The downdraft currently taking place across emerging markets at large has been well publicised in the media of late. The ‘easy’ times of the past flowed courtesy of debt-driven consumption in the developed world (creating strong demand for emerging market exports), strong investment driven growth in China and the consequent commodity price boom. In this new environment, however, countries need to be productive and efficient in their own right in order to grow.
Both Brazil and South Africa fall short in this regard and need to address a number of structural impediments.
Brazil holds the ignominious distinction of having the world’s worst-performing currency so far this year. The South American giant is battling rising interest rates, weak growth and a deteriorating fiscal situation. The country has suffered from falling commodity prices and has made little progress in terms of productivity gains. Lower income with little cutback on consumption has resulted in a poor savings experience and this, in turn, has constrained investment spending.
The economy has become increasingly reliant on government spending. It seems that government spending makes up a significant component of GDP (around 26%) and that the bulk of this is not investment orientated and is inefficient in nature.
Of course, all of this, plus a clearly deteriorating credit rating, has led to upward pressure on interest rates at a time when the Brazilian economy desperately needs interest rates to come down. Public debt has risen and the interest cost on that debt currently gobbles up in excess of 7% of GDP. There is no happy ending if debt and interest rates continue to rise at their current trajectory.
The Brazilian economy suffers from a number of inefficiencies, including poor education and a lack of qualified labour, poor transport and energy infrastructure, a low investment rate (less than 20% of GDP), high production costs and poor corporate governance (corruption due to inequalities). It is in addressing these issues that a cure will be found for the country’s woes. A reduction in government spending is also necessary but would be extremely painful in such a weak economic environment. It would not prove popular and may be a bridge too far from a political perspective.
South Africa needs to look at Brazil very carefully because already there are many unhealthy similarities. The country suffers from a large current account deficit, is vulnerable to weak commodity prices and is overly reliant on foreign inflows to fund this deficit. Structural impediments include: constrained electricity supply, poor education (South Africa ranks close to the bottom of countries in terms of global maths scores), poor labour market flexibility, high unemployment and significant inequality (leading to corruption). The cost to export from South Africa is higher than average due to high costs emanating from inefficient ports.
The economy is weak and, following the most recent negative second quarter growth, is at risk of slipping into a technical recession. The consumer is under pressure and demand is soft, yet interest rates are on an upward trajectory based on inflation flowing from administered price increases (electricity tariffs et al). South Africa has, therefore, entered into a ‘stag-flationary’ environment. Normally interest rates should be coming down due to the weak state of the economy so it is unfortunate that this is not the case.
The fiscal side is also severely constrained. Government spending (which is far too consumption oriented) needs to be more subdued otherwise the country puts itself at risk of more credit rating downgrades. Lower tax revenue flowing from a weak economy is forcing the government to widen its net when looking for additional sources of tax revenue. This at a time when the tax base is already narrow (a small taxpayer pool produces the bulk of the country’s total income tax revenue) and overburdened. The cost of borrowing new funds has also now gone above the nominal GDP growth rate.
South Africa needs to look at Brazil very carefully because already there are many unhealthy similarities.
The solution to South Africa’s woes lies not in on-going currency depreciation - although that is likely to happen - but in addressing the structural issues mentioned above. The pain in addressing these issues will, ultimately, be very small when compared to the long-term pain likely to be experienced if these matters remain unresolved.
Before we get too negative, however, it should be noted that the potential of the South African economy is significant. Over 60% of the population is now of working age, so once the unemployment and education situation is successfully resolved then the sky is the limit. In September 2015 McKinsey Global Institute echoed this point in a new reported entitled South Africa’s Big Five: Bold Priorities for Inclusive Growth. The ‘big five’ opportunities are, according to McKinsey: Advanced manufacturing, infrastructure productivity, natural gas, service exports, and raw and processed agricultural exports. The McKinsey researchers believe these priorities “have the potential to raise annual GDP growth by 1.1 percentage points, adding R1 trillion (US$87 billion) to annual GDP by 2030 and creating 3.4 million new jobs over the same period”.
The McKinsey report adds: “Once the country has awakened these ‘big five’, they will stir new life and growth into the entire economy.”
How they stack up
Source: The World Bank, OECD, Statistics SA, Reuters, Business Day, Trading Economics, World Economic Forum, WITS
“The Brazilian economy suffers from a number of inefficiencies, including poor education and a lack of qualified labour.”