Skip to content Skip to sidebar Skip to footer

South Africa: economic insights

Article provided by Coface

Non-energy commodity prices have started to drop

Metals prices have dropped considerably: Financial market participants’ readjustment to the real economy, following a period of ‘panic’ and a high level of uncertainty, notably after Russia’s invasion of Ukraine in February.

The combined effects of smoother value chain operations and lackluster global GDP growth prospects are exerting downward pressure on metals prices. The ongoing relative easing of value chain disruptions is because most countries worldwide have not implemented tough restrictions while facing a new COVID-19 wave linked to the Omicron variant BA.5. Simultaneously, global demand for metals is decreasing, especially regarding copper and steel, driven by the sluggish economic outlook in China.

Agro-commodity prices remain at somewhat high levels, but the prospect of the reopening of the Black Sea corridor, fears of a global recession, and record crops in Russia have pushed prices down (Chicago SRW at USD 8/bushel vs. 10-12 USD/bushel in recent months, since the beginning of the war). The price of corn has also dropped by around 30% compared with the April high.

Despite the slowdown in Chinese demand, the price of a barrel of oil has never fallen below USD 94 since the beginning of the war, so great have been the fears about a potential supply shortage on the market. These fears have been fanned by the confirmation, after weeks of negotiations, of an embargo by the European Union on Russian oil transported by sea.

Nevertheless, prices of all commodities still remain very volatile, and trends on commodities markets may shift brutally in this uncertain environment depending on the evolution of the war, US-China relations, etc.

Risk/reward in favour of the greenback

Since March, the Fed has raised its policy rate by 225 basis points (bps), including a 75 bps increase on June 15, the largest in almost three decades, followed by another 75 bps hike in the July Policy meeting, bringing the Fed Funds rate at 2.25-2.50%, confirming the fastest pace of tightening since the mid-1990s. Jerome Powell also said the central bank would be looking for a moderately restrictive level by the end of the year, meaning a 3% to 3.5% level for the FFR.

The current environment has two effects:

  1. The uncertain environment is encouraging risk-averse investors to return to safe assets in the U.S.
  2. Monetary tightening and rising interest rates are also encouraging investors to move their capital back to the U.S.

This overall has led to a strong appreciation of the USD against most other currencies.

Inflation set to remain high

As with any Fed tightening, emerging markets are likely to experience capital outflows, putting pressure on their currencies. In order to protect their currencies, emerging market central banks may have to adjust their monetary policy accordingly by raising interest rates, which will slow growth. For commodity-exporting countries with currently strong terms of trade, there is a little more room for monetary policy to continue to support the economy, as the currency is more likely to remain stronger

Inflation breached the upper threshold of the SARB’s target range in May, and increased further to 7,4% YoY in June. Core inflation increased as well, reflecting the pass-through of input prices increases on to the consumers. While some economists think that the inflation rate has peaked, it might continue to increase, as

a) producers will continue to adjust their prices;

b) the rand has started to depreciate vs. USD, and

c) that energy inflation remains very high in South Africa, and that oil prices are set to remain high in 2022, which maintain inflationary pressures.

Currently, headline inflation is expected to average 6,5% for 2022.

Monetary policy tightening to continue

Given current inflation dynamics, the SARB raised the policy rate by 75 bps in July, above market expectations of 50 bps. To date, rates have gone up by 150 bps, taking the repurchase rate (repo) to 5.5%, which is still well below its 6.25% pre-crisis level. The risk to the inflation outlook remains tilted to the upside, which will pressure the SARB to stay on the hiking path, with a rate probably at 6.25 or 6.5% by end-2022.

While the rand had shown strength since the post-pandemic rebound thanks to the high demand for South African commodities, it has now started to depreciate due to the very aggressive monetary policy in the U.S., policy normalisation in other important markets, as well as a weaker trade momentum, affected in Q2 by the floods that hit Durban, as well as deteriorating prospects on key export markets (especially Europe and China).

In order to lower imported inflation due to a weaker rand, the SARB has little choice but to adjust interest rates, especially since it expects the current account surplus to shrink significantly in 2023, and return to a deficit by 2024.

Furthermore, the central bank wants to stabilize inflation expectations towards the mid-point of the target range and to try hitting the inflation target in 2024.

Pessimism on the outlook

High levels of inflation, tighter monetary policy, and unreliable electricity provision will weigh on growth prospects over the medium term. However, positive investor sentiment could materialize if existing fiscal plans are implemented, and additional tax revenue is directed to fixing core structural issues—like electricity supply, as evidenced by the focus of Cyril Ramaphosa on handling the electricity issues faced by the country.

Nonetheless, progress on this front will take time to materialize, meaning that the manufacturing and mining industries will remain under pressure in the short to medium term, limiting South Africa’s growth outlook.

This is evidenced by the drop in business confidence in the manufacturing sector, while confidence in the construction sector is affected by the high-interest rate environment.

On the demand side, consumer confidence is very low as well, as households are now facing a high inflation environment with less disposable income.

SMME concentrated mostly in vulnerable industries

Insolvencies are likely to increase

In terms of corporate insolvencies, 2021 data (available up to August) suggest that insolvencies might slightly increase in 2021 compared with 2020, but will remain significantly below 2019 levels. However, for 2022, we have seen that insolvencies have started to pick up. Considering the current environment of high input costs and tighter financing conditions, companies’ cash flow is much more at risk, and insolvencies should increase in South Africa in 2022.

In South Africa, SMEs already lack access to financing. Considering the current context of high-interest rates, this access will be even more challenging.

Given that SMEs in South Africa are concentrated in sectors that have been in constant difficulty since the onset of the COVID-19 crisis, we might see a sharp rise in insolvencies for SMEs particularly due to the deterioration of their cash flow while faced with higher borrowing costs and input price pressures (and more particularly that of energy).

Coface is a proud Partner of the NSBC

Get the best business tips delivered to your inbox!

© NSBC Africa 2023. All Rights Reserved.