An International Monetary Fund (IMF) team led by Ana Lucía Coronel visited South Africa during November 6-21, 2019 to conduct its regular Article IV consultation activities. Discussions focused on the economic performance and outlook; policies to strengthen economic stability; and reforms to reinvigorate private investment, growth, and job creation. In a statement issued, IMF sees a vulnerable outlook for South Africa.
Below are the key points highlighted in IMF’s statement.
A vulnerable outlook
IMF staff projects economic growth to remain sluggish in 2020—below population growth for the sixth consecutive year. On current policies, the medium-term growth outlook would remain subdued accompanied by somewhat muted inflationary pressures. With low growth and low job creation, the increasing labor force is projected to exacerbate unemployment pressures, poverty, and inequality.
Amid weak economic performance, credit expansion remains low, notwithstanding an uptick in unsecured loans. External debt and gross financing needs remain elevated, while external financing continues to be heavily reliant on non-FDI inflows. However, the relatively easy global financing conditions are providing breathing space to finance government operations.
Persistent challenges
South Africa’s undeniable economic potential remains largely untapped and the recent economic performance points to rising risks. The economy faces three immediate challenges:
• Persistently weak economic growth. Subdued growth is largely attributable to stagnant private investment and exports and declining productivity, mainly due to the slow pace of reform to address weaknesses in the business climate, including regulatory constraints, labor market rigidities, and inefficient infrastructure. Unreliable electricity supply has exacerbated the growth constraints. Small and medium-sized enterprises (SMEs) are especially disadvantaged in this environment.
• Deteriorating fiscal and government debt. Weak revenue and increased current expenditure have worsened the budget composition, and raised deficits and borrowing requirements, undermining the sustainability of public finances. This fiscal trajectory has also lifted financing costs across the economy.
• Major difficulties in the operations of state-owned enterprises (SOEs). Inefficiencies in SOEs operating in network industries such as electricity and transport, translate into costly inputs for businesses, and repeatedly require financial support from the fiscus.In sum, the reliance on government spending to boost growth has not delivered the anticipated results as the supply-side nature of the growth constraints has not been addressed. Moreover, government financing of SOE current spending is not growth-enhancing and has increased debt service costs that are now the fastest growing expenditure item, crowding out other forms of public spending. Thus, the economy has been left with high and rising debt, low growth, and limited fiscal space to respond to shocks.
Authorities’ policy response
The authorities are in the process of building support around a policy mix to boost growth, stabilize debt at lower levels, and increase the operational and financial efficiency of SOEs, particularly in the energy sector. The recently issued Medium Term Budget Policy Statement (MTBPS) candidly confirmed the fragile fiscal and debt situation amid weak tax revenue, rigid spending, and persistent operational and financial difficulties at Eskom and other SOEs. Tax administration has been strengthened and spending on goods and services has been rationalized. Some action has been taken to streamline regulation for mining exploration, ease visa restrictions for tourists, facilitate company registration, and initiate the allocation of broadband spectrum. However, substantive and coordinated reform implementation will be needed to lift South Africa from the low growth trap.
Reinvigorating economic performance
A more decisive approach to reform is urgently needed. Impediments to growth have to be removed, vulnerabilities addressed, and policy buffers rebuilt. Expediting structural reform implementation is the only way to sustainably boost private investment and inclusion.
The authorities have a window of opportunity to advance policy and reform initiatives. The FY20/21 budget to be presented in February should articulate measures to address fiscal and SOE challenges and stabilize government debt. Moreover, the Integrated Resource Plan and Eskom Roadmap should move to the implementation stage through coordinated action among all stakeholders to deliver an efficient energy sector that would ensure reliable electricity generation, remove pricing uncertainty, and provide private investment opportunities.
At the same time, IMF staff recommends timely implementation of the proposals contained in the discussion document on “Economic Transformation, Inclusive Growth, and Competitiveness” to improve the cost-effectiveness of network industries; foster firm competition; create conditions for growth in labor intensive sectors; and increase trade efficiency and competitiveness.
Restoring fiscal discipline
Consistent with the MTBPS, IMF staff projections show a debt path that exceeds 70 percent of GDP after 2022 and does not stabilize. Without fiscal adjustment to contain this debt build-up, increasing financing needs and sovereign risk would significantly raise borrowing costs, further crowd out growth-enhancing public and private investment, and weaken confidence, with adverse macro-financial spillovers.
