24 April 2020
By Peter Worthington, Senior Economist, Absa Group
The COVID-19 pandemic is cutting a swathe of economic devastation across the world; an unprecedented global recession now upon us. Unfortunately, South Africa, which was already in recession when COVID-19 hit, will not get away lightly. The second quarter of 2020 will mark a huge step-down in activity in South Africa, with only a gradual and partial recovery afterwards, given likely permanent firm closures, worker layoffs and impaired balance sheets
We now forecast real GDP to contract by 6.4% in 2020, more than double our -3.1% forecast a few weeks ago before the lockdown extension, manifesting via consumer spending, business capex and exports. The magnitude of the recession that South Africa is likely to suffer suggests that economic activity could take more than two years to return to pre-2020 levels – a huge welfare loss to the nation. And downside risks to growth still dominate, as weakness begets more weakness.
A recession this deep and long will ravage South Africa’s already-fragile public finances, as tax revenues crater and critical spending needs that cannot be fully financed by reallocation from within the existing budget envelope manifest.
Even before President Ramaphosa’s announcement of a much needed R500bn economic support package on Tuesday, we expected the budget deficit to hit a huge12.5% of GDP this year, and public indebtedness to surge upwards. Now, since only R130bn of the support package is to be met by reallocation within the 20/21 Budget expenditure envelope, South Africa’s deficit and debt ratios are set to rise even higher, although the R200bn loan guarantee program which forms a major part of the support package will presumably not manifest above-the-line, but rather only as a contingent liability of the government.
Still, with such a large budget deficit, financing is a critical issue. In addition to the R130bn reallocation, President Ramaphosa said last night that South Africa would also look to domestic institutions, citing specifically the Unemployment Insurance Fund. At end March the UIF had a net asset value of roughly R152bn at end-March, but it is unclear how much more cash it can supply, on top of the R40bn it is providing into the previously announced Temporary Employer/Employee Relief Scheme.
President Ramaphosa also said that South Africa was talking to various international financial institutions, including the IMF and the New Development Bank, as well as unspecified “global partners”.
However, the governing alliance has so far insisted that it will not seek any money from the IMF that comes with policy conditions, and so it will be interesting to see whether the IMF’s typical lending conditionality might be relaxed for COVID-19 related assistance. Overall, though, there is scant fiscal room to manoeuvre.
The good news is that while there may be limited fiscal space, there is still substantial room to offer further monetary policy support. The SARB has done a lot already. We estimate that the SARB’s 225bp of rate cuts so far this year will provide R35bn to consumers and R48bn to businesses, but of course these benefits flow only to debtors.
Additionally, just after the March MPC meeting, the SARB unveiled a raft of other measures, including, notably, a decision to purchase government bonds in the secondary market (on a limited but unspecified scale) and the relaxation of banks’ capital requirements, which it estimated would allow South Africa’s commercial banks to lend an extra R390bn or so (provided of course that there is demand for credit). These ancillary support efforts are unprecedented in scale and scope, a clear indication of the unusual times.
Fortunately, there is still more that the SARB can do if needed, especially since inflation is not a concern. We forecast a downside breach of the inflation target this year which is reason for the SARB to cut another 50bp at the May meeting. And of course, with the repo rate at 4.25% currently, South Africa is quite far from the zero bound on nominal interest rates, so if inflation surprises to the downside, or activity shrivels beyond expectations, then further policy cuts are a possibility. At this juncture the costs of not doing enough on monetary policy seem so much greater than the costs of doing too much. But, as the SARB frequently and correctly argues, monetary policy alone cannot save South Africa.
Once the health crisis recedes, South Africa will still need to wrestle its enormous budget deficit down and implement a raft of challenging structural reforms to reboot the economy. There are some hints that the government intends to ‘not let a good crisis go to waste’, essentially using the urgency of the crisis to implement policies that previously seemed just out of reach.
We see four reforms, which are already on the government’s agenda, as particularly critical over the next year to lift business confidence, boost growth and avoid further credit rating downgrades. The first is securing electricity supply in a liberalised market for generation. The government is now awaiting concurrence from the regulator on its plans, but more could be done.
The second is delivering regulatory certainty in the key mining sector, in part via an agreement on the ‘once empowered, always empowered’ standoff that is preventing agreement on the Mining Charter. The third is opening the visa regime for skilled foreigners once the travel ban is lifted. The fourth is the auction of broadband spectrum.
So far, the crisis has not sparked any evolution in the governing alliance’s thinking about labour market rules, but reformers in the ANC must understand that increased labour market flexibility is as key to job creation as much better government performance in delivering quality public education. Perhaps in the political ebb and flow moves towards greater labour market flexibility could be offset by a fresh look at a basic universal income approach to social welfare, especially if firms lay off lots of workers and growth is slow to recover. The commitments to top up social grants for the duration of the crisis could mark a step in this direction.
Indeed, many countries around the world have sharply stepped up direct cash payments to citizens to help them through the crisis and if weakness persists, these welfare approaches may need to remain in place. The fact is that after this unprecedented shock, the world, and South Africa face extraordinary uncertainty. No one knows for sure how long the pandemic will last, nor how long countries will have to continue with stringent social distancing and its terrible economic costs, nor what the multiplicative negative effect of the economic aftershocks will bring.
COVID-19 will force profound social, political, and economic changes across the globe. At this stage we can only dimly understand what they look like and what they are going to mean for our lives. It seems though that the assumption of an ever more hyper-globalised will be scrutinised more closely.
Local may become lekker for a huge range of products beyond the artisanal cheese at the farmers’ market. Nations may look to insure themselves by seeking robust self-sufficiency in terms of supply of foodstuffs and medical supplies. Materialistic consumerism may not survive. Anything that involves mass movement and aggregation of peoples may be viewed more dimly. Firms may rush to automate, and many types of work may remain online. In the interests of public health many governments may seek to increase monitoring of their citizens’ lives.
Some countries are likely to come through this crisis in a much stronger relative position than others. For South Africa, with its scant fiscal space, limited bureaucratic capacity and ongoing socio-political divides, all of which hobbled the country even before COVID-19, the challenges will be huge. However, it is early days still. Perhaps the challenge of COVID-19 will pull the nation together in a way that leaves it better placed afterwards to deal with its multiple challenges. Certainly, the broad-based support from all the social partners behind the support package offers hope in that direction.