FROM WHERE WE STAND

The mood in South Africa currently is overwhelmed by the depressed sentiment that has arisen in the country since the middle of last year. Those familiar with the South African setting will know that there is much to be down about, including uncertainty surrounding the country’s political leadership, the collapse of Zimbabwe, power outages, Rand weakness, higher price inflation and, in sympathy with the global setting, a slower pace of economic expansion to the extent that there is a growing reference to ‘recession’ being on the horizon for the South African economy.
Given this backdrop, the note below, written with Gillian Findlay (of Cambial Communications and a lecturer at WITS Business School) offers a perspective on the implications of current events and sentiment for South Africans and investors in the country.
IS THERE AN UPSIDE?

We are bombarded on a daily basis with bad news about Africa in general and our country in particular. No, not just bad news, but often appalling or shocking news and, given this gloomy setting, it can be hard to see the region in a balanced light. Yet, there is a wide divergence between perception and reality and, although not attempting to sugar-coat the situation, the reality is better than common wisdom suggests.

WORLD GROWTH IS BETTER THAN IT SEEMS

First, the world economy might be slowing, but it will not come to a grinding halt as suggested by some doomsayers. Every year, the global population swells by 80 million. This increase in population is equivalent in size to Vietnam, Germany, the Philippines or Egypt. Assuming an average per capita income of US$ 7 000, this is equivalent to adding an additional Chile, Mexico, Lithuania or Poland to the world economy each year.

While not costless to the environment, from an economic perspective, a new population demands food, fertilizer, nappies, clothes, motorbikes, phones, electricity, credit cards, loans and other financial services. So this population growth will result in economic growth. Moreover, the demographic transition that has taken place in the United States, Europe and Japan (stagnant population size with increasing old-young dependency ratios) suggests that the world must look elsewhere for sustained economic expansion. In short, young, growing populations that are hungry for income, goods, services and wealth are good for economic growth, not bad.

Second, while some of the developed economies are seeing more modest growth, China (the world’s fourth largest economy) and India (the 12th largest) are still seeing growth in the region of 8%-10% per annum. Sub-Saharan Africa is achieving economic growth of 6.6%, well ahead of world growth of 3.7%, while the advanced economies are producing stalling rates of less than two percent per annum. Note that China, India and sub-Saharan Africa account for 55% of the globe’s population. Further, a growth rate of 7% a year means that every ten years the economy doubles in size. At current growth rates, by 2015 the world, then, will effectively have another Africa, another China and another India. By 2020 China will produce more cars than the United States.

Other pieces of evidence provide further insight into important trends. In 2007, global foreign direct investment (FDI) reached US$ 1.5 trillion. Of this, one third – US$ 0.5 trillion – was destined for emerging markets. Last year saw higher flows to developing economies (16%) and the former Soviet-bloc countries (41%), whilst FDI flowing into Africa was at a record level. Private capital inflows into Africa have increased fivefold since 2000. In support of this point, the recent African Development Bank and OECD African Economic Outlook 2008 concludes that, in spite of the emerging risks including rising food prices, Africa is doing better “due to favorable external environment but, as importantly, due to internal factors”. The continent’s prospects are brighter now, with new drivers of growth. The growing number of countries in Africa that have embraced democracy over the past 15 years reinforces this observation.

Without taking anything away from the problems South Africa faces, such as crime, the recent xenophobic attacks, soaring food and fuel prices, and rising interest rates, we should not lose sight of the fact that we live in an excellent neighbourhood and a thriving sub continent. How can this claim be upheld when Zimbabwe’s political fabric and economy have crumpled?

ZIMBABWE IS NOT OUR ONLY NEIGHBOUR

Considering South Africa’s neighbourhood, Angola has the fastest growing economy in the world. After recording growth in gross domestic product (GDP) in excess of 20% in 2005, and 18.6% in 2006, the country’s economy increased by 19.8% in 2007. To boot, the country has a current account surplus equal to 15.0% of GDP. Substantial investments are being made into infrastructure, meaning that, unlike many instances in the past, the commodity windfall is not being squandered. Consequently, in real terms, per capita income is soaring.

