.

• Over the past four years, the average monthly real salary in the formal private sector has declined by 8% to a level of R18,500.

• Excessively high interest rates have further exacerbated the plight of South African households by a sharp increase in debt servicing costs, which, as a percentage of household disposable income, has now risen to 9.2% - the highest level in 15 years, and significantly higher than before the Covid pandemic

 Inflation under control

Households and businesses with debt would have been disappointed at the decision by the MPC to maintain the official bank rate at 8.25% (and the prime rate at 11.75%) during their July policy meeting.

Fortunately, some good news filtered through less than a week later with the publication by Statistics SA of the latest inflation rate, as measured by the CPI. This rate declined marginally to 5.1% in June (from 5.2% in May). Importantly, the CPI has now been within the Reserve Bank’s target range for inflation for a full year, with two leading indicators of future expectations for inflation also pointing in the right direction.

Firstly, the food price component slowed to 4,1% in June 2024, from 4,3% in the previous month, due to moderation in price increases across most products in the food basket, except for bread and cereal products, as well as meat. According to the Agriculture Business Chamber (Agbiz), potential future price increases of wheat and rice are expected to be moderate, due to early forecasts by the International Grains Council of global wheat and rice production in the current season that are well above long-term production levels.

The sub-index for food & beverages has dropped to below the mid-point of the MPC’s inflation target range (3% to 6%). In combination, food (including non-alcoholic beverages) and alcoholic beverages comprise more than 21% of the weighting of the CPI basket and any further downward movement will almost certainly serve to lower the CPI further.

Secondly, after some nervousness with an uptick in producer prices in April, the producer price index (PPI) has declined again, with the June reading of 4.6% virtually on the nose of the mid-point of the Reserve Bank’s target range for inflation.

Price increases at the factory gate are currently lower than consumer inflation. As a rule, producer prices act as a leading indicator for consumer prices, which bodes well for a further drop in the CPI in the months ahead. 

Consumer price index groups with year-on-year
increases well above the CPI (in June 2024)
CPI group	Weight	y-o-y %
	%	change
Electricity	3.7	15.3
Insurance	9.89	8.1
Water	3.46	7.9
Fuel	4.82	7.6
Restaurants & hotels	3.25	7.5
Note: Groups with a weighting of more than 3%
Sources: Stats SA; Own calculations

Scrutiny of the June CPI data reveals the negative impact of several consumption expenditure groups that are directly influenced by the public sector (usually referred to as administered prices), especially electricity, water and fuel.

With a bit of luck, the recent strength of the rand exchange rate could eventually lead to a moderation of fuel price increases. Overall, a further moderation of inflationary trends should continue in 2024, with a good chance of an interest rate cut in September.

Forward PMI at 28-month high

In June, the Absa/BER purchasing managers’ index (PMI) for business expectations in manufacturing in 6 months’ time reached its highest level since February 2022. The June reading of 68.1 represents a significant improvement on the average index value of merely 53.2 during the preceding 24 months and promises to further boost the exceptionally strong recovery of manufacturing sales since the middle of last year. Ever since the relentless rise in interest rates, confidence in the country’s key manufacturing sector has been under pressure, with the quarterly average 6-month forward PMI dropping to below the neutral 50-mark on two occasions.

Several other key economic indicators are also reflecting an improved outlook for higher growth, most likely because of the historic transition to a government of national unity that is committed to preserving South Africa’s democratic constitution and the principle of private property rights.

Manufacturing sector shines

South Africa’s manufacturing sector sales performance continues to reach new record high levels, with a cumulative figure of R1.1 trillion having been achieved between January and April. It is the second successive year that manufacturing sales breached the R1 trillion level within merely four months.

When adjusted for inflation by the CPI, total manufacturing sales between January and April increased by more than 9% year-on-year. In the aftermath of the debilitating effects of the Covid pandemic, South Africa’s factories have outperformed most other key sectors of the economy, with average monthly sales values well above those that existed before 2020.

