South Africa: a sunnier future?

This year has seen a plethora of elections globally, and emerging markets countries are no exception. One of the most consequential of these, for both the country and financial markets, was South Africa. Three members of our EM Debt team highlight the government’s progress to date, and the implications for the economy and markets.

The background: South Africa’s general election at the end of May saw the ANC lose its parliamentary majority and a Government of National Unity (GNU) formed. This party includes the ANC and Democratic Alliance (DA), along with a few smaller parties, although importantly not the Economic Freedom Fighters party which is known for its more radical policies. This outcome set the scene for a continuation of the positive economic momentum seen of late, with an improvement in performance of the energy sector, a consolidation in fiscal accounts and an uptick in growth.

Markets and positioning: in the medium term we are constructive on South African assets and, in particular, local bonds. Even though assets have rallied aggressively post the election and the formation of the new government, the bond curve is still very steep and asset swaps are very wide. In this environment of an improving growth outlook, potential for a fiscal rule, and a change to the inflation target, this all points toward further yield curve flattening and asset compression. In the shorter term, the rand will remain vulnerable to global macro factors, including the direction of travel for the Fed and commodity prices. We are constructive on hard currency sovereign assets with a preference for the long end of the curve where, similar to the local bond curve, the spread curve is steep. This is where we see material room for flattening and outperformance on reform progress that leads to higher growth, tighter fiscal policy and reduced debt sustainability concerns in the long term.

Political stability versus economic potential: we think this is one of many factors needed to unlock South Africa’s economic potential. Bigger structural reforms around labour, education, tackling crime and further developments in allowing private sector participation in the infrastructure of the economy will ensure further longer-term growth potential.

Risks and potential policy deadlock: economic policy is fairly well aligned within the major government parties. We believe the greater risks come in the form of longstanding differences around the Black Economic Empowerment policy, National Health Insurance, and broader geopolitical party alignments. However, we think that the two larger GNU parties feel it is in their best interests to keep the party alive and well. There are strains within the ANC, and tensions are coming to the surface around the education bill. In relation to this, there are demands from the core of the ANC and this could cause friction with the DA and other parties. The question is, can a more effective and equitable education to the population be delivered, while keeping the centres of excellence which are legacies of the former apartheid system (i.e. selective education)?

Political stability going forward: we think political stability is sustainable in the short to medium term, and certainly until the next ANC elective conference in 2027, when a new ANC leader will be elected. The DA realises that this is its chance to make a difference in managing and reforming the country and will be willing to compromise to maintain power, as we have seen recently in relation to the education bill. It is also true that the ANC needs partners to maintain its control of government. There are scenarios, post that outcome, where we see the GNU becoming a lot more fractious, as parties within the ANC look towards the next general election.

Reform optimism: state-owned enterprise (SOE) reforms are progressing, perhaps due to momentum from the previous government, for example, at Eskom. We are also seeing more hopeful signs of reform in Transnet, the country’s state rail network. We think the government has seen what works i.e. bringing in the private sector as a competitor for SOEs.

Data as a signal of reform success: fiscal out-turns will be critical to follow, on both the revenue generation side via varying taxes, and via expenditure control and realised efficiencies. We will be tracking the energy availability factor (EAF) at Eskom, following the load-shedding issues experienced in recent years. The continued improvement in this EAF, which we see at this point being a mostly maintenance-led recovery, will be a critical signpost for the company’s reforms and in providing consistent power that can continue to harness a pick-up in growth prospects for the country. At Transnet, we will be tracking tonnage and other measures on logistics on rails and ports.

Energy stability and infrastructure improvements: we think that energy stability is less of an issue than in the past, and a huge amount of renewable energy has come online, through both the Independent Power Producer (IPP) process and self-generation. Costs have been decreasing, making it far more attractive for IPPs to come online. Transmission growth is key, as a lot of generation now takes place in more remote parts of the country, so that will be a focus area for infrastructure going forward. Supply is less of a constraint, and we see that remaining in place going forward. A far more critical stress in the infrastructure at present is around logistics in rail and ports, but also water stability, particularly in the KwaZulu Natal region which is a political hotspot.

Unlocking potential through FDI: this has been disappointing, partly as South Africa was an exporter of foreign direct investment (FDI). The problem with inward FDI was that that country was always in the news for the wrong reasons, for example, load shedding, crimes, railways not functioning, strikes, public transport system that did not work, skills shortages/brain drain and corruption. We believe that the GNU has begun to turn the news cycle around. Reduced loan shedding helps, and there is hope of Transnet joining the improving Eskom story. Some significant FDI success stories would help lead the way, in a similar way to Hungary’s auto industry. FDI is important both as a driver of sustainable growth (i.e. helping in non-debt financing of the current account), but also as  it helps bring technological change/productivity growth, as multinational corporations tend to bring international best practice with them. As with the Hungary example, the cluster effect can create a virtuous cycle.