ITRANSACT ECONOMIC OUTLOOK

THIRD QUARTER

2020

SOUTH AFRICA’S STRUCTURAL VULNERABILITIES WORSEN AS THE COVID-19 PANDEMIC TAKES A TOLL ON THE COUNTRY’S ECONOMY

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This installation of quarterly economic information is kindly provided by Pan-AfricanResearch Services (Pty) Ltd, a subsidiary of Pan-African Capital Holdings. RESEARCH TEAM

Dr. Iraj Abedian - (Chairman of the Itransact Investment Platform Board) PhD (Econ), SFU, Canada, Chief EconomistNthabiseng Tsoanamatsie - M.Com (Econ), B.Com (Honours) Univ. of Pretoria, Senior Economist & Head of ResearchHlompho Mphanje - M.Com (Econ), B.Com, Hon (Econ), Univ. of JHB Economic Analyst

CONTENTS

SUMMARY AND ASSUMPTIONS ___________________________________________________________ 2

ACTIVITY _____________________________________________________________________________ 3

PRICES, INTEREST RATES AND EXCHANGE RATES __________________________________________ 10

FISCAL AND EXTERNAL ACCOUNTS ______________________________________________________ 13

FORECAST TABLE _____________________________________________________________________ 16

DISCLAIMER _________________________________________________________________________ 17

CONTACT DETAILS ___________________________________________________________________ 17

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• Employment: 2.2 million individuals lost their jobs during the second quarter of 2020 amid strict economic lockdowns to slowdown the progress of Covid-19 infections. Surveys show improvement in employment prospects in H2 2020 from Q2 2020, but also indicate that overall, they remain low. At the same time, government is in the process of trimming its public sector wage bill, therefore increases in employment will need to come from the private sector.

• South Africa’s Growth: There was a dramatic decline in activity across the South African economy during the second quarter of 2020. This also means that the South African economy has declined for four consecutive quarters starting in H2 2019. Nonetheless, we expect GDP to rebound during Q3 2020 and this is already being confirmed by available high frequency data. Downside risks to growth, however, remain.

• Agriculture: The sector was the only one that grew positively during Q2 2020. It has been benefiting from favourable weather conditions, while foreign demand has been good, and its classification as an essential service during the country’s lockdowns was helpful. The sector’s good performance is likely to continue as the latest estimates point to an overall healthy output in 2020.

• Investment: Although investment has been quite muted, President Ramaphosa’s “Economic Reconstruction and Recovery Plan” is largely centered around investment in infrastructure. Projects in the recovery plan will be prioritised for immediate implementation and will benefit from fast-tracked regulatory processes.

• Business Confidence: Business confidence improved in the third quarter of 2020 following a significant decline in the second quarter of 2020. The markedly better business confidence during the Q3 2020, together with the fact that the metric has typically had a close relationship with GDP historically, suggests that overall activity improved in the economy during the quarter, with GDP rebounding.

• Inflation: South Africa’s inflation remains low and is currently at the lower bound of the Reserve Bank’s target range. Both demand-pull and cost-push inflation are muted.

• Interest Rates: Amid the global economic downturn, including South Africa’s own economic crisis due to the Covid-19 shock, the Reserve Bank cut interest rates consistently throughout 2020, implementing its last rate cut in July. South Africa’s interest rate cuts were also relatively aggressive compared to many of its emerging market peers.

• Fiscus: The Medium-Term Budget Policy Statement confirmed the fact that South Africa’s fiscus has weakened significantly more since Budget 2020. Debt-to-GDP is rising substantially, but is projected to stabilise at just over 95% in 2025/26.

SUMMARY AND ASSUMPTIONS

There was a dramatic decline in activity across the South African economy

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As the effects of the Covid-19 pandemic, along with the economic lockdowns hit the South African economy, it became clear that the country’s scourge of high unemployment was only going to worsen. The official unemployment rate had already crossed the 30% mark by the first quarter of 2020 when it increased by one percentage point to 30.1% from 29.1% in the fourth quarter of 2019. It was of course then expected that the unemployment rate would rise sharply during the second quarter of 2020, a period when South Africa had implemented very strict economic lockdowns.