Further good news on the manufacturing front is the announcement by steel producer ArcelorMittal South Africa (AMSA) that it will continue to operate its longs business, the closure of which was deferred earlier this year (in steel industry terminology longs business refers to the manufacturing of steel products such as wire, rod, rail, and bars as well as certain types of structural sections and girders, mainly for use in construction).

Any closure of AMSA’s longs business would have been devastating for the 3,500 workers employed at the plant, as well as the town of Newcastle, in KwaZulu-Natal, where AMSA’s factory is located. It would also have impacted negatively on the whole of the country’s manufacturing and construction industries.

Reasons for the decision to keep the plant fully operational include the securing of a working-capital facility of R1-billion for a 12-month period, some improvements in Transnet’s performance, and a provisional safeguard duty of 9% on certain hot-rolled steel products.

Any progress with the work being done by the National Logistics Crisis Committee will serve to enhance the efficiency of roads, railways and harbours, which, in turn, should also serve to ultimately stimulate manufacturing sector exports.

Mineral prices start to recover

The recent recovery of mineral prices is a most welcome development for the South African economy, which remains reliant on commodity exports for the bulk of its foreign exchange earnings.

Since the recent lows recorded between March and April, the prices of the top-six minerals produced by South Africa (in value terms) have all edged upwards. Manganese has been the top performer with a price increase of 36%, followed by gold, which remains in record-breaking mode. Since the beginning of the second quarter of 2024, platinum, iron ore and coal have all experienced price increases above 5%, with chromium ore also moving up slightly.

Several research agencies, including BMI, share an overall positive view on metal and mineral price forecasts for 2024, with some key commodities starting to gain on last year’s price levels, whilst remaining above pre-2020 levels. Iron ore is expected to lead gains in ferrous metals, mainly due to positive sentiment over China’s recently announced economic stimulus measures. Despite the Chinese economy being hamstrung by over-supply in its property sector, China remains the world’s largest consumer of metals.

Even a marginal uptick in the demand for minerals from the world’s second largest economy is bound to exert a positive impact on prices. The sectors for energy and construction will also continue to drive demand for a variety of metals and minerals, with a robust US economy likely to boost prices in 2024 and beyond.

Precious metal prices have already responded to the return to price stability in most key economies, with lower interest rates on the cards in the US and Europe. Gold is a shining example of the recovery of precious metal prices and has reached new record highs for several months in succession.

Rising mineral prices have a multi-faceted positive impact on the South African economy. Firstly, despite the problems still being experienced with the efficiency of transport logistics, higher prices will boost the country’s trade balance, which has been in surplus for eight successive years and is now likely to retain this feat.

A stronger balance of payments will impact positively on the rand exchange rate, which has been the strongest global currency against the US dollar since the beginning of March. Currency strength, in turn, should do its bit in easing inflation via the easing of import cost pressures.

Welcome reprieve from loadshedding

During April, May and June, South Africa enjoyed three full months of uninterrupted electricity for the first time in several years, due mainly to the expansion of solar power installations. Eskom has announced that its energy availability factor has reached 65.5 percent for the first time since 2021.

According to Isabel Fick, the head of Eskom’s systems operations, the contributions of solar power plants and rooftop solar installations were allowing Eskom to replenish its pumped storage capacity during the day rather than at night. During 2023, about 2 500 MW of rooftop solar capacity was added, much of which was coupled to battery storage, increasing the overall installed base to above 5 400 MW.

An estimated 2,800 MW of photovoltaic solar is already connected to the Eskom grid. The next stage of harnessing more solar power will focus on two crucial issues, namely an expansion of grid capacity and designing a model that allows surplus solar capacity from independent power producers to also become available. Business chambers around the country have welcomed the renewed stability of electricity supply, which has raised productivity and lowered input costs.

Apart from the relentless rise in solar power generated by households and businesses, Eskom has reviewed the performance of plant managers and other senior employees at its power stations., resulting in extensive changes to the leadership at some of the utility’s worst-performing power stations.

