Speech

Remarks by David Lipton
First Deputy Managing Director, International Monetary Fund
at the University of Cape Town
Cape Town, South Africa, March 5, 2015

As prepared for delivery

Introduction

Good morning. Thank you, Professor Ellyne Mark, for your kind introduction. I am very pleased to visit the University of Cape Town and greatly appreciate your warm welcome. The beauty of your city never fails to impress, and South Africa’s hospitality is special.

It is always profoundly moving to visit your country to witness the extraordinary changes that have taken place since the 1990s. South Africa’s political and economic achievements speak to the capacity of people of diverse backgrounds to overcome their differences in pursuit of common goals. But it is also clear how much work is left to build an inclusive society. For example, despite the broad reduction of poverty since 1994, income inequality remains among the world’s highest.

When I was last in South Africa almost two years ago I spoke to the global and domestic challenges this country faces as it seeks to build the sustained economic growth needed to achieve higher living standards for all South Africans. I highlighted concerns about a world economy struggling to move past the 2008 financial crisis, and I spoke to crucial structural issues that are constraining growth here.

Today I would like to revisit these challenges.

Let me begin with a number: last year your economy grew only 1.5 percent. That meant that per capita income did not rise at all. It also meant that the unemployment rate—among the highest in the G-20 countries—is still about one-quarter.

What are the broader implications? It suggests that South Africa faces an uphill path to build a stronger and more productive economy. Despite the efforts of many of your fellow South Africans, despite the great hopes for Sub-Saharan Africa’s recent strong performance, South Africa continues to face sluggish growth that leaves millions behind. Moreover, the absence of crucial reforms leaves South Africa vulnerable to sudden shifts in the global economy.

This may sound a bit bleak, so I would actually like to offer you an optimistic message. There are many things your country can do to continue transforming your economy and society.

How to do this? Let’s take a step back and begin with the global economy, as it has an important impact on South Africa’s fortunes.

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Global Outlook

Global growth over the past year has been weaker than we had hoped in the wake of the 2008 financial crisis. Among the most important negative trends has been weak growth of emerging market countries, which is having an impact across the world. For 2015, the IMF has slightly reduced its forecast for global growth to 3.5 percent, rising to 3.7 percent next year.

There have been many factors at work, not all of them economic, including geopolitical shockwaves from Ukraine and the Middle East. Africa particularly has felt the sharp decline of the price of oil and other commodities.

As we all know, Europe continues to struggle, although growth was higher than expected at the end of 2014 and shows some signs of strengthening. Japan has experienced only modest growth. Among the emerging economies, China’s slower growth has had a significant impact on global demand; its growth is expected to moderate further in the coming year.

There was good news from the U.S., where a rebound is gaining strength, supported by lower oil prices, more moderate fiscal adjustment than we saw over the past two years, and continued support from monetary policy. But this tells us that the advanced economies are diverging.

Lower oil prices, while affecting different countries differently are, overall, good news for the global economy. Oil exporters—including those in Africa—are certainly feeling the pinch. But at the same time lower prices are giving a lift to oil consumers. This is reducing pressure on current accounts, budgets and inflation. This is the case for South Africa.

But overall, the risks in the global economy must be regarded with concern. Many of them are linked to financial market sentiment, which has compounded the vulnerabilities of oil exporters and the exposure of some countries to a rising dollar.

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Outlook for Sub-Saharan Africa

There is reason to remain hopeful about Sub-Saharan Africa, which remains the second fastest-growing region after developing Asia. Even with the reduced demand for commodities and slower growth among the emerging markets, most countries in the region are expected to maintain high rates of growth in 2015. Growth in the region should remain at about 4 ¾ percent this year.

This is important because Sub-Saharan Africa’s economic performance over the past 15 years has changed this continent’s outlook profoundly. High growth is partly a result of demand for commodities and investment from the emerging markets. But it also is the result of stronger governance and policy frameworks, the development of services and the financial sector, increased farm productivity, and investment in infrastructure. While some countries struggle to gain momentum—and the Ebola crisis has hurt the three most affected countries—Africa has done well and needs to continue on this path.

South Africa plays an important role in the Sub-Saharan African economy. Your companies are expanding rapidly to the north to benefit from the region’s robust growth.

This integration has been mutually beneficial. It has forged higher regional integration, encouraged competition, given rise to greater economies of scale, and filled the gap left by European banks in the syndicated loan market. Also, small and medium enterprises in South Africa – key to creating jobs – export predominantly manufacturing goods to Africa. South Africa has been a gateway to Africa, and retaining this position will to a large extent depend on domestic developments here.

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Outlook for South Africa

However, South Africa’s growth trajectory has not mirrored the rest of Sub-Saharan Africa. The outlook for 2015 and beyond is for continued sluggish growth. Private consumption should strengthen, partly supported by households’ higher purchasing power as inflation falls. This, of course, assumes that less income is lost to protracted strikes. But investment remains weak, and export performance is lackluster.

Last year’s 1.5 percent growth—the lowest since 2010—should rebound to 2.1 percent this year, again if industrial relations normalize. This is low by emerging market standards. Also, by comparison with those countries, South Africa’s current account and fiscal deficits are elevated and the unemployment rate among the highest in the world. About 1 in 4 South Africans is out of work, and 1 in 2 among young people.