Nonetheless, an interesting and rather peculiar metric was recorded for the official unemployment rate, as it

actually registered a decline of 6.8 percentage points to 23.3% q/q in the second quarter of 2020. This of course was not a true reflection of the unemployment rate. The decline was on account of the marked increase in the number of people that were not economically active. Also, it was due to the economic lockdowns - the official definition of unemployment warrants that individuals look for and are available for work. The negative impact on employment was captured by the expanded definition of the unemployment rate that rose from 39.7% q/q during the first quarter of 2020 to 42% q/q in the second quarter. The Statistics South Africa data also shows that 2.2 million people lost their jobs during the second quarter of 2020 relative to the first quarter.

ACTIVITY

Graph 1: Quarterly change in unemployment rate, Q1 2008 – Q2 2020

Source: Stats SA and PAIRSNote: official definition includes those individuals not employed in the reference week, are available for work and had actively looked for work or tried to start a business in the four weeks preceding the survey.

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Graph 2: PMI: employment sub-index

Source: BER and PAIRS

1. Manpower Group Employment Outlook Survey: Global, Q3 and Q4 2020.

The substantial loss in jobs was broad-based across the economy during the second quarter of 2020. Still, private households and construction were the hardest hit, each experiencing a 23.6% and 20.7% loss in employment, respectively. The former is likely due to strict social distancing requirements as well as an indication of the great extent to which households were adversely affected financially by the harsh lockdowns. Construction was already one of the worst performing sectors pre-pandemic and it also did not fall under permitted essential services. After utilities, agriculture lost the least number of jobs (-7.6%) and this is because the sector consistently fell under ‘essential services’, while at the same time experiencing robust growth throughout H2 2020. The economy opened up more during the third quarter, hence there is expectation for some recovery in employment, although many jobs are likely lost permanently.

The employment sub-index of the (BER) purchasing managers’ index (PMI) dropped to 26.6 index points in April during the level 5 economic lockdown but has been trending up since May to reach 44.5 index points in September. This suggests that there was some improvement in employment during Q3 2020 and/or that the pace of job loses is slowing. However, since the sub-index remained under the 50-point neutral mark, it also suggests that employment will remain muted overall. The employment prospects survey by the Manpower Group1 shows a net employment outlook of -17 index points during Q3 2020, and a slight improvement in hiring sentiment for Q4 2020 as the net employment outlook improves to -13 index points. Overall, the survey shows that the net employment outlook remains negative in H2 2020.

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The South African government is a significant employer in the economy even though the private sector is the dominant employer. The Development Policy Research Unit2 shows that in the first quarter of 2017, the public sector accounted for 17.1% of total employment in the economy with the rest, 82.9%, employed in the private sector. Nonetheless, Graph 3 indicates that total employment in the public sector is currently markedly higher than it was two decades ago. This, as the Graph shows, can be attributed to the rapid increase in the sectoral employment starting from around 2005, with

substantial increases especially in 2008 (4.8%), 2011 (4.8%) and 2014 (4.5%). Meanwhile, Graph 4 shows that while employment growth by the private sector had also picked up during 2004, it never meaningfully recovered since its marked contraction in 2009 (i.e.: during the great recession). It is therefore clear that there has been more growth in employment in the public sector than in the private sector since 2009, which is not only difficult to expand further at similar rates, but also unsustainable.

2 Development Policy Research Unit, 2017. “Monitoring the Performance of the South African Labour Market”, Employment Promotion Programme, DPRU.

