SOUTH AFRICA 2000
April 24, 2000
Professor Zonis
Alwyn Andrew-Mziray
Molly Haney
Hilda Rodriguez
John Wiese
Janice WIlliams
Made possible by
C.N.A. · Deutsche Bank · Diamond Technology Partners · Pfizer
INTRODUCTION
Slow economic growth and low foreign investment resulting from a relatively small market size have accompanied South Africa’s political transition from apartheid to democracy. The lack of rapid economic progress has limited the monetary as well as fiscal ability of the government to cope with the pressing social ills affecting the nation such as shortage of skilled labor force, high unemployment rates, violent crime, and lack of educational attainment. The ANC political mandate serves to secure political stability but new macro and microeconomic policies such as privatization and affirmative action have created tensions in the coalition. In addition, other forces such as regional instability, specifically Zimbabwe’s land redistribution crisis, may be expected to have impacts on South Africa’s ability to portray itself as fertile land for investment and springboard for the rest of the Southern Africa. Thus, a cycle of social uncertainty and lack of economic confidence has defined South Africa to potential new foreign investors and has served as a barrier to increased investment.
EXECUTIVE SUMMARY
Our assessment of the feasibility of investment in South Africa for the next three to five years is based on a model composed of 5 essential, interacting variables. These are macroeconomics, education, unemployment, privatization and crime. In addition, other forces also affect the economic outlook of South Africa such as regional stability, health and corruption. Together, these variables present a stagnate economy, where new foreign investment is not expected. However, companies that already have investments in South Africa and show profitability will remain there, so the situation is not completely detrimental to growth, but rather to new foreign investment.
MACROECONOMICS
South Africa’s political and economic environment has in the past year been through some changes as a new president took office and a new governor assumed control of the reserve bank. This second democratic political transition saw the presidency transferred to Thabo Mbeki and with it the challenge of achieving economic growth sufficiently high to tackle unemployment. Accompanying this political transition was an economic one where Reserve Bank Governor, Tito Mboweni took control of monetary policy, which remains constrained by the same factors that plagued his predecessor, Chris Stals. The bank’s objective has always been to protect the value of the currency in the interest of a balanced and sustainable economic growth. Governor Mboweni’s focus of monetary policy is on the inflation rate and not the currency.
President Mbeki and Governor Mboweni have the challenge of promoting sustainable growth sufficiently high to absorb new entrants to the labor market, but they also need to decrease unemployment. To achieve this growth they will require a more accommodating monetary policy, continued fiscal consolidation, more aggressive privatization, and labor market reform and trade liberalization. The government has thus implemented the GEAR (Government’s Growth, Employment and Redistribution Strategy. GEAR proposes structural reforms and conservative fiscal monetary policies.
In dealing with the structural side, the Government decided to emphasize on trade liberalization. They also began to reduce exchange controls and allowed individuals to invest offshore as well as domestic institutions to enter swap transactions. The privatizing of and restructuring of state assets was also brought forth. However, thus far, partial privatizations have taken place only in Telkom, Transet (Spoornet), Debel (which is made up of 20 different companies in the armament business), and South African Airways. Eskom, an electricity provider, was also sold and achieved excellent electrification targets. The other lackluster area, was the government’s effort to develop policy to better manage the labor market. Four pieces of legislation were produced that have increased labor market rigidities and costs. These restricting policies have been the one area where Governor Mboweni has been constantly criticized.
Fiscally, the government emphasized on decreasing the budget deficit and restructuring public services. They were rather successful in decreasing the deficit, however the monetary policy was limited by their overall external position, which remained weak. Once growth picked up, the current account widened. A dependence on portfolio inflows and short-term debt as well as low reserves, forced the South Africa Reserve Bank to maintain a relative high real interest rate. From time to time, the Bank responded to speculators on the currency by hiking interest rates and intervening in the foreign exchange market.
