Economy still in a sticky spot

The size of the subsidies SA pays its South African Customs Union (Sacu) neighbours is sure to come up for discussion after the release of the latest Reserve Bank quarterly bulletin on Thursday.

Transfers to Sacu were the main reason behind the surprise jump in the deficit on the current account of the balance of payments in the second quarter.

With the trade balance improving, the market had expected that the deficit would narrow to 1.9% of GDP, from 2% in the first quarter. Instead, it increased to 2.4%.

Without the Sacu transfers — which were the equivalent of 0.4% of GDP, according to the Reserve Bank’s economists — the deficit would have been unchanged.

The second quarter was the first quarter of the new fiscal year, and February’s budget projected an increase in the Sacu transfers from R40bn to R56bn, hence the hit to the income part of the current account.

The Sacu transfers to SA’s neighbours are calculated in terms of a formula but, in essence, this arguably is a form of development aid that SA provides to its poorer neighbours. In countries such as Lesotho, those Sacu revenues can make up half or more of the national budget.

A case can be made for them. SA’s prosperity is linked to that of its neighbours, and while they do lift the current account deficit, that is probably less important now that the deficit is down to the 2% range.

Sadly, the current account deficit has come down in the past couple of years more because imports have fallen in a very weak economy than because exports have done particularly well. However, SA’s current account deficit still puts it in contradistinction to other emerging markets that run surpluses.

For now at least, international investors seem to be so obsessed with the search for yield that idiosyncrasies such as a country’s current account deficit do not seem to concern them too much.

As the quarterly bulletin shows, SA benefited from strong portfolio inflows that jumped to R65bn on a net basis in the second quarter, from R7.5bn in the first quarter, and the largest chunk of this was foreign investors buying South African bonds.

Those capital inflows helped to fund the country’s current account deficit.

But there are warning bells in the balance of payments numbers. While volatile portfolio flows increased, other kinds of cross-border investment – particularly foreign direct investment – showed net outflows and the Reserve Bank reported that, overall, the net inflow of capital had declined (from R37bn to R3bn).

A current deficit really means SA is spending more than it produces and investing more than it saves, making it dependent on constant foreign inflows for financing.

This reliance on volatile portfolio flows makes SA extremely vulnerable to shifts in international sentiment regarding emerging markets or to SA’s own issues — and to the kind of outflows that could result from further credit ratings downgrades, for example.

And if international investors are reluctant to come into SA on a longer-term basis, because of its policy uncertainty and poor growth prospects, so too are domestic investors.

As the bulletin shows, domestic investment spending (measured by gross fixed capital formation) declined again in the second quarter, which means it has now been negative for four of the past six quarters, and particularly disturbing is the fact that private sector investment spending was down nearly 7% during the quarter.

So, while the economy showed some bounce in the second quarter, there’s little sign of a meaningful upturn.