Graph 3: Total employment (2010 = 100) and change in employment in the public sector, 1990 – 2019

Source: SARB and PAIRS Note: Seasonally adjusted

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Graph 4: Total employment (2010 = 100) and change in employment in the private sector, 1990 – 2019

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The public sector wage bill, in a similar manner to total employment in the public sector, has risen significantly over the past years – the National Treasury3 indicates that the real cost of the wage bill has gone up by 51% since 2008. It currently makes up over 35% of consolidated expenditure by government. The 2020 Supplementary Budget had indicated that the proposed R160.2 billion medium-term reduction in the wage bill was still on the table. The 2020 Medium-Term Budget Policy Statement (MTBPS) has proposed growing the wage bill by 1.8% in the current FY2020/21, and aiming for a growth rate of only 0.8% annually over the 2021 medium-term

expenditure framework (MTEF). In order to achieve this, the MTBPS confirmed that government will not be implementing the third (and final) year of wage increases as determined in the 2018 wage agreement. Current Budget guidelines are also proposing a wage freeze for the coming three years. Various other options are also being explored to rein in the public sector wage bill across different sectors. As such, with government in the process of curbing this expenditure item, South Africa’s employment opportunities largely have to come from the private sector, and this will require improved confidence and investment.

3 2020 Medium Term Budget Policy Statement

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Graph 5: Compensation of employees as % of consolidated government expenditure, 2005/06 – 2018/19

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The second quarter saw a dramatic decline in activity across the economy, with all major sectors, except agriculture, contracting markedly. As a result, real GDP recorded a decline of 16.4% on a quarter-on-quarter basis, which translated to a contraction of 51% q/q on an annualised basis. This means that the South African economy has declined for four consecutive quarters starting during H2 2019. Nonetheless, due to increased activity on account of less strict lockdowns as well as the fact that production will be coming up from a very low base, we expect GDP to rebound during Q3 2020, this is already being confirmed by available high frequency data. Downside risks to growth, however, remain. These include, amongst others, the reinstatement of stricter lockdowns in other parts of the world due to the resurgence of higher rates of the Covid-19 infection.

On a quarter-on-quarter and annualised basis, Agriculture expanded by 15.1% during the second quarter of 2020 following another increase of 28.6% q/q. As we have reported previously, agriculture has been benefiting from favourable weather conditions, while foreign demand has also been good, supported by its classification as an essential service during the country’s lockdowns. The sector is likely to continue performing well as the latest output estimates4 indicate that maize production, the sector’s key product, will be

37% higher in 2020 than it was in the previous year. At the same time, the wheat crop is also expected to be the largest since the 2008 season.

Still on the primary sector, mining contracted by 73.1% q/q on an annualised basis as production declined in all mining sub-sectors. This second quarter decline was preceded by another contraction of 21.5% q/q in the first quarter of 2020. Production in the sector was impeded by the national lockdowns, lower global demand (esp. from China), as well as the supply chain disruptions. We expect a rebound in mining production during Q3 2020. Already, high frequency data shows that production recovered by 20.3% m/m in July and increased again in August by 6.8% m/m. Furthermore, commodity price data shows that the international prices of platinum and gold, both important South African mining products, increased by 14.7% and 11.8%, respectively, from the second quarter to the third quarter. Nonetheless, the rolling electricity cuts by Eskom that returned as soon as economic activity picked up will have had a negative effect on the energy intensive sector.

Real manufacturing output declined by a staggering 74.9% q/q on an annualised basis, which resulted in the sector being the largest negative contributor towards the second quarter GDP growth. It is to be noted that

4 Crop Estimates Committee, Department of Agriculture, Land Reform and Rural Development

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production in the sector was already dampened by low domestic demand together with low business confidence prior to the second quarter. This is evident in the purchasing managers index (PMI) that had been in the contraction territory since August 2019. Production declined in all subsectors due to weakness in manufacturing being broad based. Production of motor vehicles, for example, was markedly impacted by supply chain disruptions, while the production of beverages and textiles were adversely affected by restrictions on sales, including a ban on alcoholic beverages for some time.

Even though Graph 6 shows that PMI rebounded into the expansionary territory in May 2020 following its

steep decline in April, this does not necessarily imply that activity in the sector had increased to pre-pandemic levels. However, as the monthly PMI survey questions are based on comparison to preceding months, the comparatively higher PMI values reflect the rising of activity as lockdown restrictions were increasingly loosened. Still, the rise does signal positive developments in the manufacturing sector. The significant increase in the new sales orders sub-index, for instance, shows an up-tick in demand as there was further opening up of the economy. Available monthly data indicates that production in manufacturing expanded by 5.9% in July and by 3.6% in August 2020. This does indeed point to the sector’s recovery in Q3 2020.