If an aggressive implementation of GEAR is carried through, then growth rates in the region of 5.0-6.0% could be achieved in three to four years time.[i] This growth rate would be necessary to absorb all new entrants into the labor market. The policies set out in GEAR were to have produced growth of 6.1% by 2000, and annual growth of 4.2% from 1996-2000. Growth in the non-agricultural employment sector was to have reached 4.3% per year by 2000, averaging 2.9% over the period. However, real GDP growth in the period 1996-1998 averaged just 2.4% compared to the target of 3.4%, while employment contracted on average by 2.2% per year versus a target of 2.3%.[ii]
While a range of domestic and international economic fundamentals point to improving conditions in South Africa, growth rates sufficiently high to begin reducing unemployment will not be forthcoming in the next two years. Goldman Sachs forecasted a GDP growth of 1% in 1999 and 2.6% in 2000, which based on past experience would have little effect on job creation.
Real GDP growth is expected to be at 1% in 1999, 2.6% in 2000 and 3.4% in 2001[iii]. This growth will come mainly from an improvement in private consumption expenditure, the wealth effects of the ‘de-mutualization’ of Old Mutual and lower interest rates. Other factors that will also help with growth: are better export growth, especially with Asia’s improving conditions, higher growth in Europe and better commodity prices.
Sustainable GDP growth in the region of 5-6% will need to be achieved if unemployment levels are to fall. This level of growth will only be attainable if monetary policy is freed from the reactions placed on it by the forward book and only if investor confidence is raised by the transparency that inflation targeting can bring. Furthermore, the public sector will have to be made smaller and more efficient and privatization will have to be more aggressive. The government will also have to improve the absorption capacity of the labor market, for one thing, making labor legislation less onerous. With aggressive structural reforms, South Africa could achieve sustainable real growth GDP growth of about 5.5%, which would generate upwards of 500, 000 jobs per year[iv]. This level of growth would begin to show in about 3-4 years time.
Significant changes in monetary policy are taking place now and are significant in two places. First, the move to explicit inflation targeting has been confirmed. This happened in the 1st quarter of 2000. A core inflation rate of 6-7% has been targeted for the end of 2000 and 2001[v]. This could be realistically met without a too restrictive monetary policy. Governor Mboweni has suggested the formulation of a policy target agreement between the government and the central bank. This agreement would define the efforts required to contain inflation in pursuit of sustainable higher economic growth and employment creation. Inflation targeting requires the participation of labor and business if it is to work. Mboweni has a lot of experience and strong contacts with labor and business sectors. Bringing them into the inflation debate would allow for a pact on appropriate inflation targets. Mboweni has an apparent desire to introduce a culture of greater transparency in the formulation of monetary policy in South Africa. Inflation targeting should support this desire. It is expected that inflationary pressures will be subdued. Structural changes in the economy, especially agricultural market reforms and reforms in the trade regime, should keep prices lower. Moreover the government’s recent stance on the wage increases for the public sector (6.3%) will help keep inflation in check. Lower mortgage costs and cuts in the prime overdraft rate have benefited headline consumer inflation as well as lowering month-on-month inflation growth.
Second, all indications are that there will be far less focus on the exchange rate. It appears unlikely that the bank will intervene to protect the currency as it did in the past. Tito Mboweni’s comment the day before he became governor were that “…it was a waste of time trying to take on speculators. When you intervene they take you to the cleaners.” The point here is that under his leadership, there should be far less intervention in the currency market. However, Governor Mboweni’s comments on exchange rate management in his address to the Reserve Banks Management were rather subdued. He stated that the intervention was required for smoothing fluctuations and that its purpose was not to oppose market trends. This was certainly the standard explanation of his predecessor, Chris Stahl. South African Reserve Bank had a gross international reserves including gold of $6.2 billion in 1999 with projection of$ 6.5billion at the end of the year 2000.[vi] The reserve bank’s policy is to protect the value of the currency in the interest of balanced and sustainable growth.
