South Africa Macroeconomic outlook

Country’s economic performance since the mid-2000s has been remarkable. Economic growth has picked-up fairly clearly beside the backdrop of sound macroeconomic policy management and a positive external situation. Tax collections enhanced considerably, allowing the fiscal deficit to turn down and fiscal policy to be managed in a comparatively counter-cyclical manner during the upswing. This in turn allowed government debt to be reduced substantially to 28 % of gross domestic product (GDP) in 2007.

Growth ongoing to slow down in early 2008, on account of the weakening external situation, power shortages, and the impact of the South African Reserve Bank (SARB)’s tightening cycle begun in mid-2006. The crisis of late 2008 pushed an already slowing economy into its first downturn since 1992. The economy contracted for 3 consecutive quarters beginning in the fourth quarter of 2008 and about 1 million jobs were lost.

Playing off strongly counter-cyclical policies and the global improvement, South Africa’s economy has emerged from recession since the 3th quarter of 2009, and growth accelerated further to 4.6% in the first quarter of 2010, led by a rebound in the export-oriented and interest-sensitive sectors—mining, manufacturing, and financial services. However, changes in global sentiment triggered by recent events in the euro area, caused portfolio inflows to abate, the local stock market to wobble, and the rand to weaken somewhat in May.

From the demand side, on the other hand, private consumption growth remains weak, showing high levels of indebtedness, and with ample unutilized capacity, investment growth is also fragile. Consumer Price Index Inflation has stayed within the 3-6 % target band since February and stood at 4.8 % in April 2010. The stock market and the rand strengthened notably through April from last year’s lows amid large capital inflows.

Fiscal policy has been strongly countercyclical. In the face of a huge income shortfall in fiscal year 2009/10 (April-March), the government continued to execute an motivated infrastructure investment program. This, together with a rapid raise in recurrent expenditure, in particular, wages, led to the deterioration of the fiscal balance in terms of GDP by 5.7 % points from 2008/09 to 2009/10. The fiscal year 2010/11 budget announced in February 2010 outlined an determined fiscal consolidation path, targeting a real growth of fiscal spending around 2-3 % a year. Overall fiscal deficit is expected to fall gradually to 2½ % of GDP under the staff’s central growth forecast.
After a pause since August 2009, the SARB reduced the repo rate by another 50 basis points in March 2010 in response to an improved inflation outlook, but has kept the repo rate unchanged since then, citing broadly balanced risks to inflation outlook.

The South African financial sector weathered the global financial crisis without major problems. There was no need for public support, and capital adequacy ratios remained above their regulatory minima throughout the crisis period. Nevertheless, private sector credit growth has turned negative in recent months, compared to growth of 20 percent or so during 2005-2008. The recession has also led to a pronounced increase in impaired loans in the banking system to 6 percent of gross loans and advances in January 2010 from 4 % in 2008. As a result, banks’ profitability declined, although it remains positive, and the bank’s balance sheets have been shrinking.

South African continues to maintain a floating exchange rate regime. Without seeking to influence the level of the nominal exchange rate, the SARB has been gradually buying foreign exchanges in recent months when presented with the opportunities provided by strong inflows. As of May 2010, gross international reserves stood at close to $42 billion, equivalent to 98 % the sum of short-term external debt and the projected current account deficit in 2010.

The medium-term outlook is for the recovery to be sustained, provided that the global recovery continues. Output growth is projected to be 3¼ percent in 2010, gradually rising to 4½ percent over the medium term with the output gap expected to close by around 2013. Inflation is also expected to remain within the target band over the forecast horizon. The external current account, after narrowing temporarily in 2009, is expected to widen over the medium term as private demand recovers and the public investment programs continue to unfold.

After several years of sustained growth, for the first time since 1992 South Africa’s economy fell into recession with GDP contracting by 1.8% in 2009. The economic slowdown had started already in 2008 with the weakening of domestic demand and was exacerbated when the global crisis led to a sharp fall in exports. Growth is expected to recover gradually to 2.4% in 2010, helped by the recovery of global demand and boosted by the FIFA World Cup, and to accelerate further in 2011 to 3.3%.

Output in manufacturing and mining declined in 2009 as a result of lower exports and agriculture contracted because of adverse climatic conditions. The only sector that showed sustained growth was construction, boosted by a public investment programme and by the forthcoming football World Cup.

Thanks to its prudent macroeconomic policies, South Africa was one of the few countries on the continent able to implement strong and coordinated countercyclical fiscal and monetary policies. Fiscal stimulus measures together with cyclical revenue shortfalls resulted in a sharp deterioration of the fiscal position by 6.2 % points of GDP, culminating in a deficit 7.3% of GDP in 2009/10. The Central Bank responded to the recession by cutting the repo rate by 500 base points. Weak demand and the appreciation of the currency helped reduce inflation from its peak of 11.5% in 2008 to 7.1% in 2009. A sharp increase in electricity prices and wage cost pressures prevented a further decline of inflation into the target range of 3-6%. This made the trade-off between fighting the recession and achieving low inflation more delicate, causing public debate over the mandate of the Bank. Inflation is expected to decrease in 2010, falling back into the target range.

In the coming years, the main policy challenge will be to strike a good balance between fostering growth, while preserving fiscal sustainability and low inflation

South Africa‘s economic and social outlook remains shadowed by huge structural challenges, notably deficiencies in transport and energy infrastructure, which raise production costs and limit growth potential. Public service delivery, also a severe bottleneck to growth, has proven inadequate in a period of severe economic distress and has led to significant social discontent. Demonstrations took place throughout 2009 and if the government fails to improve basic service delivery social instability could continue.

President Zuma, elected in April 2009, must achieve a delicate balancing act: reassuring the international and domestic business community by upholding market friendly policies, while delivering on his promises to alleviate poverty, against a backdrop of sharply increased unemployment.

Public resource mobilisation has improved, as shown by the rising number of registered taxpayers, both individuals and corporations. However, the recession resulted in significant revenue shortfalls in 2009. Further simplification of the tax code and of filing procedures will meet business expectations and free staff within the tax administration to strengthen auditing in sectors where evasion is still widespread. Here again, voter satisfaction with public service delivery must be improved in order to broaden and strengthen the direct tax base and to increase its contribution to public financing.