Elsewhere in our neighbourhood, the Mozambican former President Joachim Chissano became the winner of the inaugural Mo Ibrahim Prize for good governance and excellent leadership in Africa. The largest individual prize in the world, it is worth US $5 million for 10 years and US$200 000 annually for life thereafter. Chissano was hailed for his achievements in “bringing peace, reconciliation, stable democracy and economic progress to his country” and particularly that he stepped down after two terms in office. Although Mozambique remains dependent upon foreign assistance for much of its annual budget, and the majority of the population remains below the poverty, today the economy is growing quickly (7% in 2007) and this pace is expected to be sustained into the next decade.

Returning to the issue of governance, it would not be surprising if the next recipient of the Mo Ibrahim prize is Festus Mogae, the ex-President of Botswana, who handed over the reins to Ian Khama in April this year. The country has enjoyed many years of political stability, while being among the fastest-growing economies in Africa over the past 40 years and amongst the fastest growing in the world over the past 20 years. From being one of the poorest countries in Africa when it gained independence in 1966, Botswana has transformed itself, through sound macroeconomic policies and good governance, into a country with upper middle-income status. As evidence of this, Botswana has the third highest per capita GDP in US dollar terms on the entire continent and it is the 70th wealthiest country in the world on a purchasing power parity basis. These accomplishments have earned Botswana the highest sovereign debt ratings and the best Transparency International anticorruption rank in Africa.

Namibia, another of our neighbours, has an economy that has doubled in size since 2000. Further, a decade of steadily rising real per capita GDP means that, today, Namibia’s per capita income stands at more than double the average for the continent. Whilst the population size is small, the country has a well-diversified economy and a current account surplus equal to 13.7% of GDP.

Excluding Zimbabwe, all of South Africa’s neighbouring countries have seen a decade of uninterrupted growth. Contrary to the conventional view that South Africa is located in a rogue neighbourhood, we are located in a thriving quarter.

THINGS ARE NOT AS BAD AS THEY SEEM

Considering South Africa, the decade of uninterrupted growth in the economy is set to continue, albeit at a slower pace than in recent years. Whilst some commentators are suggesting that the economy could dip into recession later this year, based on available data this looks like an unlikely outcome (certainly, no better than a 20 percent likelihood at this stage). Further, if a recession materialised, it is likely to be short lived, and succeeded by the resumption of relatively high growth.

The reasons for our optimism on the growth front are wide ranging and well established. The investment drought is long over, with investment spending now close to the level of 25% of GDP required to produce growth of at least four percent per annum. Moreover, investment spending is supported by government and the private sector, which are massively expanding infrastructural capacity. The country has seen 15 years of structural adjustment with sound fiscal and monetary policy in place; over this time per capita incomes in South Africa have increase by 27%. Further, last year saw the first budgeted surplus ever and exchange control for the vast majority of the population has been all but abolished.

On the currency front, the rand looks falsely weak at current levels (circa R7.70 to the US$) as its correlation with commodity prices has broken down in recent months. But this relationship will be restored in time. Using purchasing power parity as a guideline, around R6.00 to the US$ looks closer to fair value for the Rand. Whilst this is not a forecast, it is possible that, with a recovery in investors’ appetite for emerging market risk, the Rand could head in this direction, driven by fundamentals and a yawning valuation difference relative to currencies of industrialised economies.

THIS MEANS THERE ARE GREAT OPPORTUNITIES

From the above, it is evident that the state of Africa continues to improve; and southern Africa is no exception to this point, with the sub continent have achieve massive advances in social, political and economic conditions in the past 15 years. This is not to say that the region is without problem – far from it. All of the countries in the region, including South Africa, have been starved of investment capital and social capital for decades and, in some places, generations. However, the direction countries in the region have taken since the start of the 1990s, with the exception of Zimbabwe, is clear and the improvement is sustainable.

Located in this increasingly benevolent neighbourhood, and being the beneficiary of ongoing structural reform and healthy fiscal and monetary policies, the case for the South African economy is sound. Recent setbacks to economic growth, disruptions in service delivery and more agitated price inflation should be seen in this context. Setbacks are part of the ordinary progression of economies. Investors who are able to see beyond the shrill, emotionally-charged reactions that such setbacks have brought about in recent months will do well.

By taking a balanced, holistic view of Africa and South Africa, we note that there is much to celebrate.