It is expected that monetary easing will continue well in to 2000 but that it’s pace will slow from that experienced in the first seven months of 1999 and the accelerated easing that followed after. Goldman Sachs expects that the return of the current account to deficit will bring the Rand under some renewed pressure but that the growth of commodity exports will be the supportive currency. According to Carlos A. Texeira at Goldman Sachs, The Repo rate should reach 12% by the year-end implying a prime overdraft of 15%. It is anticipated a further 100bps decline in the prime rate next year. Goldman Sachs remains bullish on local debt and expects yields on the benchmark R150 to tighten to 12.5% by mid-2000. They also expect the Rand to be R6.50 to the dollar by end of 2000 and that it is undervalued by 5%.
In this economic picture both local debt and equities look very attractive. As interest rates fall and domestic demand picks up, the corporate earnings scenario looks much more enticing. Resource stocks look set to rally further as commodities relevant to S. Africa begin to perform better. The prognosis of the mining industry has not been so good due to: weak prices; restructuring that has led to significant job losses; increased activities due to wage negotiations; and the volatile state of South African industrial relations. However tourism is expected to catapult and become the mainstay of the South African economy. According to local investment banker, Guy Hayward, tourism will soon surpass both mining and agriculture as the biggest employer in the economy. He also feels that this is the best market for investment. In looking at tourism, one must take into consideration the high levels of crime in South Africa, particularly violent crime. Both internally and abroad, the investment community’s perception of South Africa is conditioned by reports of violent crime. To attract foreign direct investment and stop the flight of professionals from South Africa, crime has to be combated aggresively.
In conclusion, the main risks to the economic outlook are predominantly external developments. Higher than anticipated inflation; a major stock market correction in the US; renewed emerging market turmoil; or a liquidity crunch could lead to widening spreads in local debt, an equity market correction and weaker Rand. Domestically, factors leading to favorable economic outcome are accelerated implementation of the Growth, Employment and Redistribution strategy without which the sustainability of the upturn in the economic cycle would be put in jeopardy.
EDUCATION
Consistently ranked among the top two challenges to doing business in South Africa, the lack of educational preparation among otherwise employable individuals is far-reaching and detrimental to the country’s economic health. From the 1950s to 1994, the educational system served as the main tool for Apartheid rule, which prepared black Africans for low-wage jobs while simultaneously protected the white minority from competition.[vii] As a result, the current educational system lacks a strong infrastructure that can be easily transformed to serve all South Africans. Hence, the perpetuation of low educational attainment and lack of confidence in the educational system, further limits South Africa’s possibilities of marketing itself as a sure investment with a readily available supply of skilled labor.
Since the 1994 government shift from apartheid to democracy, the educational structure in South Africa has been under major renovation. The big picture is a multi-cultural country of young and old, on all different academic levels, integrating and maneuvering through an often non-funded and racially resistant maze of Bantu, public, and private learning options in pre-primary, primary, secondary, tertiary schools, and Technikons (skill training schools).
The new government faces the overwhelming task of designing a system that operates to ensure each citizen’s constitutional:
“right to a basic education, including adult basic education; to further education, which the state, through reasonable measures, must make progressively available and accessible…in the official language or languages of their choice…taking into account—(a) equity, (b) practicability; and (c) the need to redress the results of past racially discriminatory laws and practices…” The Consitution
The South African government is aided in this endeavor by two other main entities: Nongovermental Organizations (NGOs) and humanitarians/ grassroots activists. Collectively, the efforts of these three sectors will produce significant results in the educational arena in South Africa, but the results will not be evident in the next three to five years, but rather in a generation’s time.
Government
The current national education motto is Tirisano: Working Together to Build A South African Education and Training System for the 21st Century. This concept of working together is one that receives a lot of rhetoric because of the challenge of managing such a major overhaul through national direction, provincial budgetary accountability, and local government management.