South Africa is stuck in a low growth trap. South Africa’s economic performance has deteriorated significantly in recent years. Not only has economic growth decelerated tangibly. But economic growth compares very poorly to South Africa’s regional peers. As a consequence, socio-economic indicators have deteriorated sharply, particularly since the pandemic, even though per capita income began to stagnate before. Low economic growth has sharply curtailed the government’s ability to support economic growth through fiscal means, not least because government debt has continued to increase and put downward pressure on sovereign credit quality. A lack of investment and deteriorating infrastructure have added to economic woes, including power shortages, which have added to socio-economic dissatisfaction and weighed on the economic growth outlook. Unemployment, historically very high, has increased further. Income inequality is (among) the highest in the world.
> Per capita income began to stagnate and decline even before the COVID-19 pandemic due to slowing economic growth.
> Unemployment rates has increased form 25% in the 2010s to 34% today. Youth unemployment currently exceeds 50%.
> South Africa continues to suffer high crime rates. It has the third-highest murder rate in the world with 42 intentional homicides per 100,000 people.
> Corruption is high and has increased. Transparency International ranks South Africa 83rd out of a 180-off countries in terms of corruption (higher the rank, the worse the corruption).
> South Africa is one of the world’s most unequal countries with a Gini coefficient of 0.63. (A Gini index of 1 expresses maximum inequality.) Income inequality is significantly higher than the emerging economy average.
> All three major international rating agencies, S&P, Moody’s and Fitch, assign a long-term foreign-currency rating of BB- (or its equivalent) to the South African sovereign.
South Africa’s economic challenges are not going to go away. With an economic growth rate of 1-2% and effectively stagnating per incomes, growth-enhancing economic reform is more important than ever. However, in the short, there are simply no funds available to meaningfully tackle South Africa’s economic and socio-economic challenges. In the medium term, this will increase the risk of broader economic and financial instability. Economically, fiscal space is restricted due to already high government debt and a large underlying fiscal deficit. The government also faces significant contingent liabilities in the form of bailouts of companies operating in the critical infrastructure sector, which will further add to the government debt burden. Meanwhile, relatively high inflation will continue to erode real incomes, particularly of poorer socio-economic groups due to their inability to hedge against. This will further erode the political willingness to pursue a forceful fiscal adjustment or costly reform. South Africa is stuck in a low-level economic equilibrium.
> The IMF projects medium-term real GDP growth of 1.4%, a very low level by emerging standards and insufficient to address socio-economic problems. By comparison, real GDP growth in sub-Saharan Africa is projected to average 4-5% in the next few years. Economic growth barely keeps up with population growth, which will translate into stagnating per capita incomes.
> Low growth will also put significant pressure on fiscal account, constraining the government’s ability to support investment or significantly increase social expenditure to address failing infrastructure and socio-economic grievances. Government debt has increased from around 50% of GDP in 2018 to more than 70% last year and reach 85% of GDP by 2028. This projection does not take into account additional contingent liabilities, such as the government’s bailout of Eskom, which cost the government 3% of GDP.
> Energy production and weakening infrastructure will remain a challenge, fuel public discontent and weigh on economic growth. Rolling blackouts have become more likely and fixing the problem will take time.
Despite a downbeat economic outlook and deteriorating fundamentals, South Africa’s economy does benefit from important risk mitigating features, which a broader economic or financial instability unlikely, at least in the near to medium term. First, even though government debt is high and increasing, external debt and foreign-currency-denominated debt as share of total debt is low. This limits South Africa’s vulnerability to exchange rate shocks or a foreign investor strike. Second, government debt is high, but its maturity structure limits liquidity risks, not least because much of the debt is held by domestic banks and investment companies. Third, a floating exchange rate and limited foreign-currency mismatches allow the economy to absorb a precipitous decline in capital inflows without sustaining broader financial damage, as a weaker exchange rate then boosts export and foreign-currency revenues. Fourth, a relatively independent central helps maintain investor confidence, fiscal challenges notwithstanding. Fifth, thanks to a floating exchange rate, current account deficits are generally manageable, limiting the build-up of foreign debt.
> The structure of government remains solid due to local currency denomination and ability to issue long-term debt. However, with government debt projected to increase in the medium term, credit quality will deteriorate and the risk of financial distress will increase, if only gradually.
> South Africa has had a floating exchange rate regime for many decades, affording it to absorb balance-of-payments shocks through currency depreciation rather than the sale of foreign-exchange reserves.
> The bank system remains well-capitalized, well-managed and solid liquidity. Larger, systemically important banks are financially stronger than smaller banks. However, banks’ holdings of government has increased, which in turn has increased the banking sector’s vulnerability in case of severe sovereign distress.
> An independent central bank committed to an inflation target of has translated into relative policy credibility. Thanks to an independent central bank, inflation should remain under control and fall toward the target of 3-6%, barring a major exchange rate shock.
The next ANC(-led) government will find it politically difficult to implement the reforms necessary to revive economic growth in the face of a weakened political position and continued high levels of socio-economic dissatisfaction, which complicate structural reform and macroeconomic adjustment. According to opinion poll, the ANC will fail to win a majority of seats in the lower house. This will make it politically harder to push though politically costly, forward-looking economic reforms. To the extent that the ANC requires support from other parties, necessary compromises will dilute policy measures and reforms. Moreover, unless the government commits to reforms right after the elections, the likelihood of forward-looking reform will diminish. A more fragmented parliamentary base would make painful economic reform more difficult to implement. Absent a major financial crisis, which remains unlikely in the near term, a major reform push is unlikely. However, should financial conditions deteriorate significantly, which is not likely in the next 2-3 years, the government would likely do what it takes to restore stability, even though it would be unlikely to address the structural factors that hold back economic growth and increase government debt, such as a failing infrastructure, insufficient investment and increasing corruption. This, after all, would require an even greater macroeconomic adjustment and will encounter strong socio-economic opposition, including unions.
> Polls suggest that the ANC will lose seats and may lose its parliamentary majority altogether. The ANC has continuously controlled both house of parliament since the end of apartheid. The ANC failed to receive a majority of votes in 2021 local elections. Polls point to the ANC’s waning popularity with support dropping from 55-60% in 2019 to less than 40% most recently. In the last general elections, the ruling ANC won 230 out of 400 seats.
> A hung parliament, minority government or coalition government are not conducive to a strategic policy of economic reform that South Africa requires to escape from the low-growth trap. While a new ANC-led government is unlikely to adopt outright populist, destabilizing policies, a likely failure to address structural and macroeconomic challenges points toward continued erosion of economic fundamentals and worsening of socio-economic conditions in the next few years, even if the risk of severe financial distress will remain manageable.