Deterioration of South African’s economic prospects raises fundamental questions

Old Mutual Investment Group Chief Economist, Rian le Roux. Old Mutual Investment Group Chief Economist, Rian le Roux.

While global growth’s current sluggishness is not ideal for South African economic prospects, there are more concerning local factors to consider here at home. This is according to Old Mutual Investment Group Chief Economist, Rian le Roux, who says that issues such as electricity shortages, South Africa’s worsening competitiveness, labour troubles and the poor relationship between government, business and labour are holding back the country’s chances of structural reform.

January’s macro-economic environment offered stronger global growth and surprisingly better prospects for South Africa, with slightly faster growth, fiscal and current account consolidation and improved financial stability. However, since then we have seen disappointing global growth, a bounce-back in the oil price, widespread global rate cuts and a firming of the US dollar.

Closer to home, current account concerns have been mounting, the Budget disappointed, inflation has worsened – meaning we can most likely expect more hikes – and the growth outlook has fallen, as has the rand, says Le Roux.

“Yes, global growth is soft. Current IMF predictions for the year are around 3.5%, marginally up from 3.4%.  However, it is notably slower than the 4.7% per annum recorded in the 2002 to 2007 period, when it strongly stimulated the South African economy.”

While global growth is not great, Le Roux explains that this is not really the main problem for South Africa. “Looking at the global arena, the key issues South Africa is facing include the Chinese slowdown and the firming US dollar as these have had a major negative knock-on effect on commodity prices and demand,” he says.

“Current estimates for our growth potential are only 2%. We need 5% at least to cater for the expanding workforce and even more to accommodate the already large pool of unemployed people.

However, the burning question for Le Roux is whether hopes for a structural improvement in South Africa’s fortunes are fading away. “We are seeing sticky twin deficits and a Budget that is squeezing infrastructure in favour of current spending. Compounding these issues are worsening electricity problems that will last longer than previously believed, as well as no visible improvement in South Africa’s fractious labour relations,” he explains. “In addition, South Africa’s lack of competitiveness is deteriorating, with surging electricity and wage costs, and new headwinds are proving challenging for tourism and trade following the recent wave of xenophobia.”

Le Roux believes there is little urgency to implement growth-enhancing economic reforms, despite all these structural challenges. “It is also concerning to see a decided increase in pressures to drift in a populist direction.”

However, given this situation, it is easy to forget that the country still has a number of structural strengths held in high regard among local and foreign investors.  “The trouble is the raft of problems I mentioned earlier.  But, as many of these are self-inflicted, they should also be solvable through decisive policy action.”     

Also presenting at the media briefing, Paul Boynton, CEO of Old Mutual Alternative Investments, said that South African institutions are, on average, lacking significant commitment to alternative assets and private equity investments, with many funds having no exposure at all. However, since 2000, Old Mutual has steadily increased the percentage allocation of its total investment portfolio to alternative assets including private equity, infrastructure, impact investments and natural resources.

Old Mutual currently has a target allocation to alternative assets of 10% and an existing exposure, which is just above this target.  In comparison, Calpers, which is the largest US pension fund and one of the world’s largest private equity investors, has a target asset allocation of 10% to private equity and 1% to infrastructure.

“In the late 1990s, we ventured into infrastructure because of the long-dated nature of the assets as well as the potential they had to provide above-average returns. We also saw the merit in investing in assets that had a positive economic spinoff – improving infrastructure should help boost GDP growth,” says Boyton.

“We later became a more active player in traditional leveraged buyouts and growth capital private equity, predicated on the belief that high investment returns would be achieved. More recently, we have been attracted to renewable energy projects, including wind, hydro and solar developments.

“Though private equity is considered an illiquid asset class because of the length of time it takes to realise returns, the significant return premium is more than sufficient compensation.  Old Mutual’s experience should encourage more funds to consider an allocation.” Boynton explains.

Since 2000, Old Mutual has invested R7bn in private equity and infrastructure funds and R11bn in direct deals in both private equity and infrastructure, an aggregate investment of R18bn. Boynton says that their investment strategy has paid off, having realised a profit of R15bn over the past 15 years from these two asset classes alone.

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