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Focus on...
Mark Appleton Global Head of Multi Asset Strategy

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A new dawn

16 Aug 2018
“I wanna be there when the people start to turn it around”.

Quoting a line from a song by the late legendary jazz artist Hugh Masekela, South Africa’s new President, Cyril Ramaphosa, delivered an inspirational State of the Nation Address in February 2018 during which he alluded to a ‘new dawn’.

“We should put behind us the era of diminishing trust in public institutions and weakened confidence in leaders,” was a key statement to come out of the address. Statements such as this show that President Ramaphosa is clearly keenly aware of the issues facing South Africa, and appears to be sensitive to the challenges ahead. During his first address as State President, he spoke of a necessary collaboration between business and labour, the need to ensure economic growth, and a requirement to encourage significant new investment. In addition, he indicated that some tough love was needed to close the fiscal gap, stabilise debt and restore state-owned enterprises to health. 

These statements were like a breath of fresh air. A new leader with a credible vision was always likely to be seen as a positive by investment markets, and so far, this has proved to be the case. 

At the end of the day it all comes down to good governance. Investing in a country is like investing in a company. Over and above the business case there has to be a competent and honest management team that can be trusted to deliver on strategy. Unfortunately, over the past few years when the rest of the world has been enjoying significant economic vitality, South Africa has been dogged by a lack of confidence both from the consumer and business. The consequence has been a declining private sector investment experience.

The consideration now is just how bad this decline has been? What’s it going to take to turn it around? And just how good can it potentially get?

South Africa’s potential gross domestic product (GDP) growth rate has slipped from around 3.5% (1995 to 2008) to less than 1.5% by some estimates from 2010 onwards. This is barely ahead of the population growth rate.

Economic growth is a consequence of people plus productivity. South Africa has the people (in fact the country is in a demographic sweet spot) so it is now all about unleashing productivity. So how do you do that?

The ingredients needed to unlock this potential include: 
• Increased investment typically leads to increased productivity. A constraint is that low levels of disposable income lead to low domestic savings and consequently low investment. Attracting foreign investment is a way to break out of this conundrum. South Africa is capital hungry and a demonstrable move to good governance will go a long way in achieving this.
Efficient financial markets play a crucial role in allocating capital to investment markets. Fortunately, this is one of South Africa’s strong points.
• Political stability, rule of law and the protection of property rights. A lack of any of these, ​ debate is, however, a potential threat but hopefully it will be dealt with in a responsible manner.
Education and healthcare. Poor quality education constrains skills and productivity. There is a clear recognition of this problem in South Africa and free tertiary education coupled with a potential partnership with the private sector should see an improvement in producing skilled workers. Poor health is another impediment to growth and a move to national health insurance (albeit complex from a funding perspective) would be positive in the long term. 
Tax and regulatory systems play a significant role in supporting economic growth. Lowering barriers to entry from a regulatory perspective would be a big plus for South Africa’s economic growth. More efficient government and higher economic growth would likely lead to lower potential tax rates over time, which would reinforce a virtuous economic cycle.
Free trade and unrestricted capital flows. The more open the economy the more global savings can help to finance domestic investment. 

 

If South Africa gets it right, then the upside potential is enormous. Let’s try to quantify this. Starting with our 1.5% potential growth rate as our base the following could potentially be added:
• 1.5% - current potential growth PLUS
• 0.5% - from mining and manufacturing on the back of improved confidence PLUS
• 0.6% - from telecommunications reforms PLUS
• 0.6% - from competition policy and research PLUS
• 0.3% - from transport reforms PLUS
• 0.2% - from enhanced agriculture and tourism AND 
• In addition to the above: privatisation, education and labour reform could add even more potential growth.

So, South Africa could possibly get to a potential growth rate of 3.7% or more.

If this were to happen, what would it mean for investment markets?

Potential GDP growth is a critical input with respect to evaluating the investment appeal of various asset classes and the securities that make up those asset categories.

A high potential growth rate means that strong economic growth can be achieved without triggering a strong inflation effect. This means that the Central Bank does not have to raise interest rates to quell this pressure. Low inflation and low policy rates are clearly positive from a bond market perspective.

From an equity perspective, the effect is marked. High levels of economic growth underpin revenue and earnings growth potential and low discount rates (low interest rates) mean that the present values of those buoyant future earnings streams are boosted.

Implementation is key, but if South Africa can get it right then a new dawn will most definitely have arrived.

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