Despite the progress in reducing poverty, there is a long way to go in tackling inequality. While a black middle class has grown up in the past 20 years, the average white household still earns about six times the average black household, and inequality within the African population has increased. Access to education has improved, but the overall quality continues to lag. This means that young workers are not equipped with the skills needed in the modern economy. Health standards also continue to lag.

South Africa is experiencing many of the same external challenges as other developing and emerging market countries: weak external demand and soft commodity prices. There have been home-grown shocks as well, such as the growing disruptions to the electricity supply and protracted strikes. These structural impediments explain why several institutions, including the IMF, are now estimating that potential growth in South Africa, a sort of speed limit for the economy, has come down to about 2-2.5 percent from about 3.5-4 percent some years ago.

Looking ahead, the consumption-driven growth model of the past few years is unlikely to be sustainable. No strong boost is expected from the rest of the world, and fiscal and monetary policy stimulus cannot lift growth and create jobs on a sustained basis. Only decisive progress easing structural impediments—increased electricity availability, more harmonious industrial relations, reduced skill mismatches, lower policy uncertainty, and greater competition in several sectors—can improve the living standards of South African citizens.

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Lower Oil Prices: Breathing Room

The current environment of low oil prices and falling inflation actually provides an opportunity for South Africa to address some of these challenges. Lower oil prices are helping to reduce inflation and the current account deficit, thus reducing vulnerabilities, but this development is unlikely to boost growth and jobs under the current structural constraints.

So how to take advantage of this breathing room?

That is where the structural issues I just mentioned are so important. In essence, what is needed is a fundamental shift in a core dynamic of the South African economy that brings together insiders and outsiders across product and labor markets. This can lift investment, growth, and employment.

In some areas, reforms are under way. The financial sector is a prime example: it has relatively high capital buffers, manageable exposure in the foreign exchange market, and diversification of its markets into Sub-Saharan Africa. However, the system is highly interconnected, dominated by a few institutions, and reliant mainly on wholesale funding.

The South African government has embarked on financial sector reforms that take a long view. For example, the new framework proposed in the Financial Sector Regulation Bill would apply across the banking, insurance and securities sectors. It aims to promote better coordination and cooperation among supervisors, including group-wide supervision that can make the system more robust given the prevalence of financial conglomerates.

In addition, a recent IMF assessment recommended upgrading the financial safety net. This will require enhancing the early intervention powers of the Reserve Bank and other prudential regulators, and introducing a deposit insurance scheme to encourage a shift from wholesale to retail funding.

Also, increasing competition in the financial system would make the sector more efficient. It could provide a greater supply of financial services at lower intermediation costs, particularly to small and medium enterprises and low-income households, which would contribute to more inclusive growth and more jobs. Small and medium enterprises in many countries provide the most employment, but not in South Africa.

The 2015 Budget—announced last week—has judiciously chosen the path of consolidation, without compromising spending on the poor and infrastructure. A gradual reduction in the deficit has become necessary after years in which public debt has increased very substantially and growth has disappointed. Consolidation will reduce vulnerability and ensure a stable macroeconomic environment—a necessary condition for growth. The budget also takes active measures that contribute to growth in a very direct and tangible way by prioritizing infrastructure and by improving service delivery, including on education and health. But there are risks, and only stronger growth will put public finances on a much stronger footing, which brings me back to structural issues.

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Structural Reforms

It is important for reforms to take a long and comprehensive view, building on the strengths of the private sector. The government already has a blueprint in the National Development Plan. But implementation needs to be stepped up in a consistent way, while reducing uncertainty about government policies.

Improving electricity availability is of paramount importance. The growing problem of power outages is debilitating for people and companies alike. Urgent action is needed to improve energy availability in the short term, while also working to address them medium- and longer-term issues. Government is also making efforts to strengthen the financial position of Eskom and improve its efficiency. Greater private sector participation in the sector and in infrastructure development could also help.

Besides infrastructure, increasing competition in many sectors, improving industrial relations, reducing labor market rigidities, and addressing skill mismatches remain key to reduce unemployments. This can make a difference for the outsiders in this economy: the unemployed and small firms.

Bold leadership is needed by all stakeholders to address these challenges. Business, labor and government each have a role to play. Wage restraint could facilitate hiring commitments, and provision of better quality education and training could reduce skill mismatches. Outsiders must be brought in – the unemployed must find work, entrepreneurs must create new firms, and investors must build anew.

These reforms would also foster manufacturing and closer integration with the rest of the continent—both government objectives to create jobs. This also would benefit SMEs that export to the north.

Addressing structural issues would also help strengthen South Africa’s macroeconomic policies. For example, the structural impediments have prevented the recent exchange rate depreciation from generating an increase in exports. An IMF study found that South African firms that are more electricity- and labor-intensive and are in sectors with less competition show a worse export performance for a given depreciation of the exchange rate and for a given level of external demand. This, in turn, has elevated external vulnerabilities and forced macroeconomic policies to play a greater role in reducing the current account deficit by lowering demand for imported goods.

In sum, addressing these structural impediments would help the economy boost growth, create more jobs, and adjust to shocks. This, in turn, is the most promising way to improve living standards and make the economy more inclusive.

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Conclusion

I am optimistic that the future of the global economy lies with the emerging market and developing countries. This places South Africa in a very advantageous position, because you bridge these worlds. You are an emerging market country—a respected member of the G-20. But so much more needs to be done to emerge on the world stage as a source of growth and prosperity in a time of great hope for Africa. The challenge for South Africa is to position itself to take advantage of this bright future.