Not all gloom for SA’s economy
The SA economy is hanging onto a few life rafts. Policymakers should use them to boost the country’s growth story
SA’s economy may be in the doldrums, but there are at least three bright spots that could make a difference: new investment by renewable energy producers could boost GDP; soaring platinum group metals (PGM) prices are making mining more profitable; and significantly lower inflation should beget lower interest rates.
"I’m increasingly starting to think that green energy may be our saviour," says Bureau for Economic Research (BER) chief economist Hugo Pienaar.
He believes fresh renewable energy bidding rounds may generate hundreds of billions of rands of investment over the coming decade, kick-starting an investment-driven recovery at a time when other sectors are constrained by a lack of consumer demand.
Round 4 of the renewable energy programme generated R56bn in independent power producer (IPP) contracts. Construction on these projects explains the steep increase in SA’s fixed investment numbers in the middle of last year, after five quarters of continuous contraction.
The government’s 2019 Integrated Resource Plan determines that SA should connect another 11.6GW of new generation capacity by 2025, of which 90% must be wind and solar photovoltaic. To build all that would translate into investments worth about R480bn-R500bn, by the estimates of renewable energy expert and Kabi Solar CEO Mike Levington.
But the problem, Levington explains, is that wind and solar projects have traditionally been located in the rural Eastern and Northern Cape, not in big-load centres such as Gauteng, where power is most needed.
To transport the power there, Eskom will have to make large investments in the grid, which could take years to complete.
Levington thinks it unlikely that Eskom will be able to move more than 1GW of wind and solar from the Northern Cape by 2025. So, it will be important to position new renewable projects closer to Gauteng.
Minerals Council SA chief economist Henk Langenhoven agrees with Pienaar about the potential for IPP investment to boost SA’s growth rate, noting that mines and smelters stand ready to add 1,200MW of self-generated power to the grid over a two-year window.
However, they are being held up by red tape and Eskom’s wheeling costs — the costs of transporting self-generated power through the grid to firms’ operations — which are "so exorbitant it makes self-generation completely unviable", he says.
All these channels will have to be unblocked before SA can reap billions of rands in new IPP investment.
The BER is also excited by the surge in PGM prices, driven by demand from car manufacturers, for use in autocatalysts. These filter toxic fumes to meet stringent new global emission standards, especially in the US and Europe. China will adopt these standards next year.
Vunani Resources mining executive Hurbey Geldenhuys expects PGM prices to remain strong for another five to seven years, buoyed by the fact that there are few new investments in either the local or global pipeline, and that it takes this long to bring new production on-stream.
He expects the palladium price to rise from about $2,200 an ounce now to $3,500 over the coming year, and rhodium to rise from just under $10,000 an ounce to $12,000. On an 18-month view, he expects platinum to climb from almost $1,000 an ounce to $1,500.
Geldenhuys concedes that the outbreak of the coronavirus in China has knocked commodity prices off their highs (not to mention the scything impact it is having on tourism and global growth), but even in Vunani’s worst-case scenario — in which there is future weakness in US, European and Chinese car markets — new demand for PGMs remains robust.
If sustained, Pienaar believes higher PGM export prices could bolster SA’s economic growth rate.
Though the PGM sector is thought of as a small part of SA’s mining industry, it provided R80bn (23%) of the sector’s R350bn contribution to SA’s overall GDP in 2018. By comparison, coal provided 27% and gold 14%. (The overall mining sector contributes just under 8% of the country’s GDP.)
Last year, the PGM sector increased its share of total mining sales by 19% compared with 2018. Coal’s share dropped by 4% over the same period.
"If these [high PGM] prices are sustained, it could give us a terms-of-trade boost in the foreseeable future, which could also have quite a significant impact in terms of reducing SA’s current account deficit," says Pienaar.
"This could be important in a year in which SA is likely to be downgraded [by ratings agencies] because it would reduce our external financing needs."