Furthermore, a comprehensive maintenance plan was developed, targeting the worst-performing power stations, whilst also partnering with original equipment manufacturers (OEMs) with extensive knowledge of the equipment used at power plants.

New cabinet announced by the GNU

The appointment of South Africa’s first Cabinet under the new government of national unity (GNU) has been met with overwhelming positive response by business leaders, whilst also receiving a thumbs-up from global capital markets.

For the first time since the transition to democracy, the country’s second largest political party, the Democratic Alliance (DA) has the opportunity to introduce its track record of sound governance at provincial and municipal level, zero tolerance for corruption, and pragmatic policy making at the highest level of government in South Africa. The cabinet has been expanded again, as a result of the forming of a coalition after the May election results saw an end to the ANC’s sway over the national political executive.

In the economic cluster of the Cabinet, the reappointment of Enoch Godongwana as finance minister and David Masondo as his deputy was most welcome, especially due to the steadfast way in which National Treasury has been managing the country’s public finances, which have been under pressure ever since the occurrence of state capture and the lockdowns implemented during the Covid pandemic. Commenting on the reappointment of Minister Godongwana, Business Unity South said that it demonstrates an ongoing commitment by the government to responsible fiscal policies aimed at reducing debt and freeing up spending for productive social and economic development.

The decision to establish a separate energy portfolio headed by the previous Minister of Electricity Dr Kgosientsho Ramokgopa and the DA’s Samantha Graham as Deputy Minister has been welcomed by key stakeholders and energy sector experts. Prof. Anton Eberhard from the University of Cape Town described the restructuring as a sound development, which means that all the provisions of the Electricity Regulation Act (ERA), including electricity planning and procurement, will now fall under Dr Ramokgopa.

This move is expected to facilitate more effective implementation of energy policies than was the case under a combined portfolio for mineral resources and energy. It has also received support from James Mackay, CEO of the Energy Council of South Africa, who commented that it bodes well for dealing with the country’s broader energy challenges and delivering a national energy transition.

Proof of the urgency with which the new cabinet is approaching the crucially important challenge to lower unemployment via higher economic growth has already surfaced at the Department of Transport and the Department of Home Affairs. On 15 July, Barabara Creecy, new Minister of Transport, announced the imminent formation of a specialised unit in her department, called the Private Sector Participation Unit (PSPU). This unit will be staffed by appropriately qualified and experienced experts and will aim, inter alia, to harness private sector support for repairing and expanding the country’s transport infrastructure.

The new Minister of Home Affairs, Dr Leon Schreiber, has announced plans to resolve the visa backlog for skilled workers. This will entail a simplification of the application process and the introduction of measures like a points system for skilled workers. Research by the Reserve Bank estimates that four local jobs are created per skilled migrant.

Sterling performance by National Treasury

Over the past two years, National Treasury had made considerable progress in stabilising the country’s fiscal affairs by a conservative approach towards government spending and weaning state-owned enterprises such as Eskom and Transnet off fiscal bailouts.

The effect of improved fiscal management has resulted in South Africa achieving its first primary budget surplus in 15 years. During the year to end March 2024, state revenue exceeded non-interest expenditure by more than R31 billion (0.4% of GDP). The decline in non‐interest expenditure was driven by lower voted expenditure, largely owing to the sharp decline in payments for financial assets, reflecting government’s limited recapitalisation of State-owned companies.

National Treasury has also pressed ahead with structural economic reforms initiated by Pres Ramaphosa, aimed at implementing pro-growth and investment policies with the cooperation & participation of the private sector, especially in key sectors of the economy such as energy and logistics.

 The 2024/25 national budget will mainly be remembered for its novel utilisation of a portion of South Africa’s gold and foreign exchange contingency reserve account (GFECRA), commonly known simply as the forex reserves. Most countries have foreign exchange reserves, held by their central banks, which can be used for purposes of maintaining macro-economic stability.

