Opportunity beckons for South Africa’s revival – but don’t bet on it

With a low gross fixed investment ratio of just 14% of GDP, a big acceleration of capex is needed to lift South Africa’s growth prospects materially.

Unfortunately, actual public investment spending consistently lags the government’s ambitious plans, notes Absa CIB senior economist, Peter Worthington.

He said there are some encouraging portents of private fixed investment, including big commitments at the South Africa Investment Conferences and a sizeable pipeline of private renewable energy projects.

“In general, however, business capex depends fundamentally on business sentiment, which still remains quite depressed. A lot more structural and microeconomic reform to rehabilitate supporting infrastructure and improve the operating environment for businesses is needed to secure a big investment boom, in our view,” said the economist.

South Africa with quite a low investment rate by international standards. At about 14% of GDP, South Africa’s gross capex is below the rate of depreciation of the capital stock. This implies that investment spending in South Africa is currently mostly directed at maintenance rather than expansion of productive capacity.

One cause of the overall investment slump is the sharp fall in public spending on infrastructure. Historical data shows that total public spending on infrastructure fell an average 5.8% per annum from FY14/15 to FY20/21, almost halving its share of GDP from 6.2% in FY14/15 to 3.3% in FY20/21, noted Absa.

Unfortunately, weak sentiment continues to depress firms’ investment spending, it said.

Businesses’ investment plans are affected by many variables, including the strength of demand, the cost of credit, corporate tax competitiveness, the availability – or lack of – key enabling services such as electricity and water, safety and security issues, and, of course, general sentiment about the economy.

Despite this weak sentiment, Worthington said that anecdotal evidence, though far from comprehensive, seems to point to some pick-up in private investment spending. In particular, South Africa has secured R1.1 trillion in investment pledges since the first South Africa Investment Conference (SAIC) in 2018.

“Of course, the actual investment flows inevitably lag the pledges. In an update as of Q4 21, the government said that about 41% of the R773 billion pledged in the first three SAICs had flowed, while R44 billion of the commitments were delayed or on hold. Assuming that the projects put on hold will never materialise but taking account of the R332 billion pledged in the 2022 SAIC, still leaves about R745 billion in investment promises on the table,” said the economist.

Private investment is likely to be concentrated on renewable energy projects. The Minerals Council recently advised that its members had some R100 billion of renewable energy distributed generation projects in the pipeline (29 companies with 89 projects amounting to 6,500MW of power), and other big industries may have another R20 billion or so in similar projects, Absa noted.

“If we roughly assume that they commence from 2023 in three equal annual batches, and that each project takes two years to complete, it implies about R20 billion in fixed investment spending in 2023, and R40 billion per annum over 2024-2025 – which equates to almost 5% of total GDFI in 2021.

There are also some encouraging signals in the breakdown of capex by asset type, with investment in machinery and equipment proving surprisingly robust, Absa pointed out.

However, it said that despite these encouraging signs, South Africa remains far off the National Development Plan goal of a fixed investment ratio of 30% of GDP.

In its last macroeconomic forecast at the end of July, Absa predicted that, after a post-Covid-19 bounce in 2022, real fixed investment spending would rise 2.6% in 2023, 3.6% in 2024, and 4.6% in 2025. “It is hard to know if the outlook has deteriorated or improved since then,” said Worthington.

There are some encouraging signs, but they are not conclusive, he said, highlighting the recent scrapping of the arbitrary 100MW limit on private electricity projects. This should boost private investment in energy infrastructure.

On the other hand, however, the domestic growth outlook has deteriorated further, interest rates have risen sharply, and the rand has weakened significantly, thereby lifting the cost of imported capital equipment. “On balance, we believe these developments will leave businesses outside the renewable energy sector cautiously defensive,” said Worthington.

The economist said that South Africa will need to substantially address all the current infrastructural constraints of energy, ports, rail and water to cash in on any private investment boom. It will also need to solve the problems of ineffective governance, particularly at the level of municipalities, and the ongoing deterioration in safety and security.

“And because government’s record on delivery of its reform promises is poor, we believe that business will largely wait until they see clear light at the end of the tunnel – i.e. until they are confident that a better operating environment is imminent – before committing substantial capital for expansion.

“However, we believe that the government’s progress on all these reform fronts is likely to be patchy and slow,” said Worthington.

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