Construction sector’s decline needs tackling

THE South African construction industry has still not recovered from the highs of the mid-2000s, and evidence that it may be reaching a turning point remains scant.

Between 2003 and 2009, construction GDP growth averaged 10.4% year on year, nearly double the rate of the next-best-performing sector — finance, real estate and business services.

It can be argued that the figure was somewhat inflated by the infrastructure projects for the 2010 Soccer World Cup, but, in the six years since 2010, growth has averaged just 1.8%. Yet this is by no means the worst the industry has seen.

Construction GDP contracted in the three years between 1976 and 1978, and again between 1985 and 1987, and 1991 and 1992. All these periods coincided with aggressive interest rate hiking cycles.

In 1998, when interest rates peaked at 25.5%, the construction sector’s output fell by 6%. That we have not had a steeper hiking cycle since the global financial crisis has likely prevented a similar collapse in the sector, which delivered weak growth of less than 0.5% in the first half of this year.

There are several headwinds facing the industry. Powergeneration projects such as coal and renewables are drawing to a close. Also, the fiscal constraints facing the government, the largest contributor to civil construction demand, mean that planned infrastructure projects may need to be deferred.

Government investment has fallen for three consecutive quarters, with real capital spending growth falling by an annualised 5.4% quarter on quarter in the second quarter of 2016.

Spending on fixed investment by the private sector has not registered positive growth in the past year and a half. Given persistently low business confidence, South African businesses are preserving cash positions. The investment that is taking place is by and large being made outside South Africa, limiting growth in domestic construction activity.

However, data released this week by FNB and the Bureau for Economic Research showed that confidence in the civil construction industry climbed sharply in the third quarter to break through the key 50-indexpoint mark, which indicates that most survey respondents are satisfied with prevailing conditions.

However, looking at the drivers of this improvement points to an industry in the throes of consolidation. The single biggest contributor to the index’s 11-point rise was a marked decrease in tendering competition, which implies that conditions have improved due to a declining number of competitors.

Several large construction companies are throwing in the towel on their civil-works divisions. Construction in South Africa has become a game of attrition, which is not only bad for competition, but opens the door to monopolies and accompanying price inflation.

The construction sector’s contribution to GDP is well below that of many developed and, indeed, developing countries, which is all the more concerning given our large infrastructure gaps.

The question, then, is how to arrest the decline.

Most important, and as with so many other issues in South Africa, is the need for supply-side reforms that will improve private sector confidence and encourage the deployment of domestic and foreign capital into real assets. Significant investment is still required in transport, sanitation, education, healthcare and housing.

There is some evidence of an improving relationship between the government, business and labour. However, this has not as yet resulted in tangible policy proposals that could unlock the construction sector’s growth potential.

One silver lining is that the interest rate cycle has likely peaked. Which means, barring domestic or international shocks, project funding will not become dearer. History shows us that construction activity accelerates two to three years after the peak in the interest rate cycle.

Nxedlana is FNB chief economist