But despite the current PGM price windfall, Langenhoven remains concerned about the longer-term viability of SA’s mines, noting that "though commodity prices are spiking, underneath costs are rising like a flight of stairs".
The problem is that about 45% of mining costs are administered or regulated by the state. These include fuel, water, rail and port charges. These administered prices continue to grow by about 7% a year compared with core inflation (consumer inflation excluding food and fuel), which in December fell to just 3.8% year on year — its lowest rate since June 2011.
In addition, Langenhoven points out that the mines are finding it increasingly difficult to ramp up their production in response to higher commodity prices given the structural hurdles they must overcome, especially those related to the expansion of electricity and water supplies.
Geldenhuys says there are only two big SA mines that will be able to increase production of PGMs significantly into the rising market: Northam and Sibanye-Stillwater.
"But all SA mines will do exceptionally well," he says. "We’re already seeing margin expansion in all PGM mines and balance sheets being restored to healthier levels."
The jury is still out as to whether SA has experienced a permanent shift lower in inflation, but the statistics are compelling.
The consumer price index (CPI) has now been inside the target band for 33 consecutive months, since April 2017, and close to the midpoint of 4.5% for 13 consecutive months, since December 2018 — both the longest stretches on record.
After the 2008 global financial crisis, inflation expectations became stuck at the top end of SA’s target range, at about 6%, and indexation set in — prices and wages were locked in to grow at 6%. This meant that inflation never fell much and so, in turn, interest rates stayed structurally high.
But inflation expectations have been falling for three consecutive years and are converging towards the Reserve Bank’s target of 4.5%. Last year, consumer inflation averaged 4.1%, its lowest rate since 2005, when it was held down by a very strong rand.
The main long-term benefit of structurally lower inflation is that it should result in structurally lower interest rates. Reducing the cost of borrowing should reduce the hurdle rate for investors, spurring investment, growth and job creation — at least in theory. It should also gradually improve SA’s global competitiveness.
Old Mutual Wealth investment strategist Izak Odendaal explains that over the past few years, the combination of weak consumer demand, intense competitive pressure, low global inflation and technological disruption has greatly reduced the pricing power of local businesses. Inflation has tumbled as a result.
However, when countries experience a big inflation shock, everyone is usually slow to adapt, he says. And, for many, the process of adjusting to lower inflation is painful.
"Everyone — government, business, individuals — was working on an assumption of 5%-6% inflation, and therefore nominal GDP growth of about 7% a year," Odendaal says. "Now that inflation is 4%, there are big shortfalls in expected tax revenue on the government’s side, while top-line growth for SA Inc has slowed substantially too."
Part of the problem is that administered prices are still growing strongly. Therefore, the cost line for some businesses is growing faster than their top line. Landlords, for instance, are experiencing sharp downward pressure on their rental income while electricity and municipal tariffs, which form a large part of their expenses, continue to grow rapidly.
What it means:
Viruses come and go; SA must attend to its fundamentals
There is much debate about whether the Bank’s policy settings remain too tight, but business says the cost of capital is not the main constraint holding back economic growth.
"To really raise the growth rate," says Odendaal, "we need to tackle the long list of structural reforms: infrastructure bottlenecks, lack of skills, woeful public services at local government, unnecessary red tape, inefficient cities."
So, though the fall in inflation has laid the basis for structurally lower interest rates, SA has not done enough to lower the cost of doing business and raise its competitiveness to spur higher investment.
As a result, fixed investment will likely remain lacking except in a few key areas — such as renewable energy.
In short, in an environment of high policy and political uncertainty, in which confidence and demand have collapsed, it will take more than lower inflation, high commodity prices and the prospect of a renewable energy splurge to reignite growth — especially with a global pandemic looming out of the East.
But at least these three bright spots provide a sign of life in a moribund economy. If SA’s policymakers could clear the obstacles, these nascent trends could develop into more generous growth drivers.