Graph 6: Purchasing managers’ index, Jan 2010 – Sep 2020

Source: BER and PAIRS

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Graph 7: Business confidence index, Q1 2000 – Q3 2020

Source: BER and PAIRS

Overall, the tertiary sector contracted by 40% on quarter-on-quarter annualised basis. The finance sector (finance, real estate and business services) that had not declined on a quarterly basis since the great recession of 2008/09 also contracted by 28.9% q/q, while trade declined by 67.6% q/q - both on annualised basis.

Domestic final demand recorded a contraction of 43.8% q/q on an annualised basis. This was its third consecutive decline following -1.2% q/q and -3.2% q/q during the fourth quarter of 2019 and the first quarter of 2020, respectively. The second quarter results came on the back of final consumption expenditure by general government declining by 0.9% q/q, while both final consumption expenditure by households and gross fixed capital expenditure plummeted by 49.8% q/q and 59.9% q/q, respectively.

Subsequent to the steep decline in overall demand during Q2 2020, high frequency data shows that retail sales increased by 0.6% m/m in July and by 4% m/m in August 2020. This points to the high likelihood

that overall retail sales rebounded during the third quarter. Although investment has been quite muted, President Ramaphosa’s “Economic Reconstruction and Recovery Plan” is largely centered around investment in infrastructure. During the announcement of the plan, he indicated that the initiative already had 276 projects by end of June 2020, with these prioritised for immediate implementation. These will also have the benefit of all regulatory processes fast-tracked. He stated that they would result in over R340 billion in new investment.

Business confidence improved in the third quarter following a significant decline in the second quarter. The (BER) business confidence index registered 24 index points during Q3 2020 after falling to an all time low of five index points in Q2 2020. The markedly better business confidence during the third quarter, together with the fact that the metric has typically had a close relationship with GDP historically, suggests that overall activity improved in the economy during the quarter, with GDP rebounding.

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South Africa’s annual inflation rate moderated slightly from 3.1% y/y in August to 3% y/y in September 2020. Because of muted domestic demand, demand-pull inflation has remained low, and we expect this to be the case until economic conditions improve and consumer confidence recovers. Cost-push inflation, in a similar manner, remains contained; the annual producer price inflation (PPI) for final manufactured goods only

recorded a 2.5% increase y/y in September 2020. One of the main factors for this has been international prices of oil that have remained subdued, causing fuel price to also stay muted. We expect these current features of the economy – lackluster domestic demand and muted producer prices, to continue to exert downward pressure on consumer inflation.

PRICES, INTEREST RATES AND EXCHANGE RATES

Graph 8: CPI and core inflation, Jan 2019 – Sep 2020

Source: Stats SA and PAIRS

CPI (y/y) Core Inflation (y/y) Inflation Targeting Band

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Graph 9: The South African exchange rate, Jan 2020 – Nov 2020

Source: SARB and PAIRS

The South African exchange rate has been strengthening since its sizable depreciation from end-March 2020 (on account of the sub-investment grading by Moody’s as well as the Covid-19 economic crisis). Since then the rand has gained some ground. As of Nov. 3rd, it had appreciated by approximately 18.6% against the US dollar since its lowest value of around R19.08 per US dollar in early April. Some of the factors contributing to this rebound include the fact that South Africa’s exports

have been relatively strong compared to imports. At the same time, South Africa’s strong institutions, including the South African Reserve Bank, are also helping the rand, while the risk from the country’s elevated debt is being moderated by the fact that government debt is largely rand denominated. Nonetheless, we still expect the South African exchange rate to remain volatile as the ongoing economic crisis unfolds.

