South Africa: Latest Outlook Shows Urgent Need for Policy Reforms

IMF News, July 7, 2016

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South Africa has made considerable economic and social progress since 1994, but income inequality and unemployment "remain among the highest in the world."
Growth has waned in recent years due to external and domestic shocks.
In 2015, South Africa was hit by China’s slowdown and rebalancing, weak commodity prices, U.S. monetary policy normalization, leadership changes at the National Treasury, other political developments that shook confidence, and a severe drought that significantly reduced agricultural output.
Electricity shortages are easing, but deep-rooted structural problems—poor education outcomes, and product and labor markets that are out of reach for too many people—continue to hold back growth.

Growth slowed to 1.3 percent in 2015, the lowest since the global financial crisis and below most emerging market economies and commodity producers.
The IMF projects 2016 growth at 0.1 percent, which would mean a second year of falling per capita incomes.
A muted recovery is expected from 2017, "approaching 2-2½ percent in the outer years" as shocks dissipate and more power plants are completed.
With these projections, unemployment will likely rise over the medium term.

Downside risks dominate and stem mainly from China, heightened global financial volatility, and domestic politics and policies that may reduce confidence.
Shocks could be amplified by linkages between capital flows, the sovereign, and the financial sector, especially if combined with sovereign credit rating downgrades to speculative grade.
The United Kingdom’s decision to leave the European Union has further increased risks due to extensive financial linkages between the United Kingdom and South Africa and sizable trade linkages with the EU as a whole.
The report notes progress in dialogue between government, businesses, and labor, which could catalyze reform implementation and invigorate growth.

Structural reforms should be a priority to boost growth and jobs, in addition to addressing infrastructure bottlenecks.
Recommended reforms include:
- Greater competition.
- Labor market policies and industrial relations that work for a greater portion of the population.
- Better quality of government services—especially in education.
- Improved governance and efficiency in state-owned enterprises.
Job creation in small- and medium-sized enterprises is emphasized as "the best way to ensure a sustainable reduction in unemployment and inequality" because they are more labor-intensive and hire a relatively high share of low-skilled workers.
To generate reform momentum, the report suggests the government implement a focused set of tangible measures with a priority on boosting private sector employment.
Examples of short-term confidence-boosting measures: clarifying the regulatory environment in the mining sector and reforming state-owned enterprises to reduce policy uncertainty and increase confidence and trust.
Advancing reforms will require building trust among stakeholders, ideally via a social bargain.

Sources of resilience cited:
- Strong institutions and policy frameworks.
- The flexible exchange rate regime.
- Strong private corporate balance sheets.
- A high share of rand-denominated external debt.
- Well-capitalized banks.
- The large domestic institutional investor base.
Elevated vulnerabilities cited:
- The current account deficit "remains among the highest in emerging markets" despite beginning to adjust.
- Rising government debt, largely due to low growth.
- Financially-weak state-owned enterprises have increased fiscal vulnerabilities.
- Sovereign downgrades could trigger capital outflows.

The 2016 budget envisaged significant deficit reduction this year and next to stabilize debt.
The budget targets could be challenging to achieve if IMF staff’s less-optimistic growth projections materialize.
Any additional fiscal consolidation "needs to be carefully designed to minimize the negative growth impact and protect the poor."
State-owned enterprise reforms are essential to limit fiscal risks and to support growth; greater private participation and effective regulators could help improve state-owned enterprise performance and free up resources for investment.
The report concludes that "making a strong push on structural reforms is the absolute, urgent priority to put the South African economy on a path to improving living standards and create jobs."

IMF Country Focus — July 7, 2016