The bounce back in economic activity during the third quarter of 2020 largely related to the lifting of severe Covid-19 lock-down measures. The cuts in interest rates by the Reserve Bank, as well as the increased and extended social payments, clearly provided further support.

A breakdown of the third quarter surge in South African economic growth shows that the improvement was extremely broad-based, with every sector recording positive growth. In particular, mining activity expanded by 288%, while manufacturing was up 210%, retail 137% and construction 71%. Despite these very impressive percentages, only the agricultural sector has a level of output that is above the pre-Covid-19 level of activity. Economic activity in all the other sectors of the economy remains below the level that prevailed a year ago. In fact, at the start of Q4 2020, the South African economy was still -5.8% below the level of activity that prevailed at the end of 2019 and -6.3% below the peak level of output achieved in Q2 2019.

Although the South African economy improved far more than expected in Q3 2020, the current resurgence in infections and selected lockdown measures have, unfortunately, dampened the recovery in the first part of 2021. For 2020, South African GDP is expected to have contracted by around -7.5%, while for 2021, GDP growth is forecast at around 2%, down from an estimate of 3% a few months ago. In 2019 the South African economy grew by a mere 0.2%, down from 0.8% in 2018 and 1.4% in 2017. Within this context, growth of 2% in 2021 appears encouraging, but it is well below the level of output required to generate a meaningful increase in employment.

To try to improve SA’s growth performance over the next few years, one of the key challenges the economy faces is that the traditional policy measures a country would typically use to revitalise economic growth under current circumstances are restricted – especially fiscal and monetary policy. In particular, government cannot afford to cut taxes extensively to boost household consumption and corporate investment, given extreme fiscal constraints. The government does not have the scope to meaningfully further increase its own spending, including social payments, given that the current debt trajectory has worsened considerably.

This means that government needs to move ahead rapidly in trying to initiate a wide range of private/public partnerships as a means to stimulate growth and employment. This includes continuing to make it easier to do business. Fortunately, government has a clear intention to implement a range drastic changes to its budget to control expenditure, while finding a way to implement a series of growth-friendly policy initiatives, including on infrastructure.

Ultimately, the success of the government’s growth and employment agenda in 2021 and beyond will be determined, not by the quality of the policy document, but by its ability to make progress in implementing real reforms that encourage the business sector. Closing the gap between SA’s current trend growth rate and a modest target of 3% on a sustained basis will require a significantly larger implementation effort than is currently evident, including the co-ordination of economic policy across key government departments and actively partnering with the private sector.

South African inflation and interest rates on a steady course

In prevailing economic conditions, it is unsurprising that SA’s rate of consumer inflation remains well contained, slowing to only 3.2% year-on-year in November 2020. Core consumer inflation has been below the mid-point (4.5%) of the inflation target for the past 31 months, averaging a mere 4% in that period. This subdued level of inflation, coupled with the severe negative impact of the Covid-19 lockdown on economic activity, clearly supports the Reserve Bank maintaining its current accommodative monetary policy for a considerable period.

The bank kept the repurchase rate (repo rate) unchanged at 3.5% during its final MPC meeting of 2020. The decision was not unanimous. Two members of the committee voted for a cut of 25 bps, while three members wanted rates to remain on hold. The Reserve Bank last adjusted interest rates on 23 July 2020, when it cut the repo rate by 25 bps. Since the beginning of 2020, the repo rate has been reduced by a total of 300 bps. Overall, as mentioned above, the Reserve Bank appears very comfortable with the outlook for inflation, although it remains mindful of the country’s need to attract and retain foreign investment while acknowledging the limited impact of lower interest rates on SA’s growth dynamics.

The South African Reserve Bank has been consistent in stressing that monetary policy cannot, on its own, improve the potential growth rate of the economy or reduce fiscal risks. These should be addressed by implementing prudent macroeconomic policies and structural reforms that lower costs generally, and increase investment opportunities, potential growth and job creation. It is also interesting that the bank highlighted that SA’s high public sector financing needs have been met by local private sector savings and borrowing from international financial institutions, rather than foreign private sector portfolio investment.

The policy response from the South African Reserve Bank during 2020 has been entirely sensible given global and local economic developments. It has managed to get inflation expectations anchored around the mid-point of the inflation target. While this achievement was assisted by a range of unfortunate economic outcomes, especially in terms of economic growth and employment, it should lead to a more stable interest rate environment in the months ahead. The Reserve Bank has been very clear in highlighting the benefits of inflation becoming anchored at the mid-point of the inflation target, including the ability to “look through” short-term moves in inflation without the need to adjust interest rates.

SA’s credit rating was downgraded by both Moody’s and Fitch

In its October Medium Term Budget Policy Statement (MTBPS), National Treasury increased its projected budget deficit for 2020/21 from an estimated -6.8% of GDP at the time of the February 2020 National Budget to -15.7% of GDP. Correspondingly, the increased borrowing requirement is likely to push government debt up from 63.3% of GDP in 2019/20 to a massive 81.8% of GDP in 2020/21, increasing further to 92.9% of GDP by 2023/24 before peaking at 95.3% of GDP in 2025/2026. In comparison, the February 2020 Budget had projected government debt to GDP to be at 65.6% in 2020/21, rising to 71.6% by 2022/23.

According to National Treasury, these deficit and debt targets are only possible if government starts to implement significant fiscal reforms, especially in relation to salary costs, while ensuring that economic growth revives. This suggests that the risks to government finances are, unfortunately, firmly to the downside.

Given the developments in the MTBPS and the expected economic impact of Covid-19, Moody’s and Fitch downgraded SA’s international credit rating by one notch on 20 November 2020. In particular, Moody’s downgraded the credit rating from Ba1 to Ba2 and maintained a negative outlook for the rating, while Fitch downgraded the credit rating from BB to BB-, also with a negative outlook. In contrast, S&P kept SA’s credit rating unchanged at BB-, but with a stable outlook. This means that S&P and Fitch have SA on the same credit rating, while Moody’s is effectively one notch higher – but all SA’s international credit ratings are now below investment grade.

The key driver behind the latest rating downgrade is the further expected weakening in SA’s fiscal strength over the medium term. While SA is not the only country to have been severely affected by the crisis, its capacity to mitigate the shock over the medium term is lower than that of many sovereigns, given its significant fiscal, economic and social constraints and rising borrowing costs.

It is clear that the latest credit rating downgrades largely reflect the negative impact of Covid-19 on economic growth as well as government finances. It is to be hoped that this is not used as an excuse, and that government endeavours to re-establish sound fiscal management within the public sector as soon as possible. It is hard to argue against the key concerns highlighted by all of the credit rating agencies.

As always, the positives associated with SA remain the country’s exchange rate flexibility, credible monetary policy, well-capitalised and regulated financial sector, deep capital markets, and moderate external debt. But clearly that is not enough. In essence, there is no substitute for sustained high economic growth accompanied by job creation.

Unfortunately, while the government has identified a number of key policy initiatives that could help to re-invigorate the South African economy (such as infrastructural development) there is still not enough evidence of implementation. Unsurprisingly, the implementation of sound economic policies builds confidence, but the opposite is also true. If SA can make progress in lifting economic growth and reinstating its fiscal credibility, international credit ratings should start to stabilise and then slowly rise.