TRANSFORMATION AND CHANGE
Where great expectations collide with risk, surprise and inequality
Politics, power and the economy have become intertwined in SA and investors may be in for a bumpy ride
One’s expectations can severely skew opinions on the outcomes of events. Set low (such as for the state of the nation address), it’s hard for them to be disappointed; set too high and they are bound to be disappointed. The issue of setting expectations hit home while I was on two recent trips in Africa – one in Nigeria and one in SA.
Friends seemed to have pretty low expectations for my visit to Nigeria and were pleasantly surprised, I think, that I hadn’t been kidnapped by Boko Haram or caught Ebola. While I had set my expectations a little higher, I was still surprised by the ease of getting around, the quality of the meetings I had and the people I met. The long queue for immigration was not unexpected. The quality of Nigeria’s roads was better than expected.
By contrast, SA is held to a higher standard, perhaps reinforced by the level of inequality. The shiny Gautrain, the quality of the roads, the pursuit of excellence at the best wineries or the stratospheric restaurant quality now available in Johannesburg and Cape Town.
These factors make the level of unemployment all the more stark and the lack of growth-supportive transformation of the economy all the more pressing.
It makes an investor’s one-and-a-half-hour-long immigration queue at OR Tambo (before getting on that shiny Gautrain) all the more frustrating — even if it’s the same length as in Lagos. The fact you aren’t asked for a bribe on entering the country makes allegations of corruption at parastatals all the more galling.
One response to this is to say that SA is held to too high a standard. Expectations should be lowered and some slack should be given to the government. But why? Especially when dumbing down means you are basically saying you are happy with unemployment staying higher for longer and that the country’s education or healthcare problems only need be solved in the medium term.
I think this is an especially important question when considering that SA (and the ANC) has or knows all the answers. SA has an amazing capacity to identify and solve its problems, and so must be held accountable for the lack of implementation of those solutions versus other demands.
The national minimum wage stands out in this regard because I think it’s widely understood that the key driver of inequality is the deep divide between the unemployed and the employed, between the formal and the informal sectors. The national minimum wage only serves to deepen these divides by presenting new hurdles. It overlooks the diagnosis of the wider problem of inequality by narrowing the debate to being only about the employed. It’s that narrow focus that leads me to find the national minimum wage unjust.
While it doesn’t necessarily surprise as a policy, that doesn’t mean it should be allowed to sail into implementation without the risks being highlighted. However, implementation expectations for the government on policy — good and bad — have now ground lower and lower, to such a level that complacency could be a key risk.
Good policy such as the Financial Intelligence Centre Act (Fica) amendment bill gets held up; bad policy such as aggressive land reform that reduces agricultural productivity is also not implemented.
This brings us back to this year’s state of the nation address, which was, at a very broad brushstroke, the same as last year’s on radical economic transformation. Implementation last year was very low on this matter. The same can be said of previous years back to Mangaung, Polokwane and the National Democratic Revolution document.
Is it any different now? That is the ultimate issue for now through to the elective conference and 2019.
The question is important for markets and investors, focusing the mind in the same way as risks around a Cabinet reshuffle. SA’s risk profile is characterised by a very skewed distribution. There is a high probability of an "okay" outcome (the "bumble along" scenario) in which investors can pick up carry, yields creep down and the rand grinds stronger.
However, there is then a range of decreasing probability outcomes that represent a worse and worse deal for the economy, unemployment and development. The market effect of such outcomes rises exponentially as you move out the distribution – basically until you get a Nenegate-style reaction.
This is the dilemma for investors. Do you take a small gain with the knowledge that this could be wiped out with a massive loss, but with a tiny chance? The answer is generally yes – as markets have a short time horizon and normally underprice tail risks.
You also need to earn a performance fee — sitting doing nothing or being short while you make a loss doesn’t quite cut it.
However, it is this skewed tail risk that has led analysts, ratings agencies and international institutions to spend so much time and effort analysing and parsing the shifts in the probabilities and natures of these outcomes. The ebb and flow of the balance of power and political capital has been especially important.
The radical economic transformation policy implementation question is harder. The capacity constraints of the government, the natural slow-moving nature of the process even at the best of times, and the fact there are countervailing policy views within the ANC and within civil society are counterweighted by higher levels of political necessity going into the elective conference.
The modal view may well be that nothing much comes of another year of promises of economic transformation of which the implementation fails. However, it is important not to discount the fact that even starting a process of policy change, a consultation, a laying out of difficult facts and implied policy paths, can have serious consequences for the sentiment of investors, particularly domestic private sector investors.
This has been seen at the macro level in the outflows of direct investment by South African corporates and, more specifically, in the mining sector, thanks to the policy process in recent years on the Mineral and Petroleum Resources Development Act changes and Mining Charter.
Negative outcomes are possible for the economy even without implementation. This is especially the case for the banking sector, where risk aversion can be felt through the whole economy in the availability and the cost of funding to businesses of every size, to job creation and households and tax.
The Fica bill and "account closing" issue have not had a serious effect on the banking sector’s risk aversion, but threats of wider policy change – especially to the banking social compact or black economic empowerment specifics in the financial industry – could have a more drastic effect.
It is partly for this reason that the Treasury and its executive function in financial sector legislation and regulation (alongside the Reserve Bank and, to an extent, the Department of Trade and Industry) have been so important in turning SA’s financial sector into one of the world’s most highly rated and safest. Such a prize could easily be lost and must be guarded.
That is not to say reform isn’t needed. Banks should constantly be pushing for greater financial intermediation and vibrancy of the economy, becoming a key driver of the formalisation of the informal shadow economy. But this should be built on the existing strong foundations, not achieved through undercutting those supports.
So expectations may be low for the actual implementation of further promises of radical economic transformation, but they could well be surprised to the upside this time and complacency should be guarded against. That in turn will have to be factored into the distribution of probabilities and outcomes for the economy, markets and politics.
Yet another reason why 2017 is set to be a fascinating, risky, complex year for SA.
• Attard Montalto is senior emerging markets economist at Nomura in London.