Specific examples include interest payments and principal repayments on external government debt denominated in foreign currencies and beefing up the public finances during times when fiscal revenue has not met budget expectations. The latter is exactly what has been implemented by National Treasury in the wake of the tax revenue shortfall experienced during the 2023/24 fiscal year.

Over the past two years, many companies in the resources sector and its supply chain were faced by weak export commodity prices, whilst sluggish world growth and weak domestic demand (due to the record high domestic interest rates) have also served to curtail turnover and profit growth.

For anyone that is concerned over the practice of resorting to foreign exchange reserves as part of fiscal stabilisation policy, it is interesting to note that the origin of the more than R1.1 trillion in gross gold & foreign exchange reserves currently held by the SA Reserve Bank (SARB) was a fiscal transfer to the SARB of (merely) R28 billion made by then finance minister Trevor Manual in 2003.

At the time, South Africa’s foreign exchange reserves were only slowly starting to recover from the disastrous attempt by the Reserve Bank to protect the rand against the fallout from an emerging market currency crisis caused initially by Thailand’s decision to decouple from the US dollar.

Global capital market approval of GNU

The decline of more than 140 basis points in South Africa’s ten-year bond yield in the aftermath of the recent elections holds the promise of hastening the imminent lowering of the Reserve Bank’s repo rate.

A positive medium to long-term relationship exists between money market rates and long-term interest rates. Should the declining trend in the long-term bond yield continue, it would serve as a clear signal that the repo rate and commercial lending rates are falling significantly behind the curve.

The chances for an easing of lending rates happening sooner rather than later have also improved for other reasons, mainly because of further declines in the producer price index and the food price index, both of which act as leading indicators of the consumer price index.

Both the PPI and the CPI have been within the inflation target range for a year and millions of indebted South Africans are eagerly awaiting a departure from a restrictive monetary policy approach, which started at the end of 2021.

Apart from the larger appetite amongst global fund managers for South Africa’s government bonds, the domestic equity market and the rand have also benefited from the historic transition to a coalition government that is committed to preserving South Africa’s democratic constitution and the principle of private property rights. Between mid-April and 16 July, the JSE all share index (Alsi) rose by more than 11%.

The recent performance of the rand has also been impressive. Between the first of March and the end of June, none of the sixteen key currencies monitored by Currencies Direct outperformed the rand against the US dollar, with even the Euro, the Chinese yuan and the Japanese yen taking a hit against the world’s dominant currency.

This time around, rand strength was not based on any relative weakness in the US dollar’s value, as the dollar index (DXY) strengthened by almost 2% to 105.9 over the past four months, leaving most of the world’s key currencies floundering.

Although the rand is likely to remain volatile against the dollar, several leading financial institutions are predicting a value of below R18 by the end of the year. A stronger and less volatile rand exchange rate will place further downward pressure on inflation, which could eventually lead to a series of interest rate cuts in 2024.

Policy priorities announced by the GNU

Speaking shortly after the first Cabinet lekgotla of the new government of national unity (GNU) to determine key priorities, Pres. Ramaphosa announced that inclusive economic growth had been identified as the most important item on the national agenda. He promised that the GNU would pursue every action that contributes to sustainable, rapid economic growth and remove every obstacle that stands in the way of growth.

Reducing red tape was another priority area, with departments and public entities having been directed to reduce the undue regulatory burdens that stifle the ability of businesses to expand their operations, especially small firms. As expected, emphasis was also placed on the just transition towards renewable energy, with the objective of South Africa creating a green manufacturing sector centred on the export of green hydrogen and associated products, including electric vehicles and renewable energy components.

The intention was expressed to turn the country into a “construction site”, as roads, bridges, houses, schools, hospitals and clinics are built, and as broadband fibre and new power lines are installed. Other sector-specific priority areas include the release of public land for social housing and redirecting housing policy to enable people to find affordable homes in areas of their choice.