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Graph 10: Selected emerging market policy rates: changes since 31 Jan 2020 in basis points

Source: SARB

At the beginning of 2020 the South African benchmark interest rate stood at 6.5% and the prime lending rate at 10%. With the global economic downturn, including South Africa’s own economic crisis due to the Covid-19 shock, the Reserve Bank cut interest rates consistently throughout 2020, implementing its last rate cut in July. The prime lending rate is currently at its lowest since the 1960s. As Graph 10 shows, South Africa’s interest rate cuts to combat the steep economic downturn was also relatively aggressive compared to many of its emerging market peers. Nevertheless, the country’s real interest rate remains at around 4% (as the consumer inflation

rates currently stands at 3%), and this still places it well above many developed economies’ interest rates, which is another factor benefiting the rand.

The Reserve Bank has alluded it is likely done for now with the interest rate cuts. It has however, communicated that it does not rule out any further rate moves should the need arise. In the meantime, inflation remains contained, and downward risks to the inflation outlook far outweigh upside risks, hence we do not expect monetary policy normalisation, at least not until H2 2021.

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The Fiscus

The Medium-Term Budget Policy Statement (MTBPS) presented during end-October 2020 confirmed the fact that South Africa’s fiscus has weakened significantly more since Budget 2020. With the shortfall in the revenue now projected at R312.8 billion relative to Budget 2020, the consolidated government budget deficit is projected at 15.7% of GDP for the current financial year, i.e.: FY2020/21. The large deficit is of course due to huge increases in expenditure on account of the Covid-19 pandemic – South Africa responded with a R500 billion fiscal package (10% of GDP). Nonetheless, government sees the deficit moderating to 7.3% of GDP in 2023/24 as it continues its efforts at fiscal consolidation once the fight against the pandemic is concluded. For instance, total main budget non-interest expenditure is projected to decline by R62.9 billion, R92.2 billion and 150.9 billion

during financial years 2021/22, 2022/23 and 2023/24, respectively.

Still, debt as a ratio of GDP is expected to reach 81.8% in during FY2020/21, which is an increase of 16.2 percentage points from the Budget 2020 projections. The debt is expected to stabilise in 2025/26 at 95.3% of GDP, assuming that government follows through with its plans of fiscal consolidation, together with the timely implementation of the economic recovery plan (see our Oct. 19th Report). Notwithstanding the plans to contain the country’s debt, Graph 12 shows that South Africa’s debt levels have become dangerously high even relative to its emerging market peers, having added more debt as a ratio of GDP than all the top 20 emerging market countries (with the exception of Argentina) over the past 10 years.

FISCAL AND EXTERNAL ACCOUNTS

1. Statistics South Africa, ‘Business impact survey of the COVID-19 pandemic in South Africa’, p. 6, 25 June 2020.

Graph 11: Gross debt-to-GDP outlook, 2016/17 – 2028/29

Source: SARB and PAIRS Note: * forecast

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Graph 12: Change in debt stocks of selected top 20 emerging markets

Graph 13: Average nominal growth in government spending, 2020/21 – 2023/24

Source: IMF, National Treasury and SARBNote: Based on the largest 20 emerging markets (based on PPP) South Africa’s 2019-21 debt projections based on the Supplementary 2020 Budget active scenario Argentina has no debt forecast for 2020-21

Source: National Treasury and PAIRS

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With this level of debt, debt service costs are expected to grow by 16.1% during FY2020/21 – FY2023/24, which is much higher than other important expenditure items such as economic development (4.6%), health (2.9%), learning and culture (1.1%) and general public services (0.6%). It is not only clear from this that the cost of servicing debt is crowding out these other expenditure items, but because they are vital for development, the rising debt levels are also endangering South Africa’s economic prospects.

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Despite the bleak picture outlined, additional risks to the fiscal outlook still remain. The first one relates to economic growth; also the Covid-19 pandemic has had a profoundly negative effect on South Africa’s economy. One of the main reasons for the upward adjustments to the expected revenue shortfalls is due to the worsening GDP projections. These went from 0.9% (Budget 2020) to -7.2% (supplementary 2020 Budget), then to

-7.8% (MTBPS). At the same time, risks to the growth outlook persist and questions still remain regarding implementation of economic reforms contained in President Ramaphosa’s economic recovery plan. Finally, implementation risks for reduction of the public sector wage bill, together with the financial difficulties still faced by state owned entities (SOEs), present another risk to the fiscal outlook.

