Private sector’s big contribution to capital expenditure expected to continue this year
SOUTH Africa is at risk of seeing an economic growth rate of below 1 percent year-on-year (y/y) this year as a number of structural problems remain unresolved.
This comes after a growth rate of likely-to-be below 0.5 percent y/y in 2019, not least due to substantial, periodic losses of electricity supply.
Not all areas of South Africa’s economy performed poorly in 2019, the private sector made a substantial contribution to capital expenditure and is expected to do so in 2020, providing support to gross domestic product (GDP). The private sector accounts for 70 percent of fixed investment in SA, while government accounts for only 16 percent and public corporations below 15 percent. Private business enterprises saw capital expenditure growth rates of 15.8 percent quarter-on-quarter seasonally adjusted annualised (q-qsaa) in the second quarter of 2019, and 10.8 percent q-qsaa in the third quarter, with a positive out turn likely for private sector corporates’ fixed investment growth in fourth quarter of 2019.
However, the government likely returned negative rates on fixed investment in 2019, with public sector capex down -16.3 percent q-qsaa in the second quarter of 2019 and -17.8 percent q-qsaa in the third quarter of 2019, after contracting by -2.1 percent q-qsaa in the first quarter of 2019. 2020 would see further contraction in government fixed investment if projects budgeted for do not go ahead, while this is also an area that risks budget cuts as government seeks to reduce expenditure to avoid a Moody’s credit rating downgrade.
Moody’s is scheduled to deliver its country review on March 27, with the Budget in February.
The agency has already placed SA’s long-term sovereign debt on a negative outlook towards the end of last year, indicating that it plans to downgrade SA to sub-investment grade, from its rating on the last rung of investment grade, if SA does not make the necessary changes that would allow its rating to return to stable. Specifically Moody’s has said SA would avoid a downgrade “if the government’s efforts to rein in spending, improve tax compliance and lift potential growth became increasingly likely to successfully stabilise debt ratios”.
National Treasury has put forward key areas where expenditure cuts need to be made to consolidate the government’s finances materially, which specifically includes cutting above inflation civil servants’ remuneration growth. If unsuccessful SA will likely see a rating downgrade.
Low inflation does not signal an interest rate cut in the first quarter of 2020 as the potential for a rating downgrade hangs over SA.
Moody’s expects SA’s GDP at 1 percent y/y to 1.5 percent y/y, with around 0.8 percent y/y likely instead this year, while SA risks potential GDP growth continuing to drop to 0 percent, and then below, without drastic action to repair the productivity of public services and infrastructure, including consistent electricity supply.
A 25 basis point interest rate cut will become increasingly likely if SA’s Moody’s rating outlook returns to stable.
However, the probability of SA avoiding a Moody’s downgrade has diminished, and could fall further, reducing the prospects for stronger economic growth, fiscal accommodation, a more supportive borrowing environment and sustained economic growth of above 3 percent in the medium-term.
Consumption expenditure by government grew in each of the first three quarters available for 2019, while government debt levels rose notably.
Borrowings have been used to top up current expenditure, resulting in the current fiscal balance being in deficit (difference between revenue and current expenditure, and current expenditure includes civil servants compensation). The government consequently continued to make a negative contribution to national savings, and continued to borrow the bulk of its new issuance of debt in the local market. Expenditure cuts in government fixed investment instead, would detract from economic growth, with previously unspent funds allocated to government infrastructure also holding the potential to contribute meaningfully to economic activity in 2020 if spent.
SA’s growth has also been afflicted by the slowing global economy. The US is expected to sign a substantial trade deal with China this year, post the first phase trade deal in January, allowing global growth to improve.
However, a declining likelihood of this would see slowing global growth, where SA’s economic performance has already been impacted by weakening global demand, along with policy uncertainty domestically and particularly the failure to implement the structural reforms needed this decade. The rand will continue to be volatile, driven by global events, and structurally weakened by SA’s poor fundamentals.