Part of the plan to ensure that municipalities are financially and operationally sustainable include systems to ensure that capable and qualified people are appointed to senior positions at local government level and to ensure independent regulation and oversight of the appointment process.

The initiation of a second phase of Operation Vulindlela was also announced, which would consolidate reforms already under way in the electricity, freight logistics and water sectors, as well as to facilitate an injection of skills and tourists through visa reforms. Closer cooperation between the public and private sectors lies at the heart of these reforms. If successful, it would be a very welcome development.

A challenging task lies ahead

It is important to note that the new-found urgency in attempting to raise the country’s economic growth rate will be faced with an initial obstacle in the form of officials in the public sector that are not necessarily aligned to the non-ANC parties in the GNU. Cabinet ministers from other parties than the ANC may face some resistance from their bureaucracies and will face a huge task in fostering a spirit of cooperation with existing technocrats and policy advisors.

New ministers will also face a steep learning curve in terms of the plethora of regulations that underpin public sector activity. An element of resistance towards the broad policy direction that was outlined on 18 July during the opening of Parliament can also be expected from some trade unions, who have enjoyed a long-standing alliance with the ANC, despite favouring labour market regulations that are not necessarily conducive to employment creation at scale.

It should nevertheless be comforting to the new coalition government that 2019 was the only time a trade union has de facto participated in a national election and the relevant party (the Socialist Revolutionary Workers’ Party) could not attract enough votes for a single seat in Parliament. It seems clear that trade unions with strong socialist leanings do not enjoy meaningful popular support in South Africa beyond the occasional drumming up of some members for a protest march.

In order to allay fears over the effectiveness of the GNU, it would be necessary to identify a selection of the new policy initiatives that could produce visible results in a relatively short time frame. These could include the fast-tracking of low-cost housing construction, repairs to municipal infrastructure (especially roads and sewerage and improved water provision to informal settlements) and the involvement of the private sector in new public works projects (e.g. the transformation of large illegal waste dumping sites into revenue-generating establishments).

Concluding remarks

Judging by comments from business leaders and the reaction of capital markets, South Africa’s transition to a coalition government promises to up the ante for fixing the mess of the state capture era, especially with regard to the mismanagement of several key state-owned enterprises and dozens of municipalities around the country.

One of the prerequisites for a successful infrastructure drive is the return to financial and operational stability of public sector entities that have become dysfunctional (Western Cape excluded). To this end, the proven experience in sound corporate governance at most of the local governments in the Western Cape provides the GNU with handy case studies. There is no need to reinvent the wheel – just ensure that municipalities are staffed by appropriately qualified and experienced personnel.

Fortunately, the chances of success are good – business leaders in the private sector are prepared to become even more involved in assisting the repair to the country’s infrastructure and fundamental fiscal policy is in place. A resilient rand, combined with a sharp drop in long-term interest rates and consumer inflation, have laid the table for higher growth, but this will be delayed until such time as lending rates decline to significantly lower levels. Against the background of high and rising unemployment, there is no justification for clinging to an overly restrictive monetary policy. It is perhaps time to consider a broadening of the membership of the MPC to also allow for inputs from economists in the private sector who are not political appointments.

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This report has been published by the Inclusive Society Institute

The Inclusive Society Institute (ISI) is an autonomous and independent institution that functions independently from any other entity. It is founded for the purpose of supporting and further deepening multi-party democracy. The ISI’s work is motivated by its desire to achieve non-racialism, non-sexism, social justice and cohesion, economic development and equality in South Africa, through a value system that embodies the social and national democratic principles associated with a developmental state. It recognises that a well-functioning democracy requires well-functioning political formations that are suitably equipped and capacitated. It further acknowledges that South Africa is inextricably linked to the ever transforming and interdependent global world, which necessitates international and multilateral cooperation. As such, the ISI also seeks to achieve its ideals at a global level through cooperation with like-minded parties and organs of civil society who share its basic values. In South Africa, ISI’s ideological positioning is aligned with that of the current ruling party and others in broader society with similar ideals.

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