Against this backdrop, fiscal consolidation of about 3 percent of GDP, mainly expenditure-based but supported by tax administration improvements, will be needed over a four-year period assuming that growth-enhancing structural reforms are adopted. This would arrest further debt build-up, and subsequently reduce debt to the levels of other investment-grade emerging economies. Lower borrowing would reduce the interest bill and provide space for higher infrastructure investment. To support consolidation, the fiscal framework should be anchored on a debt target to supplement the nominal expenditure ceiling.
The bulk of expenditure rationalization will need to focus on compensation costs and transfers to SOEs. All such transfers should be conditioned on improving governance and meeting well-defined quantitative operational and financial performance targets to ensure improved efficiency and service delivery. Efforts are also needed to improve spending efficiency, particularly on education and health, to deliver better quality public service.
Containing fiscal risks from SOEs
Rethinking the strategic orientation of SOEs with a view to restructuring, liquidating, or divesting them based on commercial viability is urgent. In the interim, SOEs’ financial performance needs to be strengthened by addressing the root cause of their inefficiencies.
Eskom, which represents an immediate threat to the fiscus, needs to speedily pursue savings in coal procurement and employee attrition; align wages with productivity; and collect arrears. Tariff regulations should be reviewed to make tariffs more predictable. Governance and accountability arrangements should ensure that Eskom management is empowered to adopt sound technical decisions. The planned turnaround of the energy sector will have to be supported by: (1) a fully competitive environment for electricity generation with private sector participation, including by accelerating the licensing of new private power plants and expediting the bids for independent power producers; and (2) transparently managed and independent energy transmission and distribution entities. Financial options that leave aside the needed operational and structural changes, such as debt transfers to special purpose vehicles, must be avoided as they would not address the underlying vulnerabilities and could act as disincentives to making the needed reforms.
Preserving monetary policy credibility
To continue to pursue low and stable medium-term inflation and credibly anchor inflation expectations in an increasingly uncertain environment, monetary policy should cautiously monitor both upside and downside risks to inflation. Upside risks relate to the effects of the drought on food prices and utility tariff increases. Downside risks are linked to protracted subdued growth. The impact of the loose fiscal stance on inflation needs to be monitored. Relative to other emerging markets, South Africa’s inflation volatility is affected mainly by inflation expectations and external prices, and less so by the output gap. As such, the structural nature of the growth slowdown has somewhat muted monetary policy transmission channels, narrowing the space for policy in either direction.
Improving governance and accountability
While progress has been made to improve governance, with significant steps taken to address state capture, more needs to be done to deter corruption. Efforts to strengthen criminal justice institutions, restore the integrity of key state entities, and empower the tax collection and prosecuting authorities are welcome and must be complemented with vigorous prosecution of those identified to have been involved in corrupt activities.
Expediting reforms
Reversing the trend decline in economic growth and creating opportunities for all South Africans will require cross-cutting product and labor market reforms. These reforms need to be appropriately sequenced. IMF staff analysis suggests that product markets should be reformed first as they can deliver the highest growth gains with considerable price benefits for consumers. These reforms will buttress private sector development, enhance competitiveness, and provide tail winds to support the needed fiscal adjustment.
• Renewed focus needs to be placed on reducing the cost of doing business. Streamlining SOE operations and sharing existing infrastructure in electricity, telecoms, and transportation with private operators will reduce high input costs and improve competitiveness. Untargeted subsidies and tax incentives for selected sectors should be replaced by a business-friendly environment that attracts competitive and innovative firms.
• Dominant market players need to be subject to healthy competition to reduce the high mark-ups in sectors lacking contestation and alleviate constraints that inhibit the emergence of SMEs. The pertinence of a range of regulatory requirements that unduly inflate production costs need to be reconsidered.
• Labor market rigidities should be tackled by decentralizing wage bargaining to help align wages more closely with productivity and reducing workforce management restrictions to align hiring and other operational decisions with business needs.
Time is of the essence
The vulnerable outlook emphasizes the urgency of rebuilding policy buffers and implementing reforms to put the economy on a sustainable and inclusive growth path. Failure to implement the needed adjustment in government and SOE spending and efficiency will worsen debt dynamics, erode financial stability, and further raise the country risk premium. With delays in structural reforms, growth and social conditions will worsen. Implementing the reforms now will benefit from the benign financing conditions in international markets and prevent disruption from an abrupt adjustment in future.
