South African Violence Shakes Core Index Conviction

One of the most liquid emerging markets with the rand an asset class proxy, South Africa is battling its third wave of Covid infections as the country begins to set a plan for recovery from the massive rioting following the jailing of former President Jacob Zuma for contempt of court. For investors, the fallout from the worst violence since the end of apartheid is far-reaching. SARB Governor Kganyago, in announcing the sixth consecutive rate hold, noted the unrest and economic damage could have lasting effects on confidence. He added it “fully negated the 2021 Q1 growth outcome.”

Political and economic analysts widely agree that the rioting was spurred directly by Zuma’s jailing, but long simmering. The country is one of the most unequal in the world, with more than half of the population living in poverty and more than 20% food insecure. Unemployment has topped 32% and nearly two-thirds of those under age 35 are jobless, according to the government’s statistics.  The World Bank has noted that inequality has increased since the end of apartheid in 1994 and the so-called Gini coefficient measuring it ranks only behind Brazil.

The South African Property Owners Association estimates that the cost of the week of rioting could be as high as USD 3.4 billion after some 40,000 business were affected, including eleven warehouses and eight factories.  While President Ramaphosa’s government is working on a support package for impacted businesses and individuals, it is also seriously considering a basic income grant.  From a social and humanitarian perspective the concept is compelling, but from an immediate economic one it would only further pressure already the already high deficit and soaring debt.

The debt-to-GDP ratio has exploded in recent years from 53% in 2018 to 80%. The Treasury is predicting that debt service costs will rise more than 40% over the next 3 years and reach 16% of total state spending.  The fiscal deficit for FY20-21 was 14% of GDP, and Treasury planned to reduce it by one-third in the current fiscal year, an elusive goal before the riots.   Wage negotiations with public sector workers remain contentious while debt-laden power provider Eskom continues to weigh on public finances due to repeated bailouts.

Recent proposals to split Eskom into several entities and sell the state’s stake in South African Airways may offer brief reprieve. Eskom’s troubles will continue to weigh as contingent liabilities and drag down potential economic growth.  Last year South African experienced 859 hours of blackouts, according to PwC, which estimates that this year it will face a similar amount  reducing GDP growth by over 2% and costing 275,000 jobs.  The government last month announced relaxation of rules for the private sector to obtain licenses for their own power generation, but the process is lengthy and expensive, and renewable projects can take several years to complete.

In the markets, the USD 1.2 trillion Johannesburg Stock Exchange is down 3.6% in USD terms in the past 30 days, although it is up 5% year-to-date. The rand, which had been a top EM currency performer this year, has lost some 6% against the greenback since the beginning of June.  Foreign investors have sold more than net USD 7 billion in South African stocks and bonds so far this year with further outflows likely.  Although the economy has generally benefited from the commodity boom, the tourism industry, which accounted for 7% of GDP before Covid, will remain shuttered and popular beaches in Durban have now been closed even to residents on contamination fears from arson.

Debt and fiscal metrics will continue to worsen as the Ramaphosa government simultaneously battles another Covid wave and attempts to transform the economy to reduce poverty. Inflation is likely to spike above May’s 30-month high of 5.2% on new riot-induced domestic, in addition to pandemic-related international, supply chain disruptions. Reputational and economic recovery  may take years from the event repercussions, and chronic political instability and insecurity will further reinforce junk rating status once thought to be the post-independence wake-up call.

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