South Africa

In recent months, the external sector in South Africa has strengthened in ways that are somewhat perplexing. The strengthening has partly to do with weak import demand due to the economic slowdown.  But the surprising aspect has been sustained inflows of foreign portfolio investment in South African domestic securities.  Just as the news on the real sector and fiscal balances has gotten worse, somewhat paradoxically foreign investors’ appetite for South African securities has grown. Negative reports on economic performance have been unrelenting -- recession and higher unemployment, biggest declines on record in manufacturing and mining, battering of the automobile industry, and a much-larger-than-anticipated fiscal gap.  Yet, the Rand stood at a 10-month high against the US dollar on June 30, whereas currencies in Brazil, India and Russia had lost much more ground against the greenback. The country issued a 10-year, US$1.5 billion bond on international markets in May, and it was oversubscribed several times over at a modest spread of 368 bp over LIBOR.  By end-June, foreigners had net purchased about US$4.5 billion of bonds and stocks on South African markets.

No doubt, foreigners are attracted by the country's good record on macroeconomic stability, financial sector discipline, and rapidly rising investment in infrastructure, although they may be deterred by its large current account deficit.  But that record has not changed in recent months. So what explains this seeming dichotomy between progressively bad news on economic performance and strengthening interest of foreign portfolio investors?  A penny (or 8 South African cents, which would have been 10 cents in April) for your thoughts.

A while ago we reported on the impact of the financial crisis on South Africa. Following the global trend, the last few months have seen the figures gradually getting grimmer, with the real economy taking the biggest toll.

GDP figures for the last quarter of 2008 came in negative (-1.8% seasonally adjusted and annualized), with manufacturing falling by a jaw-dropping 21.8%, the biggest slump since record-keeping began. The automobile industry (a large employer and the main contributor to international trade tax revenues) is down over 30% year-on-year; indeed, overall job creation is slowing down and jobs are being shed in some sectors. Mining production continues to fall, as global commodity prices remain depressed. Consumers’ expenditure is declining, credit extension to the private sector is slowing down, and housing prices dropping.

The government’s policy response was prompt. Finance Minister Trevor Manuel recently tabled a decidedly expansionary or “countercyclical” budget. While tax revenues are projected to decrease considerably, the budget shows a visible tilt toward social sector expenditure (housing, education, social protection, public works program and health). The country’s budget balance is now expected to reach -3.9% in 2009/10 (it was -1.2% in 2008/09 and +1% in 2007/08).

On the monetary side, the Reserve Bank announced that its Monetary Policy Committee will meet monthly (rather than every two months) during 2009. Soon after the announcement, interest rates were lowered for the third time in a row bringing the repo rate to 9.5%. Since December 2008, the repo rate has already declined by 2.5 percentage points. As inflation slows down and the economic outlook deteriorates, observers are expecting several more rate cuts in the coming months.

When the storm hit, South Africa had been sitting on relatively strong fundamentals and emerging from a protracted period of economic expansion. The meltdown allowed “not-so-well-hidden” vulnerabilities to surface. Unemployment, inequality, poverty, crime, and HIV/AIDS still continue to plague the country. Agriculture, mining and manufacturing declined while the trade and current account deficit (CAD) widened. Household indebtedness reached worrying levels in a low-interest rate environment and inflationary pressures mounted. Moreover, severe energy shortages erupted (inducing blackouts) and a tense political climate resulted in President Mbeki’s resignation.

In months ahead, the sustainability of the CAD and the impact of the crisis on the real economy will remain the key issues. The financial account has so far been sufficient to finance the CAD, but sudden stops of capital inflows are not unheard of in developing countries during hard times. While the free-floating exchange rate rules out insolvency issues, financing the CAD will be much more difficult and costly; on the other hand, lower global demand will hurt South Africa’s export-sector and the falling rand is not expected to significantly counter the decline.

The crisis has also impacted the real economy. House prices have been declining, along with vehicle sales. Manufacturing production has slowed, the mining sector is shrinking further, and retrenchments are on the increase. Growth is expected to slow-down which is a risky proposition for South Africa and for Africa as a whole. Luckily, the sound fiscal position will somewhat cushion the economic slowdown.

Sub-Saharan Africa received almost $12 billion in remittances in 2007, and that was only the official number. With "informal" flows added the total amount can easily be double that number. Nigeria, Kenya, Sudan, Senegal, Uganda and South Africa received the highest volume of remittances, while in smaller countries such as Lesotho remittances represent up to a quarter of GDP.

Remittance costs are significantly higher for Africa compared to other regions; costs can go up to almost 25% of the amount remitted. Remittances between African countries (from South Africa, for example) are especially expensive. Reducing these costs will mean substantial extra transfers, and this will be a focus of the World Bank’s medium term agenda on the African financial sector. The immediate concern is, however, stability of flows: the recent international credit crisis will lead to a slowdown in remittances. Remittances have generally been counter-cyclical in the past, as they tend to increase when the receiving country experiences adverse events.

But a recession in sending countries could hurt the capacity of migrants to send money home. It is still too early to determine if the latter factor will dominate and cause a decline in the total amount remitted, although there are some disturbing signs. High-frequency data on remittances for African countries are scarce, but available data show that remittances from the US seem to have slowed down in recent months; remittances from other sending countries, however, have not yet been affected.

Since some readers of this blog are senders of remittances, and others recipients, it would be helpful to hear how you see remittances changing  in the current situation.