External Accounts

South Africa’s current account deficit switched from its first recorded surplus since 2003 in the second quarter of 2020 to a deficit. This happened as the balance on the current account went from a surplus of R63 billion to a deficit of R104 billion, resulting in the current account as a percentage of GDP to go from a surplus of 1.2% in the first quarter to a deficit of 2.4%.

The change to a deficit was chiefly the result of South Africa’s trade surplus narrowing by more than half from R201.7 billion during the first quarter of 2020 to R91.5 billion in the second quarter. This resulted largely from the month-on-month trade deficit recorded during April 2020, and April was when South Africa’s lockdown level 5 was in effect, which resulted in very limited economic activity across the country. Overall, the deterioration in the trade balance came on the back of the value

of merchandise exports declining significantly more than that of merchandise imports during the quarter. Decreased volumes were responsible for the lower values of both merchandise exports and imports. Nonetheless, South Africa’s terms of trade improved to a record high as the rand price of exports increased while that of imports declined in the second quarter of 2020.

Global trade has been adversely impacted by the Covid-19 pandemic, and this is also evident in South Africa’s volume of exports and imports that are far below their end-2019 levels. During the fourth quarter of 2019, South Africa’s merchandise exports (including gold) amounted to R1,352 billion while merchandise imports amounted to R1,250 billion. However, these had dwindled to R1,090 billion for merchandise exports and R998 billion for merchandise imports in the second quarter of 2020.

Graph 14: Balance of Payments: trade balance (R millions) and current account deficit as % of GDP, Q1 2010 – Q2 2020

Source: National Treasury and PAIRS

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Variable Unit 2018 2019 2020f 2021f

Population Million 57.7 58.8 59.9 61.1Real GDP Per cent, growth 0.8 0.2 -8.1 3.2Unemployment Per cent of labour force 27.1 28.7 35.8 33.2Headline Inflation Per cent (avg) 4.7 4.1 3.3 4.0Repurchase (Repo) Rate Per cent (avg) 6.6 6.6 4.1 3.4Current Account Deficit Per cent of GDP 3.5 3.0 1.4 2.0National Government Deficit Per cent of GDP 3.9 6.3 16.7 11.3

Source: PAIRS, SARB, Stats SA Note: “avg”: average

FORECAST TABLE

With the third largest current account deficit of the world’s 40 biggest economies of 2019, South Africa is one of the world’s biggest users of foreign savings5. This is also despite its relatively low investment levels (gross fixed capital formation averaged only 19.3% of GDP from 2010 to 2019). Still, because of the country’s economic woes pre-pandemic (including the downgrade of South Africa’s sovereign credit rating to wholly junk status) as well as the current Covid-19 induced economic crisis, capital flow into South Africa has suffered. Foreign portfolio inflows declined by R97.6 billion during the first quarter of 2020, and by another R54.8 billion

in the second quarter. The outflow of capital has moderated since earlier in the year, but capital inflows remain muted. Market sentiment, especially towards emerging markets that are normally perceived to be riskier, will continue to weigh on capital inflows into South Africa, but the search for yield is still benefiting inflows to a limited extend. On the other hand, and despite dampened trade, high frequency data shows that South Africa’s trade balance recorded surpluses on monthly basis throughout Q3 2020 as exports continue to outperform imports.

5 South African Reserve Bank, 2020. Monetary Policy Review

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DISCLAIMER

Dr. Iraj AbedianPhD (Econ), SFU, CanadaChief Economistabedian@pan-african.co.za

Nthabiseng Tsoanamatsie M.Com (Econ), B.Com (Honours) Univ. of Pretoria, Senior Economist & Head of Researchntsoanamatsie@pan-africanresearch.co.za

THE RESEARCH TEAM