When You Come to a Fork in the Road, Take It

The title of this blog comes from a witticism attributed to Yogi Berra, Baseball Hall of Fame New York Yankees catcher and philosopher. The saying could be sage advice for South Africa about its future. Recent elections ended the hold the African National Congress (ANC) had on South African governance. While the ANC ended apartheid in South Africa and has governed the country since 1994, years of deteriorating economic and social conditions cost the ruling party its parliamentary majority after the May 2024 elections and forced the formation of a Government of National Unity (GNU). The ANC remains in control, but the question is: will the GNU take the fork in the road to benefit the country?

A Recap and the Market’s Reaction

The ANC’s loss of support was not a huge surprise. The party’s vote share has been slipping since 2004, and 2024 election polling indicated a high risk of the ANC losing its parliamentary majority. The expectation was the ANC vote share would fall below 50% but still allow the ANC to cobble together a government with one or two of the smaller parties. Instead, the ANC garnered just 40.2% of the popular vote, claiming only 159 seats in a 400-seat national assembly. Coming in second was the more market-friendly Democratic Alliance (DA), followed by former President Jacob Zuma’s uMkhonto weSizwe (MK) party.

Against this backdrop, Cyril Ramaphosa was reelected president of South Africa with the support of several political parties, including the DA. Next, Ramaphosa formed the GNU with the ANC and 10 other political parties. The most important participant in the GNU is the DA. Its more business-oriented focus should gain support for the GNU from the business community. In the GNU cabinet formation, Ramaphosa increased the number of ministers from 30 to 32. The dominance of the ANC in the coalition government, with 20 cabinet posts, including the key Finance portfolio, ensures policy continuity.

Coalition governments come with their own problems, however. The most obvious is that different political parties have differing views on what are the appropriate government policies. National health insurance is one such policy. The country’s National Health Insurance (NIH) Bill, signed into law by President Ramaphosa prior to the election, has been roundly criticized by the DA as expensive. The DA supports universal health care, just not the legislation that became law and now needs to be funded. Other contentious issues are likely to arise with some issues potentially leading to a breakdown in the GNU.

South African asset markets rallied following the May elections and the GNU formation. The prospect of a coalition government appeared to be the catalyst behind the rising asset prices. Investors likely concluded the GNU would check the ANC’s power and help move the country forward by addressing social risks, pursuing tax reform, controlling spending, and reinvigorating infrastructure.

A look at South African sovereign bonds validates investor support for a new government. Exhibit 1, which subtracts the US 10-year Treasury yield from comparable South African 10-year yields, shows an impressive compression in yield spreads. The shaded area represents +/- 1 standard deviation of that spread, a possible indication of a value anomaly or the absence of one. Around the time of the new government formation in early June 2024, the South African yield was 12.3%. In the period following the formation of a government, the yield plunged to 10%, creating that sharp contraction in the yield spread and the sizeable drop in the South African risk premium. Stocks and the currency joined the party. During roughly the same calendar period, the FTSE Johannesburg Stock Exchange (JSE) Index rose over 34% and the currency, the South African rand (ZAR), produced a total return of 7.2%, trailing only the performances of the Thai baht and the Malaysian ringgit.

With investors initially appearing to encourage the new government, it was no surprise that overall confidence in the economy benefited from what appeared to be a political sea change (see Exhibits 2 and 3). Consumer confidence broke out of what had been a trading range. Business confidence has moved higher, too, but the gains have been more muted than the consumer exuberance. Clearly, however, consumers and businesses believe the election could mark a significant change for South Africa’s people and its businesses, initiating long-term, positive structural changes in the economy beyond the business cycle. The GNU has a lot to deliver on. Can it? South Africa has arrived at the fork in the road.

An Economy Punching Below Its Weight

While the asset markets and confidence measures are certainly positive, they are feelings, or soft data. For now, no new jobs were created, nor has output risen. That should follow, but the current reality of South Africa is something a bit different than the rally in asset markets might portend. South Africa’s economy continues to grow significantly below its trend (see Exhibit 4). That economy has produced an unemployment rate of over 30% with a youth unemployment rate that is much higher—over 45%—according to the Statistic South Africa Department. The country simply has not been able to produce sufficient jobs for its population. Growth recently has been erratic.

How then can South Africa grow, helping create the inclusive growth that the government wants? It needs to improve its potential economic output. Businesses need to invest—to invest in plants, equipment, and people. Furthermore, the government needs to respond, where possible, by investing in infrastructure. Growth has been sluggish, seemingly stronger one quarter, weaker in the next. The poor infrastructure, including an electricity constraint and railroads and ports in dire need of investment, along with a lack of fiscal space—the availability of government resources to provide goods and services—continue to hamper economic growth. The country’s fiscus, which refers to the way the country manages and allocates public funds, and high debt are limiting factors. Exhibit 5 shows the sluggish gross capital formation across both the private and public sectors. That is the investment that drives job creation, productivity, and inclusive economic growth. Can improving confidence help generate real economic activity?

South Africa holds the dubious distinction of being one of the most unequal countries in the world. The World Bank has estimated the country’s Gini coefficient, a measure of income inequality, to be 0.63, on a scale of 0 to 1. That coefficient is high, meaning that South Africa has a highly unequal income distribution that sees a small portion of the population controlling a large share of the country’s income. Such an unequal income distribution limits social mobility, with the potential to produce social upheavals, and restricts economic growth.

One more chart closes this part of the story. Exhibit 6 shows a cross-sectional country analysis. State capture, a type of political corruption, was a major influence on the South African economy, and that negative influence continues to hang over the economy to this day. Where corruption is a high risk, other things equal, economic activity and growth can be negatively affected. The chart below would appear to validate that simple hypothesis. This exhibit shows a risk index (0 is extreme corruption risk and 10 is no risk) on the x-axis and gross domestic product (GDP) per capita on the y-axis. The relationship is a clear, positive one: corruption constricts GDP per capita, aggravating the already high unemployment and weak investment. And risks like corruption can raise the interest rate South Africa must pay on its debt. If South Africa could reduce corruption risk, it could create higher per capita GDP, all part of a necessary structural reform process.

The Alpha and the Omega

The election and the creation of a GNU were necessary but not sufficient conditions to bring about economic and social changes in South Africa. However, it is clearly a beginning. The positive response to the election by consumers, businesses, and the markets speaks to the thirst for change in South Africa. Some earlier changes in the economy could help create the necessary environment for the current government to finally start South Africa down the path toward improving the country’s potential. Will businesses invest? Will consumers spend? Can the GNU foster a fertile backdrop that can create economic incentives?

An Electricity Crisis Sparked Changes

Frequent planned and unplanned load shedding, essentially electricity interruptions or blackouts, plagued 2023 and impacted both households and businesses. Business production and shipping were hit, and the economy barely posted any growth last year. Aging generation capacity was shut down for maintenance, and coal destined to power plants was stolen, a real example of corruption’s effect. A combination of plants coming back online after maintenance and private investment in renewables lessened the energy constraint, an outcome fostered by Ramaphosa’s energy reforms. Energy availability has risen dramatically, noted in electricity production gains (see Exhibit 7). Since April 2024, there have been zero incidents of load shedding, announced or unannounced. Further investments in renewables and Eskom, South Africa’s public electric utility, capacity are needed, along with an expansion of its power grid.

The SARB Gets Control of Inflation

The South African Reserve Bank (SARB) appears to have gotten a handle on inflation and inflation expectations. Both headline and core inflation are now below the mid-point of the central bank’s inflation-targeting range (see Exhibit 8). Lower food and energy prices have helped dampen inflation. SARB has now begun a policy of gradually lowering interest rates. A lower cost of borrowing would be a relief to consumers and the spark needed to ignite growth. Maybe that, along with economic reforms, will trigger capital spending.

Conclusions

The election has brought South Africa to a fork in the road. Several thoughts are worth mentioning in closing. Some positive. Some negative. Some uncertain.

• The election outcome is a positive development. Improving asset prices and surging confidence are testimony to the view that a coalition government can produce necessary reforms, and that change could spark business investment and attract more foreign direct investment (FDI).
• The ANC-led government has fostered dramatic changes in the energy sector that could help longer-term economic growth. Eskom’s inability to provide reliable electricity had short-circuited economic growth. Now, load shedding appears to be past, but much more investment in electricity generation, like improving the grid and fostering a transition away from coal, are needed. The government has already provided the electric utility with debt relief.
• Eskom is only one part of the infrastructure that needs to be addressed as logistic constraints bedevil the economy. Roads are in poor condition, and cargo can be subjected to theft. Transnet, the state transportation company, has been beset by rising debt, underinvestment, poor management, and power issues. The government has provided the company with a ZAR47 billion facility to address its debt issues. However, state-owned enterprises (SOEs), like Transnet and Eskom, remain drags on government resources.
• Competing demands for government support will challenge the fiscus. The government’s medium-term Budget Policy Statement was both conservative and constructive. The deficit is projected to increase this year but resumes a gradual descent over the next several years. Debt as a percent of GDP will stabilize and start to decline, benefiting from a primary budget surplus. However, debt remains a concern, especially for credit rating agencies. Debt service claims a sizeable portion of government revenues. SOEs, as outlined above, will likely need more cash. At the same time, the government is negotiating with government employees over pay. Clearly, there are financial challenges.
• South Africa must address the structural inequality and poverty that plague the country. Education and skills must be improved. Such factors tax economic growth. The government, recognizing this problem, made education and skills a central plank of the National Development Plan: Vision 2030. The government, though, faces a laundry list of needs, not the least of which is a focus on crime reduction and prevention.

The election could be the missing catalyst to drive sweeping change and move South Africa along the economic path. Coalition governments will face challenges that may hamper progress, and may sometimes even break apart over competing demands. But when you come to the fork in the road, you need to take it.

Index Definitions

The FTSE Johannesburg Stock Exchange (JSE) All Share Index is the main index of the local share market in South Africa. It consists of companies that represent roughly the largest 99% of the companies listed on the main board of the JSE by market capitalization and is the largest index in terms of size and overall value. ​

The FNB/BER Consumer Confidence Index (CCI) queries adults living in predominantly urban areas in South Africa and compiles their responses to three questions on the expected performance of the economy, the expected financial position of households, and the rating of the appropriateness of the present time to buy durable goods, such as furniture, appliances, and electronic equipment. Consumer confidence, expressed as a net balance, is calculated as the percentage of respondents expecting an improvement/good time to buy durable goods less the percentage expecting a deterioration/bad time to buy durable goods.

The FNB/BER Building Confidence Index reveals the percentage of respondents that are satisfied with prevailing business conditions in six sectors, namely architects, quantity surveyors, main contractors, sub-contractors (plumbers, electricians, carpenters and shop fitters), manufacturers of building materials (cement, bricks and glass) and retailers of building material and hardware. This means that the index covers the entire building construction pipeline: from planning (represented by the architects and quantity surveyors), renovations, additions, owner builders, the informal sector (represented by building material and hardware retailers) and production (manufacturers of building materials) to the actual erection of buildings by main contractors and sub-contractors.

The Absa Manufacturing Survey is a quarterly report on the results and implications of the latest BER survey of manufacturing firms. Released in advance of official indicators of activity, it provides reliable and up-to-date information on the outlook for the sector. Apart from business confidence, the survey data highlights current and expected trends in business conditions, domestic as well as export sales volumes, production volumes, the number of factory workers, input costs and selling prices, fixed investment, and stock levels. The survey covers the various important manufacturing subsectors as well as the main provinces (Western Cape, KwaZulu-Natal and Gauteng).

The Verisk Maplecroft Corruption Index assesses risk by modelling the strength of anti-corruption legislation, the efficacy and independence of anti-corruption bodies, transparency of public finances, and the prevalence of corruption from a business perspective.

The Consumer Price Index (CPI) is used to measure the change in the out-of-pocket expenditures of households for a particular set of goods and services. In terms of its coverage, the CPI measures the cost of spending made directly by households for the items in its basket, with the notable exception that it also includes a measure of the rents that homeowners implicitly